Santander Holdings USA, Inc. - Quarter Report: 2007 March (Form 10-Q)

e10vq

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


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

for the quarter ended March 31, 2007


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

for the transition period from to .

Commission File Number: 001-16581

SOVEREIGN BANCORP, INC.

(Exact name of Registrant as specified in its charter)


Pennsylvania		23-2453088

(State or other jurisdiction of		(I.R.S. Employer
incorporation or organization)		Identification No.)


1500 Market Street, Philadelphia, Pennsylvania		19102
(Address of principal executive offices)		(Zip Code)

Registrant’s telephone number: (215) 557-4630

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 whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act):

Large accelerated filer þ Accelerated filer o Non-accelerated filer o

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class		Outstanding at April 30, 2007

Common Stock (no par value)		476,932,400 shares

FORWARD LOOKING STATEMENTS

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to shareholders (including its 2006 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the disclosure communications by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

These forward-looking statements include statements with respect to Sovereign’s vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of Sovereign, including statements relating to:

	•		growth in net income, shareholder value and internal tangible equity generation;

	•		growth in earnings per share;

	•		return on equity;

	•		return on assets;

	•		efficiency ratio;

	•		Tier 1 leverage ratio;

	•		annualized net charge-offs and other asset quality measures;

	•		fee income as a percentage of total revenue;

	•		ratio of tangible equity to assets or other capital adequacy measures;

	•		book value and tangible book value per share; and

	•		loan and deposit portfolio compositions, employee retention, deposit retention, asset quality and reserve adequacy.

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

	•		the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations;

	•		the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

	•		inflation, interest rate, market and monetary fluctuations;

	•		adverse changes may occur in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;

	•		Sovereign’s ability to successfully integrate any assets, liabilities, customers, systems and management personnel Sovereign acquires into its operations and its ability to realize related revenue synergies and cost savings within expected time frames;

FORWARD LOOKING STATEMENTS
(continued)

	•		the possibility that expected merger-related charges are materially greater than forecasted or that final purchase price allocations based on fair value of the acquired assets and liabilities at acquisition date and related adjustments to yield and/or amortization of the acquired assets and liabilities are materially different from those forecasted;

	•		deposit attrition, customer loss, revenue loss and business disruption following Sovereign’s acquisitions, including adverse effects on relationships with employees may be greater than expected;

	•		the implementation of cost savings initiatives may take longer to implement, or may cost more to implement than anticipated;

	•		the implementation of cost savings initiatives may have unintended impacts on our ability to attract and retain businesses and customers;

	•		revenue enhancement ideas may not be successful in the marketplace or may result in unintended costs;

	•		assumed attrition required to achieve workforce reductions may not come in the right place or at the right times to meet planned goals;

	•		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, policies and practices concerning taxes, banking, capital, liquidity, proper accounting treatment, securities and insurance, and the application thereof by regulatory bodies and the impact of changes in and interpretation of generally accepted accounting principles;

	•		technological changes;

	•		competitors of Sovereign may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than Sovereign;

	•		changes in consumer spending and savings habits;

	•		acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters;

	•		regulatory or judicial proceedings;

	•		changes in asset quality;

	•		if Sovereign acquires companies with weak internal controls, it will take time to get the acquired companies up to the same level of operating effectiveness as Sovereign’s internal control structure. Sovereign’s inability to address these risks could negatively affect Sovereign’s operating results; and

	•		Sovereign’s success in managing the risks involved in the foregoing.

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

contained in any forward looking statement. Any forward looking statements only speak as of the date of this document.

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

INDEX


	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2007 and December 31, 2006		5
Consolidated Statements of Operations for the three-month periods ended March 31, 2007 and 2006		6-7
Consolidated Statement of Stockholders’ Equity for the three-month period ended March 31, 2007		8
Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2007 and 2006		9-10
Notes to Consolidated Financial Statements		11-30
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		31-53
Item 3. Quantitative and Qualitative Disclosures About Market Risk		54
Item 4. Controls and Procedures		54
PART II. OTHER INFORMATION
1. Legal Proceedings		55
1A. Risk Factors		55
Item 5. Other information		55
Item 6. Exhibits		56
SIGNATURES		57
EXHIBITS INDEX		58
Ex-31.1 Certification
Ex-31.2 Certification
Ex-32.1 Certification
Ex-32.2 Certification
Amended and Restated Articles of Incorporation
Bylaws of Sovereign Bancorp, Inc.
Certification pursuant to Rule 13a-14(a)
Certification pursuant to Rule 13a-14(a)
Certification pursuant to 18 U.S.C. Section 1350
Certification pursuant to 18 U.S.C. Section 1350

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	March 31,			December 31,
	2007			2006
	(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	1,669,623		$	1,804,117
Investment securities:
Available-for-sale		13,640,209			13,874,628
Other investments		703,738			1,003,012
Loans held for investment		55,722,849			54,976,675
Allowance for loan losses		(487,286	)		(471,030	)


Net loans		55,235,563			54,505,645


Loans held for sale		402,648			7,611,921
Premises and equipment		588,695			605,707
Accrued interest receivable		363,013			422,901
Goodwill		5,006,290			5,005,185
Core deposit intangibles and other intangibles, net of accumulated amortization of $662,471 and $629,218 at March 31, 2007 and December 31, 2006, respectively		465,421			498,420
Bank owned life insurance		1,745,145			1,725,222
Other assets		2,373,220			2,585,091


TOTAL ASSETS	$	82,193,565		$	89,641,849


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	52,562,957		$	52,384,554
Borrowings and other debt obligations		19,162,252			26,849,717
Advance payments by borrowers for taxes and insurance		119,478			98,041
Other liabilities		1,497,096			1,508,753


TOTAL LIABILITIES		73,341,783			80,841,065


Minority interests		156,896			156,385


STOCKHOLDERS’ EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 8,000 shares issued and outstanding at March 31, 2007 and December 31, 2006		195,445			195,445
Common stock; no par value; 800,000,000 shares authorized; 479,861,728 shares issued at March 31, 2007 and 479,228,330 shares issued at December 31, 2006		6,186,470			6,183,281
Warrants and employee stock options issued		344,979			343,391
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 2,760,133 shares at March 31, 2007 and December 31, 2006		(19,019	)		(19,019	)
Treasury stock at cost; 1,443,928 shares at March 31, 2007 and 2,713,086 shares at December 31, 2006		(22,257	)		(49,028	)
Accumulated other comprehensive loss		(13,177	)		(24,746	)
Retained earnings		2,022,445			2,015,075


TOTAL STOCKHOLDERS’ EQUITY		8,694,886			8,644,399


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	82,193,565		$	89,641,849

See accompanying notes to consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three-Month Period
	Ended March 31,
	2007			2006
	(in thousands, except, per share data)
INTEREST INCOME:
Interest-earning deposits	$	6,236		$	2,116
Investment securities:
Available-for-sale		189,835			90,095
Held-to-maturity		—			53,553
Other investments		14,301			5,603
Interest on loans		1,016,967			688,166

TOTAL INTEREST INCOME		1,227,339			839,533

INTEREST EXPENSE:
Deposits and customer accounts		413,251			231,837
Borrowings and other debt obligations		326,235			203,738

TOTAL INTEREST EXPENSE		739,486			435,575

NET INTEREST INCOME		487,853			403,958
Provision for credit losses		46,000			29,000

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		441,853			374,958

NON-INTEREST INCOME:
Consumer banking fees		68,014			60,798
Commercial banking fees		49,408			39,016
Mortgage banking (loss) / income		(107,205	)		12,992
Capital markets revenue		5,689			3,889
Bank owned life insurance		20,509			11,327
Miscellaneous income		9,467			6,319

TOTAL FEES AND OTHER INCOME		45,882			134,341
Net gain on investment securities		970			—

TOTAL NON-INTEREST INCOME		46,852			134,341

GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		173,796			143,778
Occupancy and equipment expenses		80,519			64,193
Technology expense		23,336			21,566
Outside services		15,278			14,755
Marketing expense		8,832			10,222
Other administrative expenses		28,235			25,465


TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		329,996			279,979

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(continued)


	Three-Month Period
	Ended March 31,
	2007			2006
	(in thousands, except, per share data)
OTHER EXPENSES:
Amortization of intangibles	$	33,253		$	17,219
Minority interest expense		5,366			5,992
Merger-related and integration charges (reversal)		2,076			(2,798	)
Equity method investments		13,049			10,042
Restructuring, other employee severance and debt repurchase charges		20,032			—
ESOP expense related to freezing of plan		43,385			—
Proxy and related professional (recoveries) / fees		(391	)		14,337


TOTAL OTHER EXPENSES		116,770			44,792


INCOME BEFORE INCOME TAXES		41,939			184,528
Income tax (benefit) / provision		(6,120	)		43,130


NET INCOME	$	48,059		$	141,398


EARNINGS PER SHARE:
Basic	$	0.09		$	0.38


Diluted	$	0.09		$	0.36


DIVIDENDS DECLARED PER COMMON SHARE	$	0.080		$	0.060

See accompanying notes to consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE THREE-MONTH PERIOD ENDED MARCH 31, 2007
(Unaudited)
(in thousands)


												Unallocated
	Common											Common						Accumulated						Total
	Shares								Warrants			Stock						Other						Stock-
	Out-			Preferred		Common			& Stock			Held by			Treasury			Comprehensive			Retained			Holders’
	Standing			Stock		Stock			Options			ESOP			Stock			Income/(Loss)			Earnings			Equity
Balance, December 31, 2006		473,755		$	195,445	$	6,183,281		$	343,391		$	(19,019	)	$	(49,028	)	$	(24,746	)	$	2,015,075		$	8,644,399

Comprehensive income:

Net income		—			—		—			—			—			—			—			48,059			48,059
Change in unrealized gain/loss, net of tax:

Investment securities available for sale		—			—		—			—			—			—			17,220			—			17,220

Pension liabilities		—			—		—			—			—			—			117			—			117

Cash flow hedge derivative financial instruments		—			—		—			—			—			—			(5,768	)		—			(5,768	)


Total comprehensive income																									59,628

Stock issued in connection with employee benefit and incentive compensation plans		1,896			—		(3,514	)		(101	)		—			33,364			—			—			29,749

Employee stock options earned		—			—		—			1,689			—			—			—			—			1,689
Dividends paid on common stock		—			—		—			—			—			—			—			(37,991	)		(37,991	)
Dividends paid on preferred stock		—			—		—			—			—			—			—			(3,650	)		(3,650	)
Cumulative transition adjustment related to the Adoption of FIN 48		—			—		—			—			—			—			—			952			952

Issuance of common stock		264			—		6,703			—			—			—			—			—			6,703

Stock repurchased		(258	)		—		—			—			—			(6,593	)		—			—			(6,593	)


Balance, March 31, 2007		475,657		$	195,445	$	6,186,470		$	344,979		$	(19,019	)	$	(22,257	)	$	(13,177	)	$	2,022,445		$	8,694,886

See accompanying notes to consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Three-Month Period
	Ended March 31,
	2007			2006
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	48,059		$	141,398
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for credit losses		46,000			29,000
Depreciation and amortization		67,241			40,397
Net amortization/accretion of investment securities and loan premiums and discounts		9,854			27,415
Net loss/(gain) on sale of loans		20,623			(9,504	)
Net (gain)/loss on investment securities		(970	)		—
Net (gain)/loss on real estate owned and premises and equipment		333			972
Stock-based compensation		7,023			7,316
Origination and purchases of loans held for sale, net of repayments		(929,634	)		(506,927	)
Proceeds from sales of loans held for sale		938,488			313,638
Net change in:
Accrued interest receivable		59,888			10,957
Other assets and bank owned life insurance		172,124			(34,948	)
Other liabilities		(13,016	)		(54,679	)

Net cash provided by/(used in) operating activities		426,013			(34,965	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Adjustments to reconcile net cash used in investing activities:
Proceeds from sales of investment securities:
Available-for-sale		74,506			17,055
Proceeds from repayments and maturities of investment securities:
Available-for-sale		3,300,628			175,903
Held-to-maturity		—			93,604
Net change in other short-term investments		(34,245	)		(103,237	)
Purchases of available-for-sale investment securities		(2,783,048	)		(9,308	)
Purchases of held-to-maturity investment securities		—			(380,662	)
Proceeds from sales of loans		7,847,497			2,267,839
Purchase of loans		(4,020	)		(2,687,847	)
Net change in loans other than purchases and sales		(1,438,948	)		(791,159	)
Proceeds from sales of premises and equipment		8,955			1,558
Purchases of premises and equipment		(14,587	)		(15,779	)
Proceeds from sales of real estate owned		3,667			1,019

Net cash (provided by)/used in investing activities		6,960,405			(1,431,014	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Adjustments to reconcile net cash provided by financing activities:
Net increase/(decrease) in deposits and other customer accounts		175,150			843,146
Net increase/(decrease) in borrowings		(7,888,686	)		494,614
Proceeds from senior notes and credit facility		400,000			—
Repayments of borrowings and other debt obligations		(200,000	)		—
Net increase/(decrease) in advance payments by borrowers for taxes and insurance		21,437			11,079
Cash dividends paid to preferred stockholders		(3,650	)		—
Cash dividends paid to common stockholders		(37,992	)		(21,575	)
Proceeds from issuance of common stock, net of transaction costs		6,868			3,766
Treasury stock repurchases, net of proceeds		5,961			460

Net cash (provided by)/used in financing activities		(7,520,912	)		1,331,490

Net change in cash and cash equivalents		(134,494	)		(134,489	)
Cash and cash equivalents at beginning of period		1,804,117			1,131,936

Cash and cash equivalents at end of period	$	1,669,623		$	997,447


	Three-Month Period
	Ended March 31,
	2007		2006
	(in thousands)
Supplemental Disclosures:
Income taxes paid	$	5,567	$	815
Interest paid	$	774,148	$	420,821

Non cash transactions: In the first quarter of 2007, Sovereign reclassified $658 million of correspondent home equity loans that were previously classified as held for sale to its loan held for investment portfolio. See Note 4 for further discussion.

See accompanying notes to consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)
(Unaudited)

(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements of Sovereign Bancorp, Inc. and Subsidiaries (“Sovereign” or the “Company”) include the accounts of the parent company, Sovereign Bancorp, Inc. and its subsidiaries, including the following wholly-owned subsidiaries: Sovereign Bank, Independence Community Bank Corp., and Sovereign Delaware Investment Corporation. All intercompany balances and transactions have been eliminated in consolidation.

These financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in conformity with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary to present fairly the consolidated balance sheet, statements of operations, stockholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. It is suggested that these consolidated financial statements be read in conjunction with the Company’s latest annual report on Form 10-K.

The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates. The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

(2) EARNINGS PER SHARE

Basic earnings per share is calculated by dividing net income by the weighted average common shares outstanding, excluding options and warrants. The dilutive effect of our options is calculated using the treasury stock method, the dilutive effect of our warrants that were issued in connection with our contingently convertible debt issuance is calculated under the if-converted method. The Company’s weighted average shares outstanding used in the computation of earnings per share for the three-month period ended March 31, 2006 were restated after giving retroactive effect to a 5% stock dividend to shareholders of record on June 15, 2006.

The following table presents the computation of earnings per share for the periods indicated (amounts in thousands, except per share):


	Three-Month Period
	Ended March 31,
	2007			2006
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income as reported and for basic EPS	$	48,059		$	141,398
Less preferred dividend		(3,650	)		—

Net income available to common stockholders		44,409			141,398
Contingently convertible trust preferred interest expense, net of tax (1)		—			6,327

Net income for diluted EPS available to common stockholders	$	44,409		$	147,725


WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares		475,115			376,877
Dilutive effect of:
Warrants (1)		—			27,417
Stock options (1)		—			6,073

Weighted average diluted shares		475,115			410,367


EARNINGS PER SHARE:
Basic	$	0.09		$	0.38
Diluted	$	0.09		$	0.36


(1)		These items were excluded from diluted earnings per share for the three-month period ended March 31, 2007 since the result would have been anti-dilutive.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES

The following table presents the composition and fair value of investment securities available-for-sale at the dates indicated (in thousands):


	March 31, 2007
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	376,696	$	68	$	83	$	376,681
Debentures of FHLB, FNMA, and FHLMC		242,289		3,707		678		245,318
Corporate debt and asset-backed securities		948,303		209		7,001		941,511
Equity securities (1)		819,878		68,535		—		888,413
State and municipal securities		2,509,463		37,930		4,428		2,542,965
Mortgage-backed securities:
U.S. government agencies		267,313		1,248		86		268,475
FHLMC and FNMA debt securities		3,989,644		16,089		4,024		4,001,709
Non-agency securities		4,401,656		17,598		44,117		4,375,137


Total investment securities available-for-sale	$	13,555,242	$	145,384	$	60,417	$	13,640,209


	December 31, 2006
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	1,561,685	$	38	$	878	$	1,560,845
Debentures of FHLB, FNMA, and FHLMC		242,248		3,001		1,149		244,100
Corporate debt and asset-backed securities		953,374		3,443		6,315		950,502
Equity securities (1)		893,627		48,491		—		942,118
State and municipal securities		2,510,975		45,325		1,494		2,554,806
Mortgage-backed securities:
U.S. government agencies		45,400		765		105		46,060
FHLMC and FNMA debt securities		3,598,731		12,088		5,185		3,605,634
Non-agency securities		4,009,789		13,139		52,365		3,970,563


Total investment securities available-for-sale	$	13,815,829	$	126,290	$	67,491	$	13,874,628

(1) Equity securities consist principally of preferred stock of FHLMC and FNMA.

Investment securities available for sale with an estimated fair value of $9.3 billion and $9.7 billion were pledged as collateral for borrowings, standby letters of credit, interest rate agreements and certain public deposits at March 31, 2007 and December 31, 2006, respectively.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES (continued)

The following table discloses the age of gross unrealized losses in Sovereign’s total investment portfolio as of March 31, 2007 and December 31, 2006 (in thousands):


	At March 31, 2007
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	18,437	$	(10	)	$	16,013	$	(73	)	$	34,450	$	(83	)
Debentures of FHLB, FNMA and FHLMC		—		—			101,660		(678	)		101,660		(678	)
Corporate debt and asset-backed securities		646,673		(5,698	)		61,795		(1,303	)		708,468		(7,001	)
State and municipal securities		622,180		(4,261	)		21,178		(167	)		643,358		(4,428	)
Mortgage-backed Securities:
U.S. government agencies		238		(6	)		2,203		(80	)		2,441		(86	)
FHLMC and FNMA debt securities		523,606		(584	)		119,695		(3,440	)		643,301		(4,024	)
Non-agency securities		542,199		(1,296	)		1,724,170		(42,821	)		2,266,369		(44,117	)


Total investment securities available-for-sale	$	2,353,333	$	(11,855	)	$	2,046,714	$	(48,562	)	$	4,400,047	$	(60,417	)


	At December 31, 2006
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	1,495,712	$	(733	)	$	15,995	$	(145	)	$	1,511,707	$	(878	)
Debentures of FHLB, FNMA and FHLMC		—		—			101,341		(1,149	)		101,341		(1,149	)
Corporate debt and asset-backed securities		446,261		(4,014	)		61,820		(2,301	)		508,081		(6,315	)
State and municipal securities		247,409		(1,312	)		21,239		(182	)		268,648		(1,494	)
Mortgage-backed Securities:
U.S. government agencies		219		(8	)		2,258		(97	)		2,477		(105	)
FHLMC and FNMA debt securities		641,851		(1,009	)		126,193		(4,176	)		768,044		(5,185	)
Non-agency securities		456,897		(1,703	)		1,962,694		(50,662	)		2,419,591		(52,365	)


Total investment securities available-for-sale	$	3,288,349	$	(8,779	)	$	2,291,540	$	(58,712	)	$	5,579,889	$	(67,491	)

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(3) INVESTMENT SECURITIES (continued)

As of March 31, 2007, management has concluded that the unrealized losses above on its investment securities (which totaled 213 individual securities) are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for the time necessary to recover its cost and will ultimately recover its cost at maturity (i.e. these investments have contractual maturities that, absent credit default, ensure Sovereign will ultimately recover its cost). In making its other than temporary impairment evaluation, Sovereign considered the fact that the principal and interest on these securities are from U.S. Government and Government Agencies as well as issuers that are investment grade (Aaa rated). The change in the unrealized losses on the U.S. Government and Government Agencies mortgage-backed securities, Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) securities and the non-agency mortgage-backed securities were caused by changes in interest rates. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the intent and ability to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired.

(4) LOANS

The following table presents the composition of the loans held for investment portfolio by type of loan and by fixed and adjustable rates at the dates indicated (dollars in thousands):


	March 31, 2007					December 31, 2006
	Amount		Percent			Amount		Percent
Commercial real estate loans	$	11,584,728		20.8	%	$	11,514,983		21.0	%
Commercial and industrial loans		12,805,152		23.0			11,561,183		21.0
Multifamily loans		4,643,689		8.3			5,621,429		10.2
Other		552,691		1.0			1,518,603		2.8


Total commercial loans held for investment		29,586,260		53.1			30,216,198		55.0


Residential mortgages		14,266,675		25.6			14,316,168		26.0
Home equity loans and lines of credit		5,932,136		10.7			5,176,346		9.4


Total consumer loans secured by real estate		20,198,811		36.3			19,492,514		35.4

Auto loans		5,526,953		9.9			4,848,204		8.8
Other		410,825		0.7			419,759		0.8


Total consumer loans held for investment		26,136,589		46.9			24,760,477		45.0


Total loans held for investment (1)	$	55,722,849		100.0	%	$	54,976,675		100.0	%


Total loans held for investment with:
Fixed rate	$	32,949,098		59.1	%	$	32,321,464		58.8	%
Variable rate		22,773,751		40.9			22,655,211		41.2


Total loans held for investment (1)	$	55,722,849		100.0	%	$	54,976,675		100.0	%


(1)		Loans held for investment total includes deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts as well as purchase accounting adjustments. These items resulted in a net increase in loans of $241.5 million and an increase of $258.4 million at March 31, 2007 and December 31, 2006, respectively. Loans pledged as collateral totaled $14.9 billion and $17.7 billion at March 31, 2007 and December 31, 2006, respectively.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(4) LOANS (continued)

The following table presents the composition of the loan held for sale portfolio by type of loan and by fixed and adjustable rates at the dates indicated (dollars in thousands):


	March 31, 2007					December 31, 2006
	Amount		Percent			Amount		Percent
Commercial	$	103,613		25.7	%	$	109,123		1.4	%
Multifamily		162,339		40.4			147,022		1.9
Residential mortgages		136,696		33.9			3,088,562		40.6
Home equity loans and lines of credit		—		—			4,267,214		56.1

Total loans held for sale	$	402,648		100.0	%	$	7,611,921		100.0	%


Total loans held for sale with:
Fixed rate	$	299,035		74.3	%	$	7,395,494		97.2	%
Variable rate		103,613		25.7			216,427		2.8


Total loans held for sale	$	402,648		100.0	%	$	7,611,921		100.0	%

At the end of the first quarter, Sovereign transferred back into its loan portfolio $658 million of correspondent home equity loans that had been previously classified as held for sale. Due to illiquid market conditions for non prime loans, the Company decided not to sell these loans and to hold them for investment. Before transferring these loans back into the held for investment loan portfolio, Sovereign marked this portfolio to market as of March 31, 2007 utilizing a discounted cash flow model. The discounted cash flow model takes into account expected prepayment factors and the degree of credit risk associated with the loans and the estimated effects of changes in market interest rates relative to the loans’ interest rates. As a result, Sovereign wrote down this loan portfolio by $84.2 million via a reduction to mortgage banking revenues during the three-month period ended March 31, 2007.

(5) DEPOSIT PORTFOLIO COMPOSITION

The following table presents the composition of deposits and other customer accounts at the dates indicated (dollars in thousands):


	March 31, 2007								December 31, 2006
						Weighted								Weighted
						Average								Average
Account Type	Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	6,420,046		12	%		—	%	$	6,577,585		12	%		—	%
NOW accounts		6,159,701		12			1.11			6,333,667		12			1.24
Wholesale NOW		5,856,899		11			5.08			4,293,055		8			4.96
Customer repurchase agreements		1,462,288		3			4.35			1,487,251		3			4.67
Savings accounts		4,558,367		9			0.65			4,637,346		9			0.65
Money market accounts		9,452,904		18			3.38			8,875,353		17			3.17
Wholesale money market accounts		3,090,988		6			5.51			4,116,417		8			5.51
Certificates of deposit		11,146,958		21			4.53			11,338,935		22			4.45
Wholesale certificates of deposit		4,414,806		8			5.29			4,724,945		9			5.14


Total deposits	$	52,562,957		100	%		3.21	%	$	52,384,554		100	%		3.14	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(6) BORROWINGS AND OTHER DEBT OBLIGATIONS

The following table presents information regarding borrowings and other debt obligations at the dates indicated:

March 31, 2007

December 31, 2006

Effective

Balance

Rate

Balance

Rate

Sovereign Bank borrowings and other debt obligations:

Securities sold under repurchase agreements

200,499

3.85

199,671

3.85

Fed funds purchased

200,000

5.31

1,700,000

5.22

FHLB advances

13,175,179

4.79

19,563,985

4.81

Asset-backed floating rate notes and secured financings

1,971,000

3.55

1,971,000

3.58

Subordinated notes

1,141,816

4.67

1,139,511

4.68

Holding company borrowings and other debt obligations:

Senior notes

1,040,419

5.25

740,334

5.13

Junior subordinated debentures due to Capital Trust Entities

1,433,339

7.55

1,535,216

7.65

Total borrowings and other debt obligations

19,162,252

4.88

26,849,717

4.90

As more fully discussed in our 2006 Form 10-K, Sovereign restructured its balance sheet in order to improve its capital position. In the first quarter Sovereign sold $8.0 billion of low margin and/or higher credit risk assets and utilized the proceeds to reduce higher cost borrowing obligations.

Sovereign currently has a series of callable advances totaling $2.6 billion with the FHLB. These advances provide variable funding (currently at 3.59%) during the non-call period which ranges from 6 to 18 months. After the non-call period, the interest rates on these advances resets to a fixed rate of interest with certain caps (ranging from 4.95% to 5.50%) and floors of 0%. Based on the current interest rate environment, these instruments may be called by the FHLB upon the expiration of the non-call period.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(6) BORROWINGS AND OTHER DEBT OBLIGATIONS (continued)

On March 23, 2007, Sovereign issued $300 million of 3 year, floating rate Senior notes. The floating rate notes bear interest at a rate of 3 month LIBOR plus 23 basis points (adjusted quarterly) and mature on March 23, 2010. The notes are not redeemable at Sovereign’s option nor are they repayable prior to maturity at the option of the holders. The proceeds of the offering were used for general corporate purposes.

On January 30, 2007, Sovereign redeemed $100 million of 8.75% Trust Preferred III Securities which were due on December 31, 2031. In connection with the redemption, Sovereign recorded a $465 thousand debt extinguishment charge. Sovereign redeemed this liability as alternative lower cost sources of funding were available.

In the first quarter of 2007, Sovereign renegotiated its $400 million, 364-day revolving line of credit at the holding company with the Bank of Scotland. This line of credit has now been separated into two $200 million lines with maturity dates of August 28, 2007 and February 27, 2008 at libor plus 60 basis points.

(7) DERIVATIVES

One of Sovereign’s primary market risks is interest rate risk. Management uses derivative instruments to mitigate the impact of interest rate movements on the value of certain liabilities, assets and on probable forecasted cash flows. These instruments primarily include interest rate swaps that have underlying interest rates based on key benchmark indices and forward sale or purchase commitments. The nature and volume of the derivative instruments used to manage interest rate risk depend on the level and type of assets and liabilities on the balance sheet and the risk management strategies for the current and anticipated interest rate environment.

Fair Value Hedges. Sovereign has entered into pay-variable, receive-fixed interest rate swaps to hedge changes in fair values of certain brokered certificates of deposits and certain debt obligations. For the quarters ended March 31, 2007 and 2006, hedge ineffectiveness income / (loss) of $(0.6) million and $0.6 million, respectively, was recorded in earnings associated with fair value hedges.

Cash Flow Hedges. Sovereign hedges exposures to changes in cash flows associated with forecasted interest payments on variable-rate liabilities, through the use of pay-fixed, receive variable interest rate swaps. For the three months ended March 31, 2007 and 2006, no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. During the first quarter of 2007, Sovereign terminated $3.2 billion of pay-fixed interest rate swaps that were hedging the future cash flows on $3.2 billion of borrowings, resulting in a net after-tax gain of $1.6 million. The gain will continue to be deferred in accumulated other comprehensive income (AOCI) and will be reclassified into interest expense as the future cash flows occur, unless it becomes probable that the forecasted interest payments originally hedged will not occur, in which case the losses in AOCI will be recognized immediately. No gains or losses deferred in accumulated other comprehensive income were reclassified into earnings during the three months ended March 31, 2007 or 2006 as a result of discontinuance of cash flow hedges for which the forecasted transaction was not probable of occurring. As of March 31, 2007, Sovereign expects approximately $12.8 million of the deferred net after-tax loss on derivative instruments included in accumulated other comprehensive income to be reclassified to earnings during the next twelve months.

Other Derivative Activities. Sovereign’s derivative portfolio also includes derivative instruments not designated in SFAS No. 133 hedge relationships.

Those derivatives include mortgage banking interest rate lock commitments and forward sale commitments used for risk management purposes and derivatives executed with commercial banking customers, primarily interest rate swaps and foreign currency contracts. The Company also enters into precious metals customer forward arrangements and forward sale agreements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(7) DERIVATIVES (continued)

Shown below is a summary of the derivatives designated as hedges under SFAS No. 133 at March 31, 2007 and December 31, 2006 (dollars in thousands):


	Notional						Receive			Pay			Life
	Amount		Asset		Liability		Rate			Rate			(Years)
March 31, 2007
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	1,284,000	$	—	$	17,095		4.21	%		5.24	%		1.6
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		4,900,000		7,669		49,473		5.35	%		5.15	%		2.8


Total derivatives used in SFAS 133 hedging relationships	$	6,184,000	$	7,669	$	66,568		5.12	%		5.17	%		2.5


December 31, 2006
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	1,344,000	$	—	$	22,806		4.16	%		5.25	%		1.8
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		8,500,000		19,174		45,842		5.37	%		5.09	%		2.4


Total derivatives used in SFAS 133 hedging relationships	$	9,844,000	$	19,174	$	68,648		5.20	%		5.11	%		2.3

Summary information regarding other derivative activities at March 31, 2007 and December 31, 2006 follows (in thousands):


	March 31,			December 31,
	2007			2006
	Net Asset			Net Asset
	(Liability)			(Liability)
Mortgage banking derivatives:
Forward commitments to sell loans	$	(2,879	)	$	304
Interest rate lock commitments		345			(11	)


Total mortgage banking risk management		(2,534	)		293

Swaps receive fixed		17,071			2,380
Swaps pay fixed		13,504			26,431
Market value hedge		1,353			1,490


Net customer related interest rate hedges		31,928			30,301

Precious metals forward sale agreements		(12,916	)		(11,763	)
Precious metals forward arrangements		12,997			12,039
Foreign exchange		864			(89	)


Total activity	$	30,339		$	30,781

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(7) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of and for the three months ended March 31, 2007:


	Balance Sheet Effect at	Income Statement Effect For The Three Months Ended
Derivative Activity	March 31, 2007	March 31, 2007
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to CDs of $17.1 million and an increase to other liabilities of $17.1 million.	Resulted in a decrease of net interest income of $3.5 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other assets and other liabilities of $7.7 million and $49.5 million, respectively, and decrease to deferred taxes and stockholders’ equity of $15.2 million and $26.7 million, respectively.	Resulted in an increase in net interest income of $4.5 million.

Other hedges:
Forward commitments to sell loans	Increase to other liabilities of $2.9 million.	Decrease to mortgage banking revenues of $6.5 million.

Interest rate lock commitments	Increase to mortgage loans of $0.3 million.	Increase to mortgage banking revenues of $0.4 million.

Net customer related hedges	Increase to other assets of $31.9 million.	Decrease in capital markets revenue of $4.3 million.

Forward commitments to sell precious metals inventory, net	Increase to other assets of $81 thousand.	Decrease to commercial banking fees of $0.2 million.

Foreign exchange	Increase to other assets of $0.9 million.	Increase to commercial banking revenues of $1.0 million.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(7) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of December 31, 2006 and for the three months ended March 31, 2006:


	Balance Sheet Effect at	Income Statement Effect For The Three-Months Ended
Derivative Activity	December 31, 2006	March 31, 2006
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to CDs of $22.8 million and an increase to other liabilities of $22.8 million.	Resulted in a decrease of net interest income of $4.7 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other assets and other liabilities of $19.2 million and $45.8 million, respectively, and a decrease to deferred taxes and stockholders’ equity of $9.3 million and $17.3 million, respectively.	Resulted in a decrease in net interest income of $0.9 million.

Other hedges:
Forward commitments to sell loans	Increase to other assets of $0.3 million.	Increase to mortgage banking revenues of $2.0 million.

Interest rate lock commitments	Decrease to mortgage loans of $11 thousand.	Increase to mortgage banking revenues of $0.5 million.

Net customer related swaps	Increase to other assets of $30.3 million.	Increase in capital markets revenue of $0.8 million.

Forward commitments and forward settlement arrangements on precious metals	Increase to other assets of $0.3 million.	Decrease to commercial banking fees of $3.6 million.

Foreign exchange	Increase to other liabilities of $90 thousand.	Increase to commercial banking revenues of $0.1 million.

Net interest income resulting from interest rate exchange agreements included $108.4 million of income and $112.1 million of expense for the three-month period ended March 31, 2007 compared with $52.6 million of income and $58.1 million of expense for the corresponding period in the prior year.

Net gains generated from derivative instruments (including trading revenues) executed with customers are included as capital markets revenue on the income statement and totaled $3.2 million for the three months ended March 31, 2007, compared with $2.5 million for the three months ended March 31, 2006.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(8) COMPREHENSIVE INCOME

The following table presents the components of comprehensive income, net of related tax, for the periods indicated (in thousands):


	Three-Month Period
	Ended March 31,
	2007			2006
Net income	$	48,059		$	141,398
Change in accumulated losses on cash flow hedge derivative financial instruments, net of tax		(8,715	)		15,575
Change in unrealized gains/(losses) on investment securities available-for-sale, net of tax		17,838			(59,587	)
Less reclassification adjustment, net of tax:
Derivative instruments		(2,947	)		(3,050	)
Pensions		(117	)		—
Investments available-for-sale		618			—


Comprehensive income	$	59,628		$	100,436

Accumulated other comprehensive income, net of related tax, consisted of net unrealized gains on securities of $55.5 million, net accumulated losses on unfunded pension liabilities of $6.0 million and net accumulated losses on derivatives of $62.7 million at March 31, 2007 and net unrealized gains on securities of $38.3 million, net accumulated losses on unfunded pension liabilities of $6.1 million and net accumulated losses on derivatives of $56.9 million at December 31, 2006.

(9) MORTGAGE SERVICING RIGHTS

Sovereign adopted SFAS No. 156, “Accounting for Servicing of Financial Assets” and elected to continue to account for mortgage servicing rights as required under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” and for purposes of determining impairment, the mortgage servicing rights are stratified by certain risk characteristics and underlying loan strata that include, but are not limited to, interest rate bands, and further into residential real estate 30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans and balloon loans. A valuation reserve is recorded in the period in which the impairment occurs through a charge to income equal to the amount by which the carrying value of the strata exceeds the fair value. If it is later determined that all or a portion of the temporary impairment no longer exists for a particular strata, the valuation allowance is reduced with an offsetting credit to income.

Mortgage servicing rights are also reviewed for permanent impairment. Permanent impairment exists when the recoverability of a recorded valuation allowance is determined to be remote taking into consideration historical and projected interest rates and loan pay-off activity. When this situation occurs, the unrecoverable portion of the valuation reserve is applied as a direct write-down to the carrying value of the mortgage servicing right. Unlike a valuation allowance, a direct write-down permanently reduces the carrying value of the mortgage servicing asset and the valuation allowance, precluding subsequent recoveries.

At March 31, 2007 and December 31, 2006, Sovereign serviced residential real estate loans for the benefit of others totaling $9.6 billion and $9.2 billion, respectively. The fair value of the servicing portfolio at March 31, 2007 and December 31, 2006 was $129.0 million and $123.1 million, respectively. The following table presents a summary of the activity of the asset established for Sovereign’s mortgage servicing rights (in thousands).


Gross balance as of December 31, 2006	$	118,638
Mortgage servicing assets recognized		15,047
Amortization		(9,482	)
Write-off of servicing assets		(72	)

Gross balance at March 31, 2007		124,131
Valuation allowance		(1,150	)

Balance as March 31, 2007	$	122,981

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(9) MORTGAGE SERVICING RIGHTS (continued)

The fair value of our mortgage servicing rights is estimated using a discounted cash flow model. This model estimates the present value of the future net cash flows of the servicing portfolio based on various assumptions. 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 result in lower valuations of mortgage servicing rights. 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. 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 annually and is used by management to evaluate the reasonableness of the discounted cash flow model.

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


	March 31, 2007			December 31, 2006			March 31, 2006
CPR speed		14.81	%		14.23	%		11.75	%
Escrow credit spread		4.96	%		4.85	%		4.37	%

A valuation allowance is established for the excess of the cost of each mortgage servicing asset stratum over its estimated fair value. Activity in the valuation allowance for mortgage servicing rights for the three months ended March 31, 2007 consisted of the following (in thousands):


Balance as of December 31, 2006	$	1,222
Write-offs of reserves		(72	)

Balance as March 31, 2007	$	1,150

For the three-month period ended March 31, 2007 and 2006, mortgage servicing fee income was $9.2 million and $5.6 million, respectively. Sovereign has (losses)/gains on the sale of mortgage loans, multifamily loans and home equity loans of $(107.1) million and $9.8 million for the three-month period ended March 31, 2007 and 2006, respectively. The loss recorded in 2007 is a result of a $119.9 million charge recorded on the correspondent home equity loans. Sovereign had planned on selling $4.3 billion of correspondent home equity loans as of December 31, 2006. As discussed previously, we were not able to sell $658 million of loans and as a result wrote them down to fair value incurring a charge of $84.2 million which was recorded within mortgage banking revenue. Sovereign also established a reserve for any potential loan repurchases that may result from certain representation and warranty clauses contained within the sale agreement. Finally, we were required to further write down the loans that we sold in the first quarter due to lower pricing on the execution of the sales which resulted from increases in delinquencies on the loan portfolio since year-end 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.

Sovereign also originates and sells multifamily loans in the secondary market to Fannie Mae while retaining servicing. At March 31, 2007 and December 31, 2006, Sovereign serviced $9.7 billion and $8.0 billion, respectively, of loans for Fannie Mae and as a result has recorded servicing assets of $21.8 million and $20.4 million, respectively. Sovereign recorded servicing asset amortization of $1.5 million related to the multifamily loans sold to Fannie Mae for the three-month period ended March 31, 2007 and recognized servicing assets of $2.9 million during the first quarter of 2007.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(10) BUSINESS SEGMENT INFORMATION

The following tables present certain information regarding the Company’s segments (in thousands):


	Mid-		New		Metro
	Atlantic		England		New York		Shared			Shared
For the three-month period ended	Banking		Banking		Banking		Services			Services
March 31, 2007	Division		Division		Division		Consumer			Commercial			Other			Total

Net interest income (expense)	$	75,454		155,655	$	153,127	$	100,237		$	61,836		$	(58,456	)	$	487,853
Fees and other income ⁽¹⁾		19,545		40,208		31,914		(112,355	)		41,956			24,614			45,882
Provision for credit losses		3,454		3,907		3,758		18,683			16,198			—			46,000
General and administrative expenses		69,605		116,091		105,938		26,927			36,646			(25,211	)		329,996
Depreciation/Amortization		2,644		4,371		4,376		8,679			2,105			45,066			67,241
Income (loss) before income taxes		21,940		75,865		75,346		(63,291	)		50,862			(118,783	)		41,939
Intersegment revenues (expense) ⁽²⁾		46,443		167,073		50,925		(298,025	)		(147,059	)		180,643			—
Total average assets	$	4,871,903	$	6,251,398	$	13,236,795	$	26,544,051		$	12,638,966		$	24,072,559		$	87,615,672


	Mid-			New		Metro
	Atlantic			England		New York		Shared			Shared
For the three-month period ended	Banking			Banking		Banking		Services			Services
March 31, 2006	Division			Division		Division		Consumer			Commercial			Other			Total

Net interest income (expense)	$	80,625		$	163,275	$	58,830	$	86,910		$	54,947		$	(40,629	)	$	403,958
Fees and other income		19,997			40,535		12,772		15,631			31,302			14,104			134,341
Provision for credit losses		(215	)		3,447		3,499		19,119			3,150			—			29,000
General and administrative expenses		67,827			118,996		36,820		36,683			29,398			(9,745	)		279,979
Depreciation/Amortization		2,520			4,141		1,103		7,140			1,501			23,992			40,397
Income (loss) before income taxes		33,009			81,367		31,283		42,284			53,717			(57,132	)		184,528
Intersegment revenues (expense) ⁽²⁾		51,498			158,463		72,164		(249,922	)		(107,854	)		75,651			—
Total average assets	$	4,407,775		$	5,526,470	$	1,609,874	$	23,939,195		$	10,851,401		$	17,704,878		$	64,039,593


(1)		As previously discussed in Note 4 and Note 9, Sovereign recorded a $119.9 million charge on our correspondent home equity loan portfolio. This charge was recorded in our Shared Services Consumer segment.

(2)		Intersegment revenues (expense) represent charges or credits for funds used or provided by each of the segments and are included in net interest income.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(11) RECENT ACCOUNTING PRONOUNCEMENTS

In March 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 156, “Accounting for Servicing of Financial Assets”, which amends FASB Statement No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 140). This Statement permits an entity (for each class of separately recognized servicing assets and servicing liabilities) to either continue to amortize servicing assets or servicing liabilities in proportion to and over the period of net servicing income or net servicing loss and assess the servicing assets or liabilities for impairment or increased obligation based on fair value at each reporting date, or measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the change occurs. In addition, the statement clarifies when a servicer should separately recognize servicing assets and servicing liabilities, requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable, and at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities elected to be subsequently measured at fair value. Finally, the statement requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of the financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. This statement is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Sovereign adopted this Statement on January 1, 2007 and elected to continue to account for its mortgage servicing rights as currently required by FAS 140.

In September 2006, the FASB issued Statement No. 157, “Fair Value Measurements” (FAS 157), which addresses how companies should measure fair value when they are required to use a fair value measure for recognition or disclosure purposes under generally accepted accounting principles. As a result of FAS 157 there is now a common definition of fair value to be used throughout GAAP. This new standard will make the measurement for fair value more consistent and comparable and improve disclosures about those measures. The statement does not require any new fair value measurement but will result in increased disclosures. This interpretation is effective for fiscal years beginning after November 15, 2007. Sovereign will adopt this interpretation on January 1, 2008.

On February 15, 2007, the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (FAS 159). This standard permits an entity to choose to measure many financial instruments and certain other items at fair value. Most of the provisions in FAS 159 are elective; however, the amendment to FASB Statement No. 115, Accounting for Certain Investments in Debt and Equity Securities, applies to all entities with available-for-sale and trading securities.

The fair value option established by FAS 159 permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity will report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option: (a) may be applied instrument by instrument, with a few exceptions, such as investments otherwise accounted for by the equity method; (b) is irrevocable (unless a new election date occurs); and (c) is applied only to entire instruments and not to portions of instruments.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(11) RECENT ACCOUNTING PRONOUNCEMENTS (continued)

FAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007. Early adoption is permitted as of the beginning of the previous fiscal year provided that the entity makes that choice in the first 120 days of that fiscal year and also elects to apply the provisions of FAS 157. Sovereign will adopt this pronouncement on January 1, 2008 and is currently evaluating whether it will elect to carry any assets or liabilities at fair value.

(12) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS

As described more fully in its annual report filed on Form 10-K, Sovereign has securitized certain financial assets to qualified special purpose entities which were deconsolidated in accordance with FAS 140.

Shown below are the types of assets underlying the securitizations for which Sovereign owns and continues to own an interest in and the related balances and delinquencies at March 31, 2007 and December 31, 2006, and the net credit losses for the three-month period ended March 31, 2007 and the year ended December 31, 2006 (in thousands):


	March 31, 2007						December 31, 2006
			Principal		Net				Principal		Net
	Total		90 Days		Credit		Total		90 Days		Credit
	Principal		Past Due		Losses		Principal		Past Due		Losses
Mortgage Loans	$	14,474,961	$	92,346	$	594	$	17,480,841	$	101,448	$	8,782
Home Equity Loans and lines of credit		6,056,459		41,293		1,958		9,574,735		125,253		448,526	(1)
Automotive Floor Plan Loans		1,407,691		—		—		1,389,164		—		—


Total Owned and Securitized	$	21,939,111	$	133,639	$	2,552	$	28,444,740	$	226,701	$	457,308


Less:
Securitized Mortgage Loans	$	71,590	$	275	$	30	$	76,111	$	383	$	17
Securitized Home Equity Loans		124,323		14,961		435		131,175		14,907		3,322
Securitized Automotive Floor Plan Loans		855,000		—		—		855,000		—		—


Total Securitized Loans	$	1,050,913	$	15,236	$	465	$	1,062,286	$	15,290	$	3,339


Net Loans	$	20,888,198	$	118,403	$	2,087	$	27,382,454	$	211,411	$	453,969


(1)		Includes charge of $382.5 million related to correspondent home equity loans classified as held for sale at December 31, 2006.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(12) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS (continued)

At March 31, 2007 and December 31, 2006, key economic assumptions and the sensitivity of the fair value of the retained interests to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows (dollars in thousands):


				Home Equity
				Loans &			Auto
	Mortgage			Lines of			Floor
	Loans			Credit			Plan Loans			Total
Interests that continue to be held by Sovereign:
Accrued interest receivable	$	—		$	—		$	6,442		$	6,442
Subordinated interest retained		18,833			—			43,996			62,829
Servicing rights		1,010			220			—			1,230
Interest only strips		—			6,582			1,010			7,592
Cash reserve		—			—			4,381			4,381


Total Interests that continue to be held by Sovereign	$	19,843		$	6,802		$	55,829		$	82,474


Weighted-average life (in yrs)		0.55			1.36			0.43
Prepayment speed assumption (annual rate)
As of the date of the securitization		40	%		22	%		50	%
As of December 31, 2006		40	%		19	%		46	%
As of March 31, 2007		40	%		18	%		42	%
Impact on fair value of 10% adverse change	$	(5	)	$	(45	)	$	(82	)
Impact on fair value of 20% adverse change	$	(6	)	$	(94	)	$	(173	)
Expected credit losses (annual rate)
As of the date of the securitization		0.12	%		0.75	%		0.25	%
As of December 31, 2006		0.12	%		1.95	%		0.25	%
As of March 31, 2007		0.12	%		2.28	%		0.25	%
Impact on fair value of 10% adverse change	$	(4	)	$	(166	)	$	(43	)
Impact on fair value of 20% adverse change	$	(8	)	$	(350	)	$	(86	)
Residual cash flows discount rate (annual)
As of the date of the securitization		9	%		12	%		8	%
As of December 31, 2006		9	%		12	%		8	%
As of March 31, 2007		9	%		12	%		8	%
Impact on fair value of 10% adverse change	$	(6	)	$	(92	)	$	(109	)
Impact on fair value of 20% adverse change	$	(11	)	$	(183	)	$	(217	)

These sensitivities are hypothetical and should be used with caution. As the figures indicate, changes in fair value based on a 10 percent variation in assumptions generally cannot be extrapolated because the relationship of the change in assumption to the change in fair value may not be linear. Also in this table, the effect of a variation in a particular assumption on the fair value of the retained interest is calculated without changing any other assumption. In reality, changes in one factor may result in changes in another (for example, increases in market interest rates may result in lower prepayments and increased credit losses), which might magnify or counteract the sensitivities.

Sovereign enters into partnerships, which are variable interest entities under FIN 46, with real estate developers for the construction and development of low-income housing. The partnerships are structured with the real estate developer as the general partner and Sovereign as the limited partner. We are not the primary beneficiary of these variable interest entities. Our risk of loss is limited to our investment in the partnerships, which totaled $164.4 million at March 31, 2007 and any future cash obligations that Sovereign is committed to the partnerships. Future cash obligations related to these partnerships totaled $47.2 million at March 31, 2007. Our investments in these partnerships are accounted for under the equity method.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(13) ADOPTION OF FASB INTERPRETATION NO. 48

Sovereign adopted the provisions of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes”, on January 1, 2007. As a result of the implementation of Interpretation 48, the Company recognized a $0.9 million decrease in the liability for unrecognized tax benefits, which was accounted for as an increase to the January 1, 2007, balance of retained earnings. On January 1, 2007, Sovereign had unrecognized tax benefit reserves related to uncertain tax positions of $67.2 million. Of this amount, approximately $10.7 million relate to reserves established for uncertain tax positions from the acquisition of Independence. Any adjustments to these reserves in future periods will be adjusted through goodwill. The remaining balance of $56.5 million represents the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate.

Sovereign’s unrecognized tax benefit reserve increased $5.3 million during the first quarter to $72.5 million as a result of $5.8 million of unrecognized tax benefits related to uncertain tax positions taken during the quarter ended March 31, 2007 offset by $0.5 million reduction as a result of a lapse of applicable statute of limitations. Sovereign recognizes penalties and interest accrued related to unrecognized tax benefits within income tax expense on the consolidated statement of operations. During the first quarter of 2007, Sovereign recognized approximately $0.8 million and for the years ended December 31, 2006, and 2005, the Company recognized approximately $1.7 million and $0.8 million in interest and penalties. The Company had approximately $4.0 million for the payment of interest and penalties accrued at March 31, 2007.

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 2007. Included in this examination cycle are the two separate financing transactions with an international bank, totaling $1.2 billion which are discussed in Note 12 in the Company’s Form 10K. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million dollars during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and the quarter ended March 31, 2007, Sovereign accrued an additional $87.6 million and $21.9 million of foreign taxes from this financing transaction 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. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of $54.7 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 — 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.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(14) RELATED PARTY TRANSACTIONS

Loans to related parties include loans made to certain officers, directors and their affiliated interests. These loans were made on terms similar to non-related parties. The following table discloses the changes in Sovereign’s related party loan balances since December 31, 2006.


Related party loans at December 31, 2006	$	59,777
Loan fundings		8,959
Resignation of executive officers		(1,250	)
Loan repayments		(1,685	)


Related party loan balance at March 31, 2007	$	65,801

Related party loans at March 31, 2007 included commercial loans to affiliated businesses of directors of Sovereign Bank totaling $51.8 million compared with $44.6 million at December 31, 2006. Related party loans also included commercial loans to affiliated businesses of directors of Sovereign Bancorp which totaled $10.4 million at March 31, 2007 and December 31, 2006.

Related party loans at March 31, 2007 and December 31, 2006 also included consumer loans secured by residential real estate of $3.6 million and $4.8 million, respectively, to executive officers and directors of Sovereign Bancorp.

Related party loans do not include undrawn commercial and consumer lines of credit that totaled $57.4 million and $66.5 million at March 31, 2007 and December 31, 2006, respectively. The majority of these amounts ($55.2 million and $63.4 million at March 31, 2007 and December 31, 2006) are on undrawn commercial lines of credit for affiliated businesses of individuals who are solely Directors of Sovereign Bank.

The Company is engaged in certain activities with Meridian Capital due to its acquisition of Independence. Meridian Capital is deemed to be a “related party” of the Company as such term in defined in SFAS No. 57 since Sovereign has a 35% minority equity investment in Meridian Capital, which is 65% owned by Meridian Funding, a New-York based mortgage firm. Meridian Capital refers borrowers seeking financing of their multi-family and/or commercial real estate loans to Sovereign as well as to numerous other financial institutions. Sovereign recognized $1.6 million of income due to its investment in Meridian Capital for the three-month period ended March 31, 2007.

As discussed in Note 16 in Sovereign’s 2006 Form 10-K, Sovereign raised $2.4 billion of equity by issuing 88.7 million shares to Banco Santander Central Hispano (“Santander”), which makes Santander the largest shareholder and related party.

In January 2006, Santander extended a total of $400 million in unsecured lines of credit to Sovereign Bank for federal funds and Eurodollar borrowings and for the confirmation of standby letters of credit issued by Sovereign Bank. These lines are at a market rate and in the ordinary course of business and can be cancelled by either Sovereign Bank or Santander at any time and can be replaced by Sovereign at any time. As of March 31, 2007, the average balance outstanding was $80.8 million, of which $36.7 million was federal funds and Eurodollar borrowings and $44.1 million was for confirmation of standby letters of credit. Sovereign Bank paid approximately $0.1 million in fees and $0.5 million in interest to Santander in the first quarter in connection with these commitments.

In May 2006, Santander’s capital markets group, Santander Investment Securities, Inc., received approximately $800,000 in underwriting discounts in connection with Sovereign’s capital market initiatives to fund the acquisition of Independence Community Bank Corp. on June 1, 2006. Also, per the terms of our investment agreement with Santander, Sovereign is obligated to have three Santander employees on its payroll, and Santander is obligated to have three Sovereign employees on its payroll.

In February 2007, Sovereign entered into an agreement with Isban U.K., Ltd., a Santander Group information technology subsidiary, pursuant to which Isban will perform a review of, and recommend enhancements to, Sovereign’s banking information systems. Sovereign has agreed to pay Isban $475,000, excluding expenses, for this review.

As discussed in Note 6, Sovereign issued $300 million of senior notes and Santander was a co-issuer of this issuance. Santander received underwriting fees of $37,500 in connection with this transaction.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(15) RESTRUCTURING COSTS AND OTHER CHARGES

As more fully discussed in Sovereign’s 2006 Form 10-K, Sovereign’s management completed a comprehensive review of Sovereign’s operating cost structure in the fourth quarter of 2006. During the first quarter, Sovereign finalized a decision to close certain underperforming branch locations. The Company identified 40 locations to be either closed or consolidated. As a result, Sovereign wrote down the fair value of the fixed assets and recorded other charges at these locations of $9.1 million during the three-month period ended March 31, 2007. Sovereign anticipates additional charges of $13.1 million when it ceases using these locations in the second quarter. Sovereign terminated additional employees in the first quarter, resulting in severance charges of $7.2 million. These charges are included in restructuring, other employee severance and debt repurchase charges on the consolidated income statement and recorded in the Other segment. A rollforward of the restructuring and severance accrual is summarized below:


	Contract
	termination			Severance			Other			Total
Accrued at December 31, 2006	$	7,043		$	45,930		$	5,906		$	58,879
Payments		(149	)		(26,520	)		(2,654	)		(29,323	)
Charges recorded in earnings		607			7,192			2,599			10,398

Accrued at March 31, 2007	$	7,501		$	26,602		$	5,851		$	39,954

Sovereign’s executive management team and Board of Directors decided to freeze the Company’s Employee Stock Ownership Plan (ESOP) and communicated this decision to its employee base during the first quarter. The debt currently owed by the ESOP will be prepaid with the proceeds from the sale of a portion of the unallocated shares held by the ESOP and all remaining shares will be allocated to participants. Sovereign recorded a non-deductible, non-cash charge of $43.4 million for the three-month period ended March 31, 2007 in connection with this action.

Sovereign incurred pre-tax charges of $14.3 million of proxy and related professional fees in the first quarter of 2006. These fees were related to certain advertisements and legal and professional fees incurred in connection with the Relational Investors LLC (“Relational”) matter. Due to the settlement with Relational, we do not anticipate any additional significant costs related to this matter.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(16) PURCHASE OF INDEPENDENCE COMMUNITY BANK CORP. (“INDEPENDENCE”)

Sovereign closed on its acquisition of 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 Santander, net proceeds from recent issuances of perpetual and trust preferred securities and cash on hand. Sovereign issued 88,705,123 shares to Santander, which makes 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. Sovereign acquired Independence to connect their Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York.

The preliminary purchase price was allocated to the acquired assets and assumed liabilities of Independence based on estimated fair value as of June 1, 2006. The Company is in the process of finalizing these values and, as such, the allocation of the purchase price is subject to revision (dollars in millions):


Assets
Investments	$	3,126.7
Loans:
Multifamily		5,571.2
Commercial		5,313.3
Consumer		517.2
Residential		1,829.0


Total loans		13,230.7
Less allowance for loan losses		(97.8	)


Total loans, net		13,132.9

Cash acquired, net of cash paid		(2,713.2	)
Premises and equipment, net		167.9
Bank Owned Life Insurance		343.3
Other assets		371.9
Core deposit and other intangibles		394.2
Goodwill		2,282.8


Total assets	$	17,106.5


Liabilities
Deposits:
Core	$	6,960.8
Time		4,070.1


Total deposits		11,030.9
Borrowings and other debt obligations		5,488.8
Other liabilities (1)		586.8


Total liabilities	$	17,106.5


(1)		Includes liabilities of $26.2 million directly associated with the transaction which were recorded as part of the purchase price which is primarily comprised of $14.4 million of termination penalties for canceling certain long-term Independence contracts related to redundant services and $2.8 million related to branch consolidation.

The status of reserves related to the Independence acquisition is summarized below (in thousands):


Reserve balance at December 31, 2006	$	22,432
Charge recorded in earnings		2,076
Payments		(4,906	)

Reserve balance at March 31, 2007	$	19,602

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

EXECUTIVE SUMMARY

Sovereign is an $82 billion financial institution with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, Maryland, and Delaware. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including: deposit and loan services, sales of residential, home equity, and multi-family loans and investment securities, capital markets products, cash management 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 various factors including the economic environment, including interest rates, consumer and business confidence and spending, as well as competitive conditions within our geographic footprint.

We are one of the 20 largest banking institutions in the United States as measured by total assets. Our customers select Sovereign for banking and other financial services based on our ability to assist customers by understanding and anticipating their individual financial needs and providing customized solutions. Our major strengths include: a strong franchise value in terms of market share and demographics; diversified loan portfolio and products; the ability to cross sell multiple product lines to our customers resulting in higher fee based revenues; and the ability to internally generate equity through earnings. Our weaknesses have included operating returns and capital ratios that are lower than certain of our peers. Additionally, our operating expense levels have been higher than we desire, and we have not achieved our growth targets with respect to low cost core deposits.

Management is in the process of implementing strategies to address these weaknesses. Now that Sovereign has successfully merged the operations and processes of Independence into Sovereign, management has completed a comprehensive review of Sovereign’s operating cost structure and established a restructuring plan, which was approved by Sovereign’s Board of Directors in the fourth quarter of 2006. The majority of this plan was executed during the fourth quarter of 2006 and the first quarter of 2007. We believe the restructuring plan focuses on a number of strategies which will help to strengthen our capital position and related capital ratios which have decreased following the Independence acquisition and improve our financial performance. Management has developed the following key initiatives to deliver improved quality of earnings, provide greater transparency and understanding of Sovereign’s businesses and strategy, and better position Sovereign for sustainable growth.

The three initiatives are to:

1. Improve productivity and expense management;

2. Improve the capital position and quality of earnings; and

3. Improve the customer experience.

In the productivity and expense management initiative we are 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 has 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 mid-December, Sovereign notified approximately 360 employees that their positions had been eliminated. Additionally, we expect that approximately 400 positions will be eliminated primarily through attrition by the third quarter of 2007 and the Company does not plan on filling approximately 140 open positions. Sovereign terminated additional employees in the first quarter, resulting in severance charges of $7.2 million. We will also be closing approximately 40 underperforming branch locations during 2007. In connection with the decision to close these locations, Sovereign recorded charges of $9.1 million in the first quarter of 2007. The majority of this charge is related to writing down to fair value the fixed assets at these locations. We anticipate additional charges of approximately $13.1 million when Sovereign ceases using these locations in the second quarter. We intend to continue to make investments in our retail franchise and are targeting the opening or relocation of 18 new branch offices in 2007 and 22 new branch offices in 2008 in more desirable locations.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

In order to improve our capital position, Sovereign sold approximately $8.0 billion of low margin and/or high credit risk assets and reduced our wholesale fundings 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 while repositioning Sovereign for sustainable growth in core earnings over the long-term. However, this balance sheet restructuring has resulted in Sovereign recording material charges to our earnings.

In order to improve the customer experience, Sovereign’s strategy is to acquire and retain customers by demonstrating convenience through our locations, technology and business approach while offering innovative and easy-to-use products and service. Customer service personnel will receive refresher service training and we have migrated back to all customer service functions being domestically based. We will realign consumer and commercial infrastructure by consolidating our commercial and retail on-line banking management structure. We have also rationalized and simplified our retail deposit product set by reducing our retail checking product set in half. During 2006, Sovereign completed the branding of approximately 1,050 ATM machines in CVS Pharmacy locations in the Northeast. This more than doubled the number of branded ATM locations and provides greater convenience for our customers. We also announced an agreement with OPEN from American Express, the company’s small business unit, to offer co-branded American Express Cards to Sovereign’s small business customers. This relationship will generate an additional source of fee revenue for Sovereign and will enable us to leverage the American Express brand to help Sovereign generate core deposits and build and retain small-business relationships. We also entered into an alliance with ADP, the country’s leading payroll services provider. With this partnership, ADP provides approximately 200 dedicated representatives throughout our footprint to assist our commercial relationship managers in providing payroll solutions for our business customers.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The Banking industry has experienced significant consolidation in recent years. Consolidation may affect the markets in which Sovereign operates as new or restructured competitors integrate acquired businesses, adopt new business practices or change product pricing as they attempt to maintain or grow market share. Recent merger activity involving national, regional and community banks and specialty finance companies in the northeastern United States, including acquisitions by Sovereign, have affected the competitive landscape in the markets we serve. Sovereign acquired Independence on June 1, 2006 and we believe this acquisition will strengthen our franchise. Management continually monitors the environment in which it operates to assess the impact of the industry consolidation on Sovereign, as well as the practices and strategies of our competition, including loan and deposit pricing, customer expectations and the capital markets.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents a substantial portion of the Company’s revenues. Accordingly, the interest rate environment has a significant impact on Sovereign’s earnings. Sovereign currently has a liability sensitive interest rate risk position. The impact of the flattening to inverted yield curve that has been experienced in 2006 and 2007 has negatively impacted our margin since the spread between our longer-term assets and our shorter-term liabilities is narrow. In the first quarter of 2006, the average interest rate spread between the 2-year Treasury note and the 10-year note was negative 3 basis points and was a positive 8 basis points in the first quarter of 2007 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities. As discussed in Note 6, Sovereign restructured its balance sheet and sold $8.0 billion of low margin and/or high credit risk assets. We utilized the proceeds to pay off higher cost borrowings. These actions helped increase our net interest margin during the first quarter of 2007 to 2.70% from 2.60% in the fourth quarter of 2006. A significant portion of the asset sales did not occur until late in the first quarter, and should help to improve net interest margin in future periods. However, net interest margin will also 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 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 has a significant impact on our operating results. We experienced a slight weakening in certain key credit quality performance indicators in the past quarter, however our credit quality metrics remain strong and our credit quality metrics are by historical standards very favorable. We do not expect this very favorable credit performance to continue in future periods indefinitely and would expect to see an increase in losses in future periods. We believe the sale of our correspondent home equity portfolio and the sale of certain residential mortgage loans in the first quarter has improved the overall risk profile of our portfolio. In addition to our credit risk mitigation programs, the economic conditions in our geographic footprint have been stable. We believe the credit risk within our investment portfolio is low. Any significant change in the credit quality of our loan portfolio would have a significant effect on our financial position and results of operations.

RESULTS OF OPERATIONS

General

Net income was $48.1 million, or $0.09 per diluted share for the three-month period ended March 31, 2007 as compared to $141.4 million, or $0.36 per diluted share for the three-month period ended March 31, 2006.

In the first quarter of 2007, Sovereign sold $2.9 billion of residential loans, $1.3 billion of multi-family loans and $3.4 billion of correspondent home equity loans. Sovereign had planned on selling $4.3 billion of correspondent home equity loans as of December 31, 2006. As discussed previously, we were not able to sell $658 million of loans and as a result wrote them down to fair value incurring a charge of $84.2 million which was recorded within mortgage banking revenue. Sovereign also established a reserve for any potential loan repurchases that may result from certain representation and warranty clauses contained within the sale agreement. Finally, we were required to further write down the loans that we sold in the first quarter due to lower pricing on the execution of the sales which resulted from the deterioration of the loan portfolio since year-end 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.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
THREE-MONTH PERIOD ENDED MARCH 31, 2007 AND 2006
(in thousands)


	2007								2006
				Tax								Tax
	Average			Equivalent		Yield/			Average			Equivalent		Yield/
	Balance			Interest		Rate			Balance			Interest		Rate
EARNING ASSETS
INVESTMENTS	$	15,175,372		$	230,601		6.09	%	$	12,715,041		$	168,049		5.29	%
LOANS:
Commercial loans		24,599,792			438,157		7.21	%		16,884,583			290,843		6.98	%
Multi-Family		5,890,879			98,783		6.72	%		—			—		—	%
Consumer loans
Residential mortgages		15,592,954			223,023		5.72	%		12,777,623			176,652		5.53	%
Home equity loans and lines of credit		9,497,940			165,351		7.04	%		9,673,570			151,660		6.32	%

Total consumer loans secured by real estate		25,090,894			388,374		6.22	%		22,451,193			328,312		5.87	%

Auto loans		5,186,143			86,142		6.74	%		4,409,850			61,383		5.65	%
Other		422,161			8,821		8.47	%		476,946			9,185		7.81	%

Total consumer		30,699,198			483,337		6.34	%		27,337,989			398,880		5.87	%

Total loans		61,189,869			1,020,277		6.72	%		44,222,572			689,723		6.29	%
Allowance for loan losses		(474,518	)		—		—			(419,386	)		—		—

NET LOANS		60,715,351			1,020,277		6.78	%		43,803,186			689,723		6.35	%

TOTAL EARNING ASSETS		75,890,723			1,250,878		6.64	%		56,518,227			857,772		6.11	%
Other assets		11,724,949			—		—			7,521,366			—		—

TOTAL ASSETS	$	87,615,672		$	1,250,878		5.75	%	$	64,039,593		$	857,772		5.40	%


FUNDING LIABILITIES
Deposits and other customer related accounts:
Core deposits and other related accounts	$	29,722,658		$	225,503		3.08	%	$	21,753,021		$	118,863		2.22	%
Time deposits		15,747,878			187,747		4.84	%		11,597,261			112,974		3.95	%

TOTAL DEPOSITS		45,470,536			413,250		3.69	%		33,350,282			231,837		2.82	%

BORROWED FUNDS:
FHLB advances		18,099,582			226,035		5.04	%		13,551,387			143,083		4.27	%
Fed funds and repurchase agreements		1,743,010			23,229		5.40	%		613,518			6,635		4.33	%
Other borrowings		5,412,697			76,971		5.71	%		4,415,349			54,020		4.93	%

TOTAL BORROWED FUNDS		25,255,289			326,235		5.21	%		18,580,254			203,738		4.43	%

TOTAL FUNDING LIABILITIES		70,725,825			739,485		4.23	%		51,930,536			435,575		3.39	%
Demand deposit accounts		6,335,301			—		—			5,086,989			—		—
Other liabilities		1,819,565			—		—			1,125,329			—		—

TOTAL LIABILITIES		78,880,691			739,485		3.79	%		58,142,854			435,575		3.03	%
STOCKHOLDERS’ EQUITY		8,734,981			—		—			5,896,739			—		—

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	87,615,672			739,485		3.41	%	$	64,039,593			435,575		2.75	%

NET INTEREST INCOME				$	511,393							$	422,197

NET INTEREST SPREAD (1)							2.41	%							2.72	%


NET INTEREST MARGIN (2)							2.70	%							3.00	%


(1)		Represents the difference between the yield on total earning assets and the cost of total funding liabilities.

(2)		Represents annualized, taxable equivalent net interest income divided by average interest-earning assets.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Net Interest Income

Net interest income for the three-month period ended March 31, 2007 was $487.9 million compared to $404.0 million for the same period in 2006. The increase in net interest income was due to growth in average interest earning assets to $75.9 billion for the three- month period ending March 31, 2007 compared to $56.5 billion for the three-month period ending March 31, 2006. This increase of $19.4 billion or 34% is due to the Independence acquisition as well as strong growth in commercial and auto loans. Offsetting this increase was a decrease in net interest margin for the three-month period ended March 31, 2007 to 2.70%, compared to the corresponding period in the prior year of 3.00%, resulting from the flattening yield curve, which became inverted during the first quarter of 2006 and whose spread has continued to remain under pressure. As previously discussed the spread between the 2-year Treasury note and the 10-year note was negative 3 basis points in the first quarter of 2006 and a positive 8 basis points in the first quarter of 2007 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities. We anticipated that Sovereign’s net interest income margin will expand in the second quarter due to the previously mentioned sales of $3.4 billion of correspondent home equity loans and $1.3 billion of multi-family loans, which settled at the end of March 2007 and whose proceeds were used to pay down high cost obligations. The extent of the improvement on net interest margin will depend on several factors such as the interest rate environment and Sovereign’s ability to grow and retain low cost deposits.

Interest on investment securities and interest earning deposits was $210.4 million for the three-month period ended March 31, 2007 compared to $151.4 million for the same period in 2006. The average balance of investment securities was $15.2 billion with an average tax equivalent yield of 6.09% for the three-month period ended March 31, 2007 compared to an average balance of $12.7 billion with an average yield of 5.29% for the same period in 2006. The increase in yield is primarily due to a rise in market interest rates and due to the investment restructuring Sovereign executed in the second and fourth quarters of 2006. The increase in average balance was due to the acquisition of Independence.

Interest on loans was $1.0 billion for the three-month period ended March 31, 2007 compared to $688.2 million for the three-month period in 2006. The average balance of loans was $61.2 billion with an average yield of 6.72% for the three-month period ended March 31, 2007 compared to an average balance of $44.2 billion with an average yield of 6.29% for the same period in 2006. Average balances of commercial loans in 2007 increased $7.7 billion, as compared to 2006 primarily due to strong demand in our commercial loan portfolio and the impact of loans acquired from Independence. Commercial loan yields have increased 23 basis points due to the rise in short-term interest rates which has particularly increased the yields on our variable rate loan products. Average residential mortgages increased $2.8 billion due to loan purchases and increased origination activity as well as loans acquired from Independence. Average home equity loans and lines of credit decreased $176 million from the prior year due to Sovereign’s decision to cease purchasing correspondent home equity loans in the first quarter of 2006. Sovereign also acquired a $5.6 billion multi-family loan portfolio from Independence whose average balance totaled $5.9 billion in the three-month period ended March 31, 2007. Average balances of auto loans increased to $5.2 billion from $4.4 billion due to strong organic in-market growth and a recent decision towards the middle of 2006 to expand loan production offices in the Southeastern and Southwestern United States.

Interest on deposits and related customer accounts was $413.3 million for the three-month period ended March 31, 2007 compared to $231.8 million for the same period in 2006. The average balance of deposits was $45.5 billion with an average cost of 3.69% for the three-month period ended March 31, 2007 compared to an average balance of $33.4 billion with an average cost of 2.82% for the same period in 2006. Additionally, the average balance of non-interest demand deposits has increased to $6.3 billion at March 31, 2007 from $5.1 billion for the same period in the prior year. The increase in the balance of deposits is primarily due to the addition of deposits in connection with the Independence acquisition. Also contributing to the increase is time deposit and money market growth which has become a more favorable funding alternative as costs on shorter term borrowing obligations continue to increase.

Interest on borrowed funds was $326.2 million for the three-month period ended March 31, 2007 compared to $203.7 million for the same period in 2006. The average balance of borrowings was $25.3 billion with an average cost of 5.21% for the three-month period ended March 31, 2007 compared to an average balance of $18.6 billion with an average cost of 4.43% for the same period in 2006. Our average balance of borrowings will decline in the second quarter due to the previously mentioned loan sales that settled near the end of March.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Provision for Credit Losses

The provision for credit losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for credit losses for the three-month period ended March 31, 2007 was $46.0 million compared to $29.0 million for the same period in 2006. The provision for credit losses for the three months ended March 31, 2007 includes a higher level of provision versus 2006 due to an increase in criticized categories in the commercial loan portfolio in 2007 and loan growth.

Net loan charge-offs for the three months ended March 31, 2007 were $24.1 million compared to $28.3 million for the comparable period in the prior year. This equates to an annualized net loan charge-off to average loan ratio of .16% for the three months ended March 31, 2007 compared to .26% for the comparable period in the prior year. However, prior year results include charge-offs associated with the correspondent home equity portfolio of $10.2 million or .12%. Sovereign sold the majority of this portfolio in the first quarter and the remaining loans in the portfolio at March 31, 2007 have been written down to fair value. Non-performing loans and non-performing assets at March 31, 2007 exclude $22.4 million of loans related to the remaining correspondent home equity portfolio that was written down to fair value since this write down considered future credit losses. Non-performing assets were $278.4 million or 0.34% of total assets at March 31, 2007, compared to $221.6 million or .27% of total assets (excluding loans held for sale) at December 31, 2006 and $200.5 million or 0.31% of total assets at March 31, 2006. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance as deemed necessary.

The following table presents the activity in the allowance for credit losses for the periods indicated (in thousands):


	Three-month Period Ended
	March 31,
	2007		2006
Allowance for loan losses, beginning of period	$	471,030	$	419,599

Charge-offs:
Commercial		16,032		12,947
Consumer secured by real estate		5,792		12,143
Consumer not secured by real estate		19,580		20,023


Total Charge-offs		41,404		45,113


Recoveries:
Commercial		4,161		4,743
Consumer secured by real estate		3,705		1,330
Consumer not secured by real estate		9,448		10,742


Total Recoveries		17,314		16,815


Charge-offs, net of recoveries		24,090		28,298
Provision for loan losses (1)		45,239		30,559
Allowance released in connection with loan sales		4,893		—


Allowance for loan losses, end of period	$	487,286	$	421,860

Reserve for unfunded lending commitments, beginning of period		15,255		18,212
Provision/(benefit) for unfunded lending commitments (1)		761		(1,559	)
Reserve for unfunded lending commitments, end of period		16,016		16,653

Total Allowance for credit losses	$	503,302	$	438,513


(1)		Sovereign defines the provision for credit losses on the consolidated statement of operations as the sum of the total provision for loan losses and provision for unfunded lending commitments.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Non-Interest Income

Total non-interest income was $46.9 million for the three-month period ended March 31, 2007 compared to $134.3 million for the same period in 2006. The decrease for the three months ended March 31, 2007 was caused by the previously discussed $119.9 million charge on the correspondent home equity loan portfolio.

Consumer banking fees were $68.0 million for the three-month period ended March 31, 2007 compared to $60.8 million for the same period in 2006, representing a 12% increase. The increase for the three months ended March 31, 2007 was due primarily to growth in deposit fees to $54.8 million for the three-month period ended March 31, 2007 compared to $50.6 million for the corresponding period in the prior year due to the acquisition of Independence. Average deposits increased from $33.4 billion for the three-month period ended March 31, 2006 to $45.5 billion for the three-month period ended March 31, 2007, as a result of the Independence acquisition.

Commercial banking fees were $49.4 million for the three-month period ended March 31, 2007 compared to $39.0 million for the same period in 2006, representing an increase of 27%. This was primarily due to higher loan fees resulting from growth in the commercial loan portfolio (resulting from the Independence acquisition as well as organic growth). Average commercial loans increased from $16.9 billion for the three-month period ended March 31, 2006 to $24.6 billion for the three-month period ended March 31, 2007.

Net mortgage banking income was composed of the following components (in thousands):


	Three months ended March 31,
	2007			2006
Mortgage servicing fees	$	9,729		$	5,974
Amortization of mortgage servicing rights		(9,482	)		(3,834	)
Net gains/(loss) under SFAS 133		(388	)		1,090
Sales of mortgage, home equity and multifamily loans and mortgage backed securities		(107,064	)		9,762


Total mortgage banking income	$	(107,205	)	$	12,992

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.

Mortgage banking income is contingent upon loan growth and market conditions. In the first quarter of 2007, Sovereign sold $1.3 billion of multi-family loans and recorded a gain of $6.1 million in connection with the sale. Mortgage banking revenues declined from the prior year due to the previously discussed $119.9 million charge on the correspondent home equity portfolio.

At March 31, 2007, Sovereign serviced approximately $9.6 billion of mortgage loans for others and our net mortgage servicing asset was $123.1 million, compared to $9.2 billion of loans serviced for others and a net mortgage servicing asset of $118.6 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.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

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


	March 31, 2007			December 31, 2006			March 31, 2006			December 31, 2005
CPR speed		14.81	%		14.23	%		11.75	%		12.42	%
Escrow credit spread		4.96	%		4.85	%		4.37	%		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.

Although all of the loans serviced for Fannie Mae (both loans originated for sale and loans sold from portfolio) are currently fully performing, the Company has established a liability related to 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 March 31, 2007, Sovereign had a $19.4 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program.

At March 31, 2007 and December 31, 2006, Sovereign serviced $9.7 billion and $8.0 billion, respectively, of loans for Fannie Mae sold to it pursuant to this program with a maximum potential loss exposure of $186.6 million and $152.3 million, respectively. As a result of retaining servicing, the Company had a $21.8 million and $20.4 million loan servicing asset at March 31, 2007 and December 31, 2006, respectively. Sovereign recorded servicing asset amortization of $1.5 million related to the multi-family loans sold to Fannie Mae for the three-month period ended March 31, 2007 and recognized servicing assets of $2.9 million during the first quarter of 2007.

Bank owned life insurance (BOLI) income represents the increase in the cash surrender value of life insurance policies for certain employees where the Bank is the beneficiary of the policies as well as the receipt of insurance proceeds. The increase in BOLI income to $20.5 million for the three-month period ended March 31, 2007 compared to $11.3 million for the comparable period in the prior year is due to $300 million of purchases of BOLI which occurred in the second quarter of 2006 and $343.3 million of BOLI acquired as a result of the Independence transaction.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

General and Administrative Expenses

General and administrative expenses for the three-month period ended March 31, 2007 were $330.0 million compared to $280.0 million for the same period in 2006. General and administrative expenses increased in 2007 primarily due to increased compensation and benefit costs associated with the hiring of additional team members and operating expenses associated with the Independence acquisition. Average full time equivalents during the first quarter of 2007 rose to 11,435 from 9,584 for the comparable prior year period due to team members acquired from Independence.

Other Expenses

Other expenses consist primarily of amortization of intangibles, minority interest expense, merger related and integration charges, equity method investment expense, employee severance and other restructuring and proxy and related professional fees. Other expenses were $116.8 million for the three-month period ended March 31, 2007, compared to $44.8 million for the same period in 2006. The reason for the variance is discussed below.

Sovereign has an investment in a synthetic fuel partnership that generates IRC Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Our investment balance totaled $12.2 million at March 31, 2007. Sovereign is amortizing this investment through December 31, 2007, which is the period through which we expect to receive alternative energy tax credits. Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $6.2 million and $6.7 million for the three-month period ended March 31, 2007 and March 31, 2006, respectively, and are included as expense in the line “Equity method investments” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. We anticipate receiving tax credits in excess of our recorded investment over the remaining life of the partnership. The alternative energy tax credit is reduced and ultimately eliminated based on a formula tied to the annual average wellhead price per barrel of domestic crude oil which is not subject to regulation by the United States.

As previously discussed, Sovereign recorded charges of $20.0 million and $43.4 million for the three-month period ended March 31, 2007 associated with restructuring charges and freezing its ESOP, respectively.

Sovereign recorded intangible amortization expense of $33.3 million for the three-month period ended March 31, 2007 compared to $17.2 million for the corresponding period in the prior year. The reason for the increase is due primarily 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.

Income Tax Provision

An income tax benefit of $6.1 million was recorded for the three-month period ended March 31, 2007, compared to a provision of $43.1 million for the same period in 2006. The effective tax rate for the three-month period ended March 31, 2007 was (14.6)% compared to 23.4% for the same period in 2006. The effective tax rate differs from the statutory rate of 35% primarily due to income from tax-exempt investments, income related to bank-owned life insurance, tax credits associated with low income housing investment partnerships and the Synthetic Fuel Partnership. The lower effective tax rate for the three-month period ended March 31, 2007 results from the reduced level of pre-tax income of the Company due to the previously discussed restructuring charges and charges associated with freezing its ESOP and additional charges on the correspondent home equity loan portfolio.

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. In establishing a provision for income tax expense, the Company must make judgments and interpretations about the application of these inherently complex tax laws.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

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. We anticipate that the IRS will complete this review in 2007. Included in this examination cycle are the two separate financing transactions with an international bank, totaling $1.2 billion which are discussed in Note 13 in the Company’s Form 10K. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million dollars during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and the quarter ended March 31, 2007, Sovereign accrued an additional $87.6 million and $21.9 million of foreign taxes from this financing transaction 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. Sovereign believes that it is entitled to claim these foreign tax credits and also believes that its recorded tax reserves for this position of $54.7 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 — 2005 could result in an adjustment to the tax balances and reserves that have been recorded and may materially affect our income tax provision in future periods.

Line of Business Results

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 and the difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business line at the time of charge-off is allocated to each business line based on the 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 $5.2 million to $75.5 million for the three-month period ended March 31, 2007 compared to the corresponding period in the preceding year. The net spread on a match funded basis for this segment was 2.43% for the first three months of 2007 compared to 2.64% for the same period in the prior year. The average balance of loans was $4.8 billion for the three months ended March 31, 2007 compared to an average balance of $4.3 billion for the corresponding period in the preceding year. The average balance of deposits was $8.1 billion for the three months ended March 31, 2007, compared to $8.3 billion for the same period a year ago. The increase in yields is due to the increase in market rates between these two time periods. The provision for credit losses increased $3.7 million for the three months ended March 31, 2007 and is driven by the charge-offs in the division’s loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $67.8 million for the three months ended March 31, 2006, to $69.6 million for the corresponding periods in 2007 or 2.6%.

The New England Banking Division’s net interest income decreased $7.6 million to $155.7 million for the three-month period ended March 31, 2007 compared to the corresponding period in the preceding year. 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 2.71% for the first three months of 2007 compared to 2.97% for the same period in the prior year. The average balance of loans was $6.0 billion for the three months ended March 31, 2007 compared to an average balance of $5.3 billion for the corresponding period in the preceding year. The average balance of deposits was $17.9 billion for the three months ended March 31, 2007, compared to $17.5 billion for the same period a year ago. The provision for credit losses increased $0.5 million to $3.9 million for the three-month period ended March 31, 2007. General and administrative expenses (including allocated corporate and direct support costs) decreased from $119.0 million for the three months ended March 31, 2006, to $116.1 million for the three months ended March 31, 2007 or a decrease of 2.4%.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

The Metro New York Banking Division’s net interest income increased $94.3 million to $153.1 million for the three-month period ended March 31, 2007 compared to the corresponding period in the preceding year. The increase in net interest income was principally due to the acquisition of Independence on June 1, 2006 and was partially offset by a compression in net spreads in this segment. The net spread on a match funded basis for this segment was 2.16% for the first three months of 2007 compared to 2.83% for the same period in the prior year. The average balance of loans was $13.1 billion for the three months ended March 31, 2007 compared to an average balance of $1.5 billion for the corresponding period in the preceding year. The average balance of deposits was $16.3 billion for the three months ended March 31, 2007, compared to $7.0 billion for the same period a year ago. The increase in rates is primarily driven by the increase in market interest rates between these two time periods. The increase in fees and other income of $19.1 million was primarily due to the acquisition of Independence on June 1, 2006. The provision for credit losses increased $0.3 million to $3.8 million for the three-month period ended March 31, 2007. General and administrative expenses (including allocated corporate and direct support costs) increased from $36.8 million for the three months ended March 31, 2006, to $105.9 million for the three months ended March 31, 2007. The increase in general and administrative expenses is principally due to the acquisition of Independence on June 1, 2006.

The Shared Services Consumer segment net interest income increased $13.3 million to $100.2 million for the three-month period ended March 31, 2007 compared to the corresponding period in the preceding year. The net spread on a match funded basis for this segment was 1.63% for the first three months of 2007 compared to 1.49% for the same period in the prior year. The average balance of loans for the three-month period ended March 31, 2007 was $25.5 billion compared with $23.4 billion for the corresponding period in the prior year. The increase in loan balances was driven by strong residential and auto loan originations, offset by a decline in our correspondent home equity portfolio as Sovereign stopped originating these loans in the first quarter of 2006. Fees and other income was a net loss of $112.4 million for the three-month period ended March 31, 2007 compared to income of $15.6 million for the corresponding period in the prior year. The reason for the decline was the previously discussed charge of $119.9 million on the correspondent home equity loan portfolio. The provision for credit losses decreased $0.4 million to $18.7 million at March 31, 2007 due primarily to lower charge-offs due to Sovereign’s decision to sell the correspondent home equity loan business in the first quarter of 2007. General and administrative expenses totaled $26.9 million for the three months ended March 31, 2007, compared to $36.7 million for the three months ended March 31, 2006. This decline in expenses is a result of the aforementioned closure of the correspondent home equity business.

The Shared Services Commercial segment net interest income increased $6.9 million to $61.8 million for the three-month period ended March 31, 2007 compared to the corresponding period in the preceding year. The net spread on a match funded basis for this segment was 2.23% for the first three months of 2007 compared to 2.31% for the same period in the prior year. The average balance of loans for the three months ended March 31, 2007 was $11.7 billion compared with $9.7 billion for the corresponding period in the prior year. The increase in fees and other income of $10.7 million was due to increases in deposit fees and precious metals revenues. The provision for credit losses increased $13.1 million to $16.2 million for the three months ended March 31, 2007. General and administrative expenses (including allocated corporate and direct support costs) were $36.6 million for the three months ended March 31, 2007 compared with $29.4 million for the corresponding period in the prior year. The reason for the increase is due to investments needed to support the growth of this reporting segment.

The net loss before income taxes for Other increased $61.7 million to a loss of $118.8 million for the three months ended March 31, 2007 compared to the corresponding period in the preceding year. Net interest expense increased $17.8 million to $58.5 million for the three months ended March 31, 2007 compared to the corresponding period in the preceding year due primarily to a $2.5 billion increase in average investments offset by a $6.7 billion increase in average borrowings. Average borrowings for the three-month period ended March 31, 2007 and 2006 was $25.3 billion and $18.6 billion, respectively, with an average cost of 5.21% and 4.43%. Average investments for the three-month period ended March 31, 2007 and 2006 was $15.2 billion and $12.7 billion respectively, at an average yield of 6.09% and 5.29%. The increase in average balance was due to our Independence acquisition. The increase in the yield is primarily due to the rise in market interest rates between periods and the investment restructuring Sovereign executed in the second and fourth quarters of 2006.

The Other segment includes the previously mentioned restructuring and severance charges of $20.0 million for the three-months ended March 31, 2007 as well as $43.4 million expense related to freezing our ESOP plan. See Note 15 for further discussion. The Other segment includes amortization of intangible asset expense of $33.2 million for the three-month period ended March 31, 2007 compared to $17.2 million for the three-month period ended March 31, 2006. The reason for the increase is due to the core deposit and other intangibles created as a result of the Independence acquisition. The three-month period ended March 31, 2006 included proxy and related professional fee expense of $14.3 million which is also discussed in Note 15.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the December 31, 2006 consolidated financial statements filed on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles 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. We have identified accounting for the allowance for loan losses, securitizations, derivatives and goodwill 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 effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management’s Discussion and Analysis and the December 31, 2006 Management’s Discussion and Analysis filed on Form 10-K.

A discussion of the impact of new accounting standards issued by the FASB and other standard setters are included in Note 12 to the consolidated financial statements.

FINANCIAL CONDITION

Loan Portfolio

At March 31, 2007, commercial loans totaled $25.0 billion representing 44.6% of Sovereign’s loan portfolio, compared to $24.7 billion or 39.5% of the loan portfolio at December 31, 2006 and $17.3 billion or 38.2% of the loan portfolio at March 31, 2006. At both March 31, 2007 and December 31, 2006, only 6% and 8%, respectively, of our total commercial portfolio was unsecured. The increase in commercial loans since December 31, 2006 has been driven by organic loan growth.

At March 31, 2007, multi-family loans totaled $4.8 billion representing 8.6% of Sovereign’s loan portfolio, compared to $5.8 billion or 9.2% of the loan portfolio at December 31, 2006 and $480 million or 1.1% of the loan portfolio at March 31, 2006. The increase from the prior year is due to the acquired multi-family loan portfolio from Independence. In the first quarter Sovereign sold $1.3 billion of this loan portfolio as part of the Company’s previously discussed balance sheet restructuring plan.

The consumer loan portfolio secured by real estate (consisting of home equity loans and lines of credit of $5.9 billion and residential loans of $14.4 billion) totaled $20.3 billion at March 31, 2007, representing 36.2% of Sovereign’s loan portfolio, compared to $26.8 billion, or 42.9%, of the loan portfolio at December 31, 2006 and $23.1 billion or 51.0% of the loan portfolio at March 31, 2006. The decrease in the consumer loan portfolio secured by real estate was driven by the sale of $3.4 billion of correspondent home equity loans and $2.9 million of residential loans that occurred during the quarter in connection with the balance sheet restructuring.

The consumer loan portfolio not secured by real estate (consisting of indirect automobile loans of $5.5 billion and other consumer loans of $410 million) totaled $5.9 billion at March 31, 2007, representing 10.6% of Sovereign’s loan portfolio, compared to $5.3 billion, or 8.4%, of the loan portfolio at December 31, 2006 and $4.9 billion or 10.8% of the loan portfolio at March 31, 2006.

Non-Performing Assets

At March 31, 2007, Sovereign’s non-performing assets increased by $42.8 million to $278.4 million compared to $235.6 million at December 31, 2006. This increase is due primarily to non-accrual commercial loans as well as an increase in residential non-accrual loans and other real estate owned. Non-performing assets as a percentage of total loans, real estate owned and repossessed assets weakened to 0.50% at March 31, 2007 from 0.43% at December 31, 2006. Sovereign generally places all commercial loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer and residential loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved for. Loans secured by residential real estate with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved for or charged off.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

The following table presents the composition of non-performing assets at the dates indicated (amounts in thousands):


	March 31,			December 31,
	2007			2006
Non-accrual loans:
Consumer:
Residential mortgages	$	62,864		$	47,687
Home equity loans and lines of credit		12,131			10,312
Auto loans and other consumer loans		1,920			2,955

Total consumer loans		76,915			60,954
Commercial		76,668			69,207
Commercial real estate		82,835			75,710
Multifamily		5,061			1,486


Total non-accrual loans		241,479			207,357
Restructured loans		552			557


Total non-performing loans ⁽²⁾		242,031			207,914


Other real estate owned		29,655			22,562
Other repossessed assets		6,722			5,126


Total other real estate owned and other repossessed assets		36,377			27,688


Total non-performing assets ⁽²⁾	$	278,408		$	235,602


Past due 90 days or more as to interest or principal and accruing interest	$	46,729		$	40,103
Annualized net loan charge-offs to average loans ⁽³⁾		.16	%		.96	%
Non-performing assets as a percentage of total assets ^{(2) (4)}		.34	%		.29	%
Non-performing loans as a percentage of total loans ^{(2) (4)}		.43	%		.38	%
Non-performing assets as a percentage of total loans and real estate owned ^{(2) (4)}		.50	%		.43	%
Allowance for credit losses as a percentage of total non-performing assets ^{(2) (1)}		180.8	%		206.4	%
Allowance for credit losses as a percentage of total non-performing loans ^{(2) (1)}		207.9	%		233.9	%


(1)		Allowance for credit losses is comprised of the allowance for loan losses and the reserve for unfunded commitments, which is included in other liabilities.

(2)		Non-performing loans and assets at March 31, 2007 exclude $22.4 million of correspondent home equity loans that were written down to fair value at March 31, 2007 since they were previously classified as held for sale at December 31, 2006. Sovereign has reclassified these loans back into our loan portfolio as of March 31, 2007. Non-performing loans and assets at December 31, 2006 exclude $21.5 million of residential non-accrual loans and $66.0 million of home equity non-accrual loans that were classified as held for sale.

(3)		Includes lower of cost of market adjustments resulting in a charge-off of $382.5 million on the correspondent home equity loans and a charge-off of approximately $7.1 million on the purchased residential mortgage portfolio both of which were classified as held for sale at December 31, 2006. These charge-offs accounted for 71 basis points of the total 96 basis points above.

(4)		The calculation of these ratios at March 31, 2007 excludes approximately $584 million of loans that have been marked down to fair value as of March 31, 2007. The calculation of these ratios at December 31, 2006 excludes $7.6 billion of loans held for sale.

Loans ninety (90) days or more past due and still accruing interest increased by $6.6 million from December 31, 2006 to March 31, 2007, mostly attributable to increases of $7.0 million in the home equity loans.

Potential problem loans (commercial loans delinquent more than 30 days but less than 90 days, although not currently classified as non-performing loans) amounted to approximately $153.2 million and $102.1 million at March 31, 2007 and December 31, 2006, respectively. This increase in potential problem loans relates primarily to a mild weakening of the credit quality of our commercial loan portfolio. As a percentage of total loans, potential problem loans were 0.27% and 0.16% at March 31, 2007 and December 31, 2006.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Allowance for Credit Losses

The following table presents the allocation of the allowance for loan losses and the percentage of each loan type to total loans at the dates indicated (amounts in thousands):


	March 31, 2007					December 31, 2006
			% of					% of
			Loans					Loans
			to					to
			Total					Total
	Amount		Loans			Amount		Loans
Allocated allowance:
Commercial loans	$	382,465		53	%	$	375,014		49	%
Consumer loans secured by real estate		49,945		36			45,521		43
Consumer loans not secured by real estate		51,977		11			45,730		8
Unallocated allowance		2,899		n/a			4,765		n/a


Total allowance for loan losses	$	487,286		100	%	$	471,030		100	%
Reserve for unfunded lending commitments		16,016					15,255


Total allowance for credit losses	$	503,302				$	486,285

The allowance for loan losses and reserve for unfunded lending commitments are maintained at levels that management considers adequate to provide for losses based upon an evaluation of known and inherent risks in the loan portfolio. Management’s evaluation takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans with loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. While management uses the best information available to make such evaluations, future adjustments to the allowance for credit losses may be necessary if conditions differ substantially from the assumptions used in making the evaluations.

The allowance for loan losses consists of two elements: (i) an allocated allowance, which is comprised of allowances established on specific loans, and class allowances based on historical loan loss experience adjusted for current trends and adjusted for both general economic conditions and other risk factors in the Company’s loan portfolios, and (ii) an unallocated allowance to account for a level of imprecision in management’s estimation process.

The specific allowance element is calculated in accordance with SFAS No. 114 “Accounting by Creditors for Impairment of a Loan” and SFAS No. 118 “Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosure” and is based on a regular analysis of criticized commercial loans where internal credit ratings are below a predetermined quality level. This analysis is performed by the Managed Assets Division, and periodically reviewed by other parties, including the Commercial Asset Review Department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity.

The class allowance element is determined by an internal loan grading process in conjunction with associated allowance factors. These class allowance factors are evaluated at least quarterly and are the result of detailed analysis to estimate loan losses. The loss analysis is based on actual historical loss experience and considers: levels and trends in delinquencies and charge-offs, trends in loan volume and terms, changes in risk composition and underwriting standards, experience and ability of staff, economic and industry conditions, and effects of any credit concentrations.

Additionally, the Company reserves for certain inherent, but undetected, losses that are probable within the loan portfolio. This is due to several factors, such as, but not limited to, inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions and the interpretation of economic trends. While this analysis is conducted at least quarterly, the Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification.

Regardless of the extent of the Company’s analysis of customer performance, portfolio evaluations, trends or risk management processes established a level of imprecision will always exist due to the judgmental nature of loan portfolio and/or individual loan evaluations. The Company maintains an unallocated allowance to recognize the existence of these exposures.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

These risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results. A comprehensive analysis of the allowance for loan losses and reserve for unfunded lending commitments is performed by the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on at least an annual basis.

In addition to the Allowance for Loan Losses, we also estimate probable losses related to unfunded lending commitments. Unfunded lending commitments are subject to individual reviews, and are analyzed and segregated by risk according to the Corporation’s internal risk rating scale. These risk classifications, in conjunction with an analysis of historical loss experience, current economic conditions and performance trends within specific portfolio segments, and any other pertinent information result in the estimation of the reserve for unfunded lending commitments. Additions to the reserve for unfunded lending commitments are made by charges to the provision for credit losses.

The factors supporting the allowance for loan losses and the reserve for unfunded lending commitments do not diminish the fact that the entire allowance for loan losses and the reserve for unfunded lending commitments are available to absorb losses in the loan portfolio and related commitment portfolio, respectively. The Company’s principal focus, therefore, is on the adequacy of the total allowance for loan losses and reserve for unfunded lending commitments.

The allowance for loan losses and the reserve for unfunded lending commitments are subject to review by banking regulators. The Company’s primary bank regulators regularly conduct examinations of the allowance for loan losses and reserve for unfunded lending commitments and make assessments regarding their adequacy and the methodology employed in their determination.

Commercial Portfolio. The portion of the allowance for loan losses related to the commercial portfolio has increased from $375.0 million at December 31, 2006 to $382.5 million at March 31, 2007. This is a result of an increase in criticized assets at March 31, 2007 and loan growth which required additional reserves. As a percentage of commercial loans the allowance increased from 1.23% to 1.30% at March 31, 2007 which reflects the mild weakening of the commercial loan portfolio that was noted during the first quarter.

Consumer Secured by Real Estate Portfolio. The allowance for the consumer loans secured by real estate portfolio remained relatively consistent at $49.9 million at March 31, 2007 from $45.5 million at December 31, 2006. As a percentage of consumer loans secured by real estate the allowance was also consistent at 23 basis points reflecting the continued favorable credit experience for this portfolio.

During the second quarter of 2006, Sovereign entered into a credit default swap on a portion of its residential real estate loan portfolio through a synthetic securitization structure. Under the terms of the credit default swap, Sovereign is responsible for the first ten basis points of losses on the $3.6 billion residential real estate loan portfolio. Sovereign is reimbursed for losses above ten basis points up to aggregate losses of 120 basis points under the terms of the credit default swap. This credit default swap term is equal to the term of the loan portfolio. The structure resulted in fewer reserves being allocated to the residential loan portfolio as a portion of the losses are reimbursed through the credit default swap.

Consumer Not Secured by Real Estate Portfolio. The allowance for the consumer not secured by real estate portfolio increased from $45.7 million at December 31, 2006 to $52.0 million at March 31, 2007 primarily due to an increase of $678 million in auto loans. As a result of this loan growth the allowance for loan losses increased.

Unallocated Allowance. The unallocated allowance for loan losses decreased to $2.9 million at March 31, 2007 from $4.8 million at December 31, 2006. Management continuously evaluates its class allowance reserving methodology; however the unallocated allowance is subject to changes each reporting period due to a level of imprecision in management’s estimation process.

Reserve for unfunded lending commitments. The reserve for unfunded lending commitments has increased from $15.3 million at December 31, 2006 to $16.0 million at March 31, 2007 due to changes in the amounts of unfunded commitments during these time periods.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Investment Securities

Investment securities consist primarily of mortgage-backed securities, tax-free municipal securities, U.S. Treasury and government agency securities, corporate debt securities and stock in the Federal Home Loan Bank of Pittsburgh (“FHLB”), Freddie Mac and Fannie Mae. Mortgage-backed securities consist of pass-throughs and collateralized mortgage obligations issued by federal agencies or private label issuers. Sovereign’s mortgage-backed securities are generally either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by Standard and Poor’s and Moody’s at the date of issuance. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. The effective duration of the available for sale investment portfolio at March 31, 2007 was 4.1 years.

Total investment securities available-for-sale were $13.6 billion at March 31, 2007 and $13.9 billion at December 31, 2006. The reason for the decrease is due to maturation of US Treasury securities that were not reinvested. For additional information with respect to Sovereign’s investment securities, see Note 3 in the Notes to Consolidated Financial Statements.

Other investments, which consists primarily of FHLB stock, decreased to $703.7 million at March 31, 2007 from $1.0 billion at December 31, 2006 as the Company sold FHLB stock given the reduced level of FHLB borrowings as a result of the balance sheet restructuring.

Goodwill and Core Deposit Intangible Assets

Goodwill remained constant at $5.0 billion at both March 31, 2007 and December 31, 2006 and core deposit intangibles decreased by $32.2 million since December 31, 2006 due to quarter-to-date amortization expense. There were no goodwill or core deposit intangible asset impairment charges recorded in 2006 and through March 31, 2007.

The estimated aggregate amortization expense related to core deposit intangibles for each of the five succeeding calendar years ending December 31, is (in thousands):


	Calendar				Remaining
	Year		Recorded		Amount
Year	Amount		To Date		To Record
2007	$	122,897	$	32,190	$	90,707
2008		100,467		—		100,467
2009		71,341		—		71,341
2010		56,617		—		56,617
2011		44,963		—		44,963

Deposits and Other Customer Accounts

Sovereign attracts deposits within its primary market area with an offering of deposit instruments including demand accounts, NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits and other customer accounts at March 31, 2007 were $52.6 billion compared to $52.4 billion at December 31, 2006.

Borrowings and Other Debt Obligations

Sovereign utilizes borrowings and other debt obligations as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the FHLB provided certain standards related to creditworthiness have been met. Sovereign also utilizes reverse repurchase agreements, which are short-term obligations collateralized by securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof, and federal funds lines with other financial institutions. Total borrowings at March 31, 2007 and December 31, 2006 were $19.2 billion and $26.8 billion, respectively. This decline is due to the balance sheet restructuring that was previously discussed. See Note 6 for further discussion.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Off Balance Sheet Arrangements

Securitization transactions contribute to Sovereign’s overall funding and regulatory capital management. These transactions involve periodic transfers of loans or other financial assets to special purpose entities (“SPEs”). The SPEs are either consolidated in or excluded from Sovereign’s consolidated financial statements depending on whether the transactions qualify as a sale of assets in accordance with SFAS No. 140, “Transfers of Financial Assets and Liabilities” (“SFAS No. 140”).

In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has interests that continue to be held in the QSPEs. Off-balance sheet QSPEs had $1.1 billion of assets that Sovereign sold to the QSPEs which are not included in Sovereign’s Consolidated Balance Sheet at March 31, 2007. Sovereign’s interests that continue to be held and servicing assets in such QSPEs was $82.5 million at March 31, 2007 and this amount represents Sovereign’s maximum exposure to credit losses related to these unconsolidated securitizations. Sovereign does not provide contractual legal recourse to third party investors that purchase debt or equity securities issued by the QSPEs beyond the credit enhancement inherent in Sovereign’s subordinated interests in the QSPEs. At March 31, 2007, there are no known events or uncertainties that would result in or are reasonably likely to result in the termination or material reduction in availability to Sovereign’s access to off-balance sheet markets. See Note 12 for a description of Sovereign’s interests that continue to be held in its off-balance sheet asset securitizations.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Bank Regulatory Capital

The Financial Institutions Reform, Recovery and Enforcement Act (“FIRREA”) requires institutions regulated by the Office of Thrift Supervision (OTS) to have a minimum leverage capital ratio equal to 3% of tangible assets and 4% of risk-adjusted assets, and a risk-based capital ratio equal to 8% as defined. The Federal Deposit Insurance Corporation Improvement Act (“FDICIA”) requires OTS regulated institutions to have minimum tangible capital equal to 2% of total tangible assets.

The FDICIA established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution’s capital tier depends upon its capital levels in relation to various relevant capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At March 31, 2007 and December 31, 2006, Sovereign Bank had met all quantitative thresholds necessary to be classified as well-capitalized under regulatory guidelines.

Federal banking laws, regulations and policies also limit Sovereign Bank’s ability to pay dividends and make other distributions to Sovereign Bancorp. Sovereign Bank is required to give prior notice to the OTS before paying any dividend. In addition Sovereign Bank must obtain prior OTS approval to declare a dividend or make any other capital distribution if, after such dividend or distribution, Sovereign Bank’s total distributions to Sovereign within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, or if Sovereign Bank is not adequately capitalized at the time. In addition, OTS prior approval would be required if Sovereign Bank’s examination or CRA ratings fall below certain levels or Sovereign Bank is notified by the OTS that it is a problem association or an association in troubled condition. The following schedule summarizes the actual capital balances of Sovereign Bank at March 31, 2007 and December 31, 2006 (in thousands):


							TIER 1			TOTAL
				TIER 1			RISK-BASED			RISK-BASED
	TANGIBLE			LEVERAGE			CAPITAL TO			CAPITAL TO
	CAPITAL TO			CAPITAL TO			RISK			RISK
	TANGIBLE			TANGIBLE			ADJUSTED			ADJUSTED
REGULATORY CAPITAL	ASSETS			ASSETS			ASSETS			ASSETS
Sovereign Bank at March 31, 2007:
Regulatory capital	$	5,203,946		$	5,203,946		$	4,959,437		$	6,687,655
Minimum capital requirement (1)		1,530,860			3,061,720			2,551,559			5,103,117


Excess	$	3,673,086		$	2,142,226		$	2,407,878		$	1,584,538


Sovereign Bank capital ratio		6.80	%		6.80	%		7.77	%		10.48	%

Sovereign Bank at December 31, 2006:
Regulatory capital	$	5,224,710		$	5,224,710		$	5,023,535		$	6,726,462
Minimum capital requirement (1)		1,679,397			3,358,794			2,671,247			5,342,494


Excess	$	3,545,313		$	1,865,916		$	2,352,288		$	1,383,968


Sovereign Bank capital ratio		6.22	%		6.22	%		7.52	%		10.07	%


(1)		Minimum capital requirement as defined by OTS Regulations.

Listed below are capital ratios for Sovereign Bancorp.


	TANGIBLE
	COMMON			TIER 1
	EQUITY TO			LEVERAGE
	TANGIBLE			CAPITAL
REGULATORY CAPITAL	ASSETS			RATIO
Capital ratio at March 31, 2007 (1)		3.95	%		6.29	%
Capital ratio at December 31, 2006 (1)		3.50	%		5.73	%


(1)		OTS capital regulations do not apply to savings and loan holding companies. These ratios are computed as if those regulations did apply to Sovereign Bancorp, Inc.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

The Sovereign Bancorp capital ratios at March 31, 2007 have increased from December 31, 2006 levels due to significant charges that were recorded in the fourth quarter of 2006 related to the balance sheet restructuring and the expense saving initiatives as discussed in our Form 10-K.

Liquidity and Capital Resources

Liquidity represents the ability of Sovereign to obtain cost effective funding to meet the needs of customers, as well as Sovereign’s financial obligations. Sovereign’s primary sources of liquidity include retail and commercial deposit gathering, Federal Home Loan Bank (FHLB) borrowings, federal funds purchases, reverse repurchase agreements and wholesale deposit purchases. Other sources of liquidity include asset securitizations, loan sales, and periodic cash flows from amortizing mortgage backed securities.

Factors which impact the liquidity position of Sovereign Bank include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, general market conditions, investment portfolio cash flows and maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of March 31, 2007, Sovereign had $12.9 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investments to be pledged as collateral for additional borrowings. Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times.

Sovereign Bancorp has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, a revolving credit agreement and access to the capital markets. Sovereign Bank may pay dividends to its parent subject to approval of the OTS, as discussed above. Sovereign also has approximately $1.8 billion of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets.

Cash and cash equivalents decreased $134.5 million from December 31, 2006. Net cash provided by operating activities was $426.0 million for 2007. Net cash provided by investing activities for 2007 was $7.0 billion and consisted primarily of proceeds from the sale of loans of $7.8 billion and the maturity or prepayment of investment securities of $3.3 billion, offset by investment purchases and the net change in loans of $2.8 billion and $1.4 billion, respectively. Net cash used by financing activities for 2007 was $7.5 billion, which was primarily due to the repayment of borrowings obligations of $8.1 billion, offset by proceeds from a senior note issuance of $0.4 billion. See the Consolidated Statement of Cash Flows for further details on our sources and uses of cash.

Sovereign’s debt agreements impose customary limitations on dividends, other payments and transactions. These limits are not expected to affect dividend payments at current levels, or if declared, reasonably anticipated increases.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Contractual Obligations and Commercial Commitments

Sovereign enters into contractual obligations in the normal course of business as a source of funds for its asset growth and its asset/liability management, to fund acquisitions, and to meet required capital needs. These obligations require Sovereign to make cash payments over time as detailed in the table below.

Contractual Obligations
(in thousands of dollars)


	Payments Due by Period
			Less than		Over 1 yr		Over 3 yrs		Over
	Total		1 year		to 3 yrs		to 5 yrs		5 yrs
FHLB advances (1)	$	15,412,560	$	7,173,930	$	1,634,956	$	975,737	$	5,627,937
Securities sold under repurchase agreements (1)		209,039		130,226		78,813		—		—
Fed Funds (1)		200,029		200,029		—		—		—
Other debt obligations (1)		4,914,287		1,104,990		1,862,597		670,075		1,276,625
Junior subordinated debentures due to Capital Trust entities (1)(2)		4,691,077		108,323		214,276		215,411		4,153,067
Certificates of deposit (1)		16,322,243		13,680,982		1,831,576		307,280		502,405
Investment partnership commitments (3)		47,193		25,883		21,181		32		97
Operating leases		814,906		100,549		170,504		143,329		400,524


Total contractual cash obligations	$	42,611,334	$	22,524,912	$	5,813,903	$	2,311,864	$	11,960,655


(1)		Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon interest rates in effect at March 31, 2007. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.

(2)		Excludes unamortized premiums or discounts.

(3)		The commitments to fund investment partnerships represent future cash outlays for the construction and development of properties for low-income housing, and historic tax credit projects. The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership or operating agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the project.

Excluded from the above table are deposits of $37.0 billion that are due on demand by customers.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Sovereign’s senior credit facility requires Sovereign to maintain certain financial ratios and to maintain a “well capitalized” regulatory status. Sovereign has complied with these covenants as of March 31, 2007 and expects to be in compliance with these covenants for the foreseeable future. However, if in the future Sovereign is not in compliance with these ratios or is deemed to be other than well capitalized by the OTS, and is unable to obtain a waiver from its lenders, Sovereign would be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any outstanding borrowings thereunder. Due to cross-default provisions in such senior credit facility, if more than $5 million of Sovereign’s debt is in default, Sovereign will be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any borrowings thereunder.

Sovereign is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to manage its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit, standby letters of credit, loans sold with recourse, forward contracts and interest rate swaps, caps and floors. These financial instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheet. The contract or notional amounts of these financial instruments reflect the extent of involvement Sovereign has in particular classes of financial instruments. Commitments to extend credit, including standby letters of credit, do not necessarily represent future cash requirements, in that these commitments often expire without being drawn upon.

Sovereign’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, standby letters of credit and loans sold with recourse is represented by the contractual amount of those instruments. Sovereign uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. For interest rate swaps, caps and floors and forward contracts, the contract or notional amounts do not represent exposure to credit loss. Sovereign controls the credit risk of its interest rate swaps, caps and floors and forward contracts through credit approvals, limits and monitoring procedures.

Amount of Commitment Expiration Per Period


	Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs
(in thousands of dollars)
Commitments to extend credit	$	19,372,474	$	9,390,242	$	3,275,536	$	3,206,779	$	3,499,917
Standby letters of credit		4,020,034		898,738		1,148,846		1,730,121		242,329
Loans sold with recourse		264,779		4,495		22,904		44,963		192,417
Forward buy commitments		650,046		650,046		—		—		—


Total commercial commitments	$	24,307,333	$	10,943,521	$	4,447,286	$	4,981,863	$	3,934,663

Sovereign’s standby letters of credit meet the definition of a guarantee under FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. These transactions are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. The weighted average term of these commitments is 3.0 years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, Sovereign would be required to honor the commitment. Sovereign has various forms of collateral, such as real estate assets and customer business assets. The maximum undiscounted exposure related to these commitments at March 31, 2007 was $4.0 billion, and the approximate value of the underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $2.9 billion. The fees related to standby letters of credit are deferred and amortized over the life of the commitment. These fees are immaterial to Sovereign’s financial statements at March 31, 2007. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Asset and Liability Management

Interest rate risk arises primarily through Sovereign’s traditional business activities of extending loans and accepting deposits. Many factors, including economic and financial conditions, movements in market interest rates and consumer preferences, affect the spread between interest earned on assets and interest paid on liabilities. In managing its interest rate risk, the Company seeks to minimize the variability of net interest income across various likely scenarios while at the same time maximizing its net interest income and net interest margin. To achieve these objectives, the treasury group works closely with each business line in the Company and guides new business. The treasury group also uses various other tools to manage interest rate risk including wholesale funding maturity targeting, investment portfolio purchase strategies, asset securitization/sale, and financial derivatives.

Interest rate risk is managed centrally by the treasury group with oversight by the Asset and Liability Committee. Management reviews various forms of analysis to monitor interest rate risk including net interest income sensitivity, market value sensitivity, repricing frequency of assets versus liabilities and scenario analysis. Numerous assumptions are made to produce these analyses including, but not limited to, assumptions on new business volumes, loan and investment prepayment rates, deposit flows, interest rate curves, economic conditions, and competitor pricing.

Sovereign simulates the impact of changing interest rates on its expected future interest income and interest expense (net interest income sensitivity). This simulation is run monthly and it includes up to twelve different stress scenarios. These scenarios shift interest rates up and down. Certain other scenarios shift short-term rates up while holding longer-term rates constant and vice versa. These shocks are instantaneous and the analysis helps management to better understand its short-term interest rate risk. Actual rate shifts do not occur in an instantaneous manner but these stress scenarios help to better highlight imbalances. This information is then used to develop proactive strategies to ensure that the Company is not overly sensitive to the future direction of interest rates.

The table below discloses the estimated sensitivity to Sovereign’s net interest income based on interest rate changes:


	The following estimated percentage
If interest rates changed in parallel by the	increase/(decrease) to net interest
amounts below at March 31, 2007	income would result

Up 100 basis points		(5.12	)%
Down 100 basis points		2.94	%

The matching of assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s interest rate sensitivity “gap.” An asset or liability is said to be interest rate sensitive within a specific time frame if it will mature or reprice within that period of time. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time frame and the amount of interest-bearing liabilities maturing or repricing within that same period of time. In a rising interest rate environment, an institution with a negative gap would generally be expected, absent the effects of other factors, to experience a greater increase in the cost of its interest-bearing liabilities than it would in the yield on its interest-earning assets, thus producing a decline in its net interest income. Conversely, in a declining rate environment, an institution with a negative gap would generally be expected to experience a lesser reduction in the yield on its interest-earning assets than it would in the cost of its interest-bearing liabilities, thus producing an increase in its net interest income.

As of March 31, 2007, the one year cumulative gap was (3.79)%, compared to (4.97)% at December 31, 2006. The impact of the previously discussed balance sheet restructuring has brought this ratio closer to 0%.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations ( continued )

Finally, Sovereign calculates the market value of its balance sheet including all assets, liabilities and hedges. This market value analysis is very useful because it measures the present value of all estimated future interest income and interest expense cash flows of the Company. Management calculates a Net Portfolio Value (NPV) which is the market value of assets minus the market value of liabilities and is used to assess long-term interest rate risk. A higher NPV ratio indicates lower long-term interest rate risk and a more valuable franchise. The table below discloses Sovereign’s estimated net portfolio value based on interest rate changes:


If interest rates changed in parallel by the	Estimated NPV Ratio
amounts below at March 31, 2007	March 31, 2007			December 31, 2006
Base		11.92	%		10.87	%
Up 200 basis points		11.24	%		10.16	%
Up 100 basis points		11.74	%		10.58	%
Down 100 basis points		11.80	%		10.79	%
Down 200 basis points		11.28	%		10.33	%

Because the assumptions used are inherently uncertain, Sovereign cannot precisely predict the effect of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes, the difference between actual experience and the assumed volume and characteristics of new business and behavior of existing positions, and changes in market conditions and management strategies, among other factors.

Pursuant to its interest rate risk management strategy, Sovereign enters into hedging transactions that involve interest rate exchange agreements (swaps, caps, and floors) and forward sale or purchase commitments for interest rate risk management purposes. Sovereign’s objective in managing its interest rate risk is to provide sustainable levels of net interest income while limiting the impact that changes in interest rates have on net interest income.

Interest rate swaps are generally used to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Sovereign utilizes interest rate swaps that have a high degree of correlation to the related financial instrument.

As part of its overall business strategy, Sovereign originates fixed rate residential mortgages. It sells a portion of this production to FHLMC, FNMA, and private investors. The loans are exchanged for cash or marketable fixed rate mortgage-backed securities which are generally sold. This helps insulate Sovereign from the interest rate risk associated with these fixed rate assets. Sovereign uses forward sales, cash sales and options on mortgage-backed securities as a means of hedging against changes in interest rate on the mortgages that are originated for sale and on interest rate lock commitments.

To accommodate customer needs, Sovereign enters into customer-related financial derivative transactions primarily consisting of interest rate swaps, caps, floors and foreign exchange contracts. Risk exposure from customer positions is managed through transactions with other dealers.

Through the Company’s capital markets, mortgage-banking and precious metals activities, it is subject to trading risk. The Company employs various tools to measure and manage price risk in its trading portfolios. In addition, the Board of Directors has established certain limits relative to positions and activities. The level of price risk exposure at any given point in time depends on the market environment and expectations of future price and market movements, and will vary from period to period.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Incorporated by reference from Part I, Item 2. “Management’s Discussion and Analysis of Results of Operations and Financial Condition — Asset and Liability Management” hereof.

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended. Based on this evaluation, our principal executive officer and our principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2007. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2007, that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

Item 1 is not applicable.

Item 1A – Risk Factors

There has been no material change in the Corporation’s risk factors as previously disclosed in our Form 10-K for the fiscal year ended December 31, 2006 in response to Item 1A to Part I of such Form 10-K. Such risk factors are incorporated herein by reference.

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds.

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended March 31, 2007:

Maximum Number

Average

Total Number of

of Shares

Total

Price

Shares Purchased

that may be

Number of

Paid

as Part of Publicly

Purchased Under

Shares

Per

Announced Plans

the Plans or

Period

Purchased

Share

or Programs (1)

Programs (1)

1/1/07 through 1/31/07

51,902

25.15

N/A

19,500,000

2/1/07 through 2/28/07

130,817

25.83

N/A

19,500,000

3/1/07 through 3/31/07

75,671

25.21

N/A

19,500,000


(1)		Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40.5 million shares of common stock as of March 31, 2007. Twenty one million shares have been purchased under these repurchase programs as of March 31, 2007. All of Sovereign’s stock repurchase programs have no prescribed time limit in which to fill the authorized repurchase amount.

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 258,390 shares outside of publicly announced repurchase programs during the first quarter of 2007.

Items 3-5 are not applicable or the response is negative.

Item 6 – Exhibits

(a) Exhibits



(3.1)		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc.

(3.2)		Bylaws, as amended and restated, of Sovereign Bancorp, Inc.

(31.1)		Chief Executive Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(31.2)		Chief Financial Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(32.1)		Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(32.2)		Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.


		SOVEREIGN BANCORP, INC.
		(Registrant)

Date: May 9, 2007	/s/ Joseph P. Campanelli


		Joseph P. Campanelli,
		Chief Executive Officer and President
		(Authorized Officer)

Date: May 9, 2007	/s/ Mark R. McCollom


		Mark R. McCollom
		Chief Financial Officer
		(Principal Financial Officer)

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

EXHIBITS INDEX



(3.1)		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc.

(3.2)		Bylaws, as amended and restated, of Sovereign Bancorp, Inc.

(31.1)		Chief Executive Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(31.2)		Chief Financial Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(32.1)		Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

(32.2)		Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.