Santander Holdings USA, Inc. - Annual Report: 2008 (Form 10-K)

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-K

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

for the fiscal year ended December 31, 2008, or

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

for the transition period from N/A to                     .

SOVEREIGN BANCORP, INC.

 

(Exact name of Registrant as specified in its charter)

Virginia (State or other Jurisdiction of Incorporation or Organization)		23-2453088 (I.R.S. Employer Identification No.)
75 State Street, Boston, Massachusetts		02109
(Address of Principal Executive Offices)		(Zip Code)

(617) 346-7200Registrant’s Telephone Number

Title		Name of Exchange on Which Registered
Depository Shares for Series C non-cumulative preferred stock		NYSE
7.75% Capital Securities (Sovereign Capital Trust V)		NYSE

None

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

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act Yes o No þ

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

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

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

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

There is no common equity held by any non-affiliate of the registrant as a result of the consummation of the transaction with Banco Santander, S.A. on January 30, 2009, following which the registrant became a wholly owned subsidiary of Banco Santander, S.A.

 

 

Form 10-K Cross Reference Index

					Page
Forward-Looking Statements					3
PART I
Item 1		— Business			4-7
Item 1A		— Risk Factors			8-10
Item 1B		— Unresolved Staff Comments			10
Item 2		— Properties			11
Item 3		— Legal Proceedings			11
Item 4		— Submission of Matters to a Vote of Security Holders			11
Item 4A		— Executive Officers of the Registrant			12
PART II
Item 5		— Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities			12
Item 6		— Selected Financial Data			13
Item 7		— Management’s Discussion and Analysis of Financial Condition and Results of Operations			14-50
Item 7A		— Quantitative and Qualitative Disclosures About Market Risk			50
Item 8		— Financial Statements and Supplementary Data			50-108
Item 9		— Changes in and Disagreements with Accountants on Accounting and Financial Disclosure			109
Item 9A		— Controls and Procedures			109
Item 9B		— Other Information			109
PART III
Item 10		— Directors, Executive Officers and Corporate Governance			109-110
Item 11		— Executive Compensation			111-140
Item 12		— Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters			140
Item 13		— Certain Relationships and Related Transactions, and Director Independence			140-141
Item 14		— Principal Accounting Fees and Services			142
PART IV
Item 15		— Exhibits and Financial Statement Schedules			143-144
Signatures					145

Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign” or the “Company”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (the “SEC” or the “Commission”) (including this Annual Report on Form 10-K and the Exhibits hereto), in its reports to shareholders (including its 2008 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the statements made by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

These forward-looking statements include statements with respect to Sovereign’s vision, mission, strategies, goals, beliefs, plans, objectives, expectations, anticipations, estimates, intentions, financial condition, results of operations, future performance and business of Sovereign. Although Sovereign believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors (some of which are beyond Sovereign’s control). Among the factors, which could cause Sovereign’s financial performance to differ materially from that expressed in the forward-looking statements are:

	•		the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts operations, which may affect, among other things, the level of non-performing assets, charge-offs, and provision for credit losses;
	•		the effects of, or policies determined by the Federal Deposit Insurance Corporation, 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, which may, among other things reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets;
	•		adverse movements and volatility in debt and equity capital markets;
	•		adverse changes in the securities markets, including those related to the financial condition of significant issuers in our investment portfolio;
	•		revenue enhancement initiatives may not be successful in the marketplace or may result in unintended costs;
	•		changing market conditions may force us to alter the implementation or continuation of cost savings or revenue enhancement strategies;
	•		Sovereign’s timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers;
	•		the willingness of customers to substitute competitors’ products and services and vice versa;
	•		the ability of Sovereign and its third party vendors to convert and maintain Sovereign’s data processing and related systems on a timely and acceptable basis and within projected cost estimates;
	•		the impact of changes in financial services policies, laws and regulations, including laws, regulations and policies concerning taxes, banking, capital, liquidity, proper accounting treatment, securities and insurance, and the application thereof by regulatory bodies and the impact of changes in and interpretation of generally accepted accounting principles in the United States;
	•		technological changes;
	•		competitors of Sovereign may have greater financial resources and develop products and technology that enable those competitors to compete more successfully than Sovereign;
	•		changes in consumer spending and savings habits;
	•		acts of terrorism or domestic or foreign military conflicts; and acts of God, including natural disasters;
	•		regulatory or judicial proceedings;
	•		changes in asset quality;
	•		the outcome of ongoing tax audits by federal, state and local income tax authorities may require additional taxes be paid by Sovereign as compared to what has been accrued or paid as of period end.
	•		Sovereign’s success in managing the risks involved in the foregoing.

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

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

PART I

Item 1 — Business

General

Sovereign is the parent company of Sovereign Bank (“Sovereign Bank” or “the Bank”), a federally chartered savings bank. Sovereign had approximately 750 community banking offices, over 2,300 ATMs and 11,643 team members as of December 31, 2008 with principal markets in the Northeastern United States. Sovereign’s primary business consists of attracting deposits from its network of community banking offices, and originating small business and middle market commercial loans, multi-family loans, residential mortgage loans, home equity loans and lines of credit, and auto and other consumer loans in the communities served by those offices.

Sovereign is a Virginia business corporation and its principal executive offices are located at 75 State Street, Boston, Massachusetts. Sovereign Bank is headquartered in Wyomissing, Pennsylvania, a suburb of Reading, Pennsylvania.

Sovereign was incorporated in 1987 as a holding company for Sovereign Bank. Sovereign Bank was created in 1984 under the name Penn Savings Bank, F.S.B. through the merger of two financial institutions with market areas primarily in Berks and Lancaster counties, Pennsylvania. Sovereign Bank assumed its current name on December 31, 1991. Sovereign has acquired 28 financial institutions, branch networks and/or related businesses since 1990. Eighteen of these acquisitions, with assets totaling approximately $52 billion, have been completed since 1995. Sovereign’s latest acquisition was Independence Community Bank Corp. (“Independence”) effective June 1, 2006 for $42 per share in cash, representing an aggregate transaction value of $3.6 billion. Sovereign funded this acquisition using the proceeds from a $2.4 billion equity offering to Banco Santander S.A. (“Santander”), net proceeds from issuances of perpetual and trust preferred securities, and cash on hand. Sovereign issued 88.7 million shares to Santander, in connection with the equity offering which made Santander Sovereign’s largest shareholder.

On January 30, 2009, Sovereign became a wholly owned subsidiary of Santander. Pursuant to a Transaction Agreement, dated October 13, 2008, between Sovereign and Santander (the “Transaction Agreement”), Santander acquired all of the outstanding shares of the Company’s common stock that it did not already own in exchange for the right to receive 0.3206 Santander American Depository Shares, or ADSs, for each share of Company common stock. As a result of the Santander transaction, the Company’s state of incorporation changed from Pennsylvania to Virginia.

Subsidiaries

Sovereign had three direct consolidated wholly-owned subsidiaries at December 31, 2008: Sovereign Bank is the only material subsidiary.

Employees

At December 31, 2008, Sovereign had 10,235 full-time and 1,408 part-time employees. None of these employees are represented by a collective bargaining agreement, and Sovereign believes it enjoys good relations with its personnel.

Competition

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

Environmental Laws

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

Supervision and Regulation

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

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

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

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

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

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

Control of Sovereign. Under the Savings and Loan Holding Company Act and the related Change in Bank Control Act (the “Control Act”), individuals, corporations or other entities acquiring Sovereign common stock may, alone or together with other investors, be deemed to control Sovereign and thereby Sovereign Bank. If deemed to control Sovereign, such person or group will be required to obtain OTS approval to acquire Sovereign’s common stock and could be subject to certain ongoing reporting procedures and restrictions under federal law and regulations. Ownership of more than 10% of the capital stock may be deemed to constitute “control” if certain other control factors are present.

In May 2006, Sovereign and Santander entered into an Investment Agreement, pursuant to which, among other things, Santander purchased from Sovereign 88.7 million shares of Sovereign’s common stock for $2.4 billion in cash. In general the Investment Agreement contains a number of important restrictions on both Sovereign and Santander, including (i) certain standstill provisions that restrict Santander from purchasing securities of Sovereign, making an offer to purchase securities of Sovereign, or taking certain other actions, in each case unless certain conditions are satisfied and (ii) restrictions on the ability of Sovereign to solicit any acquisition proposals and on the manner in which Sovereign may respond to unsolicited acquisition proposals and obligations to provide Board representation to Santander. The proceeds of Santander’s investment were used to acquire the common stock of Independence. This investment was approved by the OTS. If Santander acquires 25% or more of Sovereign’s stock, Sovereign will no longer be a savings and loan holding company and will no longer be regulated by the OTS, although Sovereign Bank will continue to be regulated by the OTS as long as it remains a federal savings bank. For a more detailed description of the Investment Agreement, please see Part III — Item 12 of this Form 10-K.

On October 13, 2008, Sovereign and Santander entered into the Transaction Agreement whereby Santander agreed to acquire all the outstanding shares of Sovereign not currently owned by it. Sovereign Bancorp, Inc. will merge with and into a wholly owned subsidiary of Sovereign organized under the laws of the Commonwealth of Virginia and immediately thereafter, pursuant to a share exchange under Virginia law, become a wholly owned subsidiary of Santander.

In late January 2009, stockholders of both Santander and Sovereign agreed to the terms of the transaction agreement. On January 30, 2009, Sovereign was acquired by Santander.

Santander is one of the largest banks in the world by market capitalization. It has more than 14,000 branches and more than 90 million customers in over 40 countries. It is the largest financial group in Spain and Latin America, and has a significant presence elsewhere in Europe, including the United Kingdom through its Abbey subsidiary and Portugal, where it is the third largest banking group. It also operates a leading consumer finance franchise in Germany, Italy, Spain and thirteen other European countries.

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

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

If capital has reached the significantly or critically undercapitalized levels, further material restrictions can be imposed, including restrictions on interest payable on accounts, dismissal of management and (in critically undercapitalized situations) appointment of a receiver or conservator. Critically undercapitalized institutions generally may not, beginning 60 days after becoming critically undercapitalized, make any payment of principal or interest on their subordinated debt. All but well-capitalized institutions are prohibited from accepting brokered deposits without prior regulatory approval. Pursuant to the FDIA and OTS regulations, savings associations which are not categorized as well capitalized or adequately-capitalized are restricted from making capital distributions which include cash dividends, stock redemptions or repurchases, cash-out mergers, interest payments on certain convertible debt and other transactions charged to the capital account of a savings association. At December 31, 2008, Sovereign Bank met the criteria to be classified as “well-capitalized.”

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

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

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

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

The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC insured limits, which in early October 2008, the U.S. government increased to $250,000 per depositor interest bearing account and provided unlimited insurance on non-interest bearing accounts. The FDIC Board of Directors has established a reserve ratio target percentage of 1.25%. This means that their “target” balance for the reserves is 1.25% of estimated insured deposits. Due to recent bank failures, the reserve ratio is currently significantly below its target balance. The FDIC has recently announced that deposit assessment rates will double effective in the first quarter of 2009, and in the second quarter of 2009, additional fees will be assessed to institutions who have secured borrowings in excess of 15% of their deposits. Sovereign anticipates that these new assessments will increase our general and administrative costs by approximately $50 million to $73 million depending on factors such as our 2009 deposit and borrowing levels. Additionally, on February 27, 2009, the FDIC adopted an Emergency Special Assessment Rule under which all insured depository institutions would pay a one-time assessment fee of 20 basis points. The assessment would be made on June 30, 2009 using the institutions deposit base at that time. At our current deposit base, this one-time assessment would cost Sovereign approximately $90 million in 2009. The interim rule also permits the FDIC to impose an additional special assessment of 10 basis points after June 30, 2009, if necessary to maintain public confidence in federal deposit insurance, or if the insurance fund falls to or below zero. Although this interim rule was adopted by the FDIC, it is subject to a 30 day comment period before becoming final and it is possible that these fee assessments may be reduced. In early March 2009, the FDIC requested an increase in their line of credit with the U.S. Treasury from $30 billion to $100 billion. If the increase is approved the FDIC has indicated that they will reduce the one-time assessment from 20 basis points to 10 basis points. Sovereign may be able to pass part or all of this cost onto its customers in the form of lower interest rates on deposits depending on market conditions.

In addition to deposit insurance premiums, all insured institutions are required to pay a Financing Corporation assessment, in order to fund the interest on bonds issued to resolve thrift failures in the 1980s. In 2008, Sovereign paid Finance Corporation Assessments of $5.3 million. The annual rate (as of the first quarter of 2009) for all insured institutions is $0.114 for every $1,000 in domestic deposits which is consistent with what was paid in 2008. These assessments are revised quarterly and will continue until the bonds mature in the year 2017.

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

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

Qualified Thrift Lender. Prior to January 30, 2009, Sovereign Bank was required to meet a qualified thrift lender test to avoid certain restrictions on their operations. The test under HOLA requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments. As an alternative, the savings institution under HOLA may maintain 60% of its assets in those assets specified in Section 7701(a) (19) of the Internal Revenue Code. Under either test, such assets primarily consist of residential housing related loans, certain consumer and small business loans, as defined by the regulations, and mortgage related investments. At December 31, 2008, Sovereign was not in compliance with the QTL test. However, under HOLA, bank holding companies such as Santander, as well as any companies they control, are not subject to the QTL test. Consequently, effective upon the acquisition by Santander of all of Sovereign’s common stock, Sovereign Bank became exempt from the QTL test.

Other Loan Limitations. Federal law limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. Separate from the qualified thrift lender test, the law limits a savings institution to a maximum of 20% of its total assets in commercial loans not secured by real estate, however, only 10% can be large commercial loans not secured by real estate (defined as loans in excess of $2 million), with another 10% of assets permissible in “small business loans.” Commercial loans secured by real estate can be made in an amount up to four times an institution’s total risk-based capital. An institution can also have commercial leases, in addition to the above items, up to 10% of its assets. Commercial paper, corporate bonds, and consumer loans taken together cannot exceed 35% of an institution’s assets. For this purpose, however, residential mortgage loans and credit card loans are not considered consumer loans, and are both unlimited in amount. The foregoing limitations are established by statute, and cannot be waived by the OTS.

In late 2006 and in the first quarter of 2007, Sovereign completed a balance sheet restructuring which involved the sale of approximately $8 billion of assets consisting of correspondent home equity loans, purchased residential loans, multi-family loans, and certain investments. These sales were completed to enable Sovereign to reduce lower yielding and/or higher credit risk assets classes and pay down higher cost borrowings. Additionally, Sovereign began to focus on increasing the amount of higher yielding commercial loans which was expected to improve profitability. Although, Sovereign continues to originate residential and multi-family loans, the loans are primarily sold after origination into the secondary markets. As a result of this change in strategy, Sovereign commercial loans in total and as a percentage of assets increased in 2007 and 2008.

Currently, Sovereign is in compliance with the loan limitation statutes described above; however, Sovereign has had to temporarily increase the amount of assets throughout the latter half of 2007 and in certain periods during 2008 that were not considered large commercial loans in order to comply with the above loan limitations. These temporary increases in assets was funded by increasing short-term borrowings with the FHLB. Towards the latter half of 2008, the Company began to aggressively manage its commercial loan portfolio to ensure that only our most profitable customers on a risk adjusted basis continued to transact with the Bank. This strategy has led to a reduction in the amount of HOLA eligible loans that reside on our balance sheet. We expect to be in compliance with this statute in 2009.

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

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

Federal Home Loan Bank System. The FHLB System was created in 1932 and consists of twelve regional FHLBs. The FHLBs are federally chartered but privately owned institutions created by U.S. Congress. The Federal Housing Finance Board is an agency of the federal government and is generally responsible for regulating the FHLB System. Each FHLB is owned by its member institutions. The primary purpose of the FHLBs is to provide funding to their members for making housing loans as well as for affordable housing and community development lending. FHLBs are generally able to make advances to their member institutions at interest rates that are lower than could otherwise be obtained by such institutions. As a member, Sovereign is required to make minimum investments in FHLB stock based on the level of borrowings from the FHLB. Sovereign Bank is a member of FHLB Pittsburgh, Boston, and New York and has investments of $644.4 million, $4.2 million and $25.9 million, respectively. Sovereign utilized advances from the FHLB to fund balance sheet growth and provide liquidity. Sovereign had access to advances with the FHLB of up to $24 billion and had outstanding advances of $13.3 billion at December 31, 2008. The level of borrowings capacity Sovereign Bank has with the FHLB is contingent upon the level of qualified collateral the Bank holds at a given time.

In December, the FHLB of Pittsburgh announced it was suspending dividends on its stock and that it would not repurchase any excess capital stock in order to maintain their liquidity and capital position. We have considered these developments and concluded that our investment in FHLB Pittsburgh is not impaired. However we will continue to closely monitor this investment in future periods.

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

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

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

Corporate Information. All reports filed electronically by Sovereign with the SEC, including the Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, and Current Reports on Form 8-K, as well as any amendments to those reports, are accessible at no cost on Sovereign’s Web site at www.sovereignbank.com as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC. These filings are also accessible on the SEC’s Web site at www.sec.gov. Also, copies of the Company’s annual report will be made available, free of charge, upon written request.

Item 1A — Risk Factors

The following list describes several risk factors that are applicable to our Company:

	•		The Current Economic Downturn May Continue to Deteriorate Our Asset Quality and Adversely Affect Our Earnings and Cash Flow.
			Our business faces various material risks, including credit risk and the risk that the demand for our products will decrease. In a recession or other economic downturn, these risks would probably become more acute. In an economic downturn, our credit risk and associated provision for credit losses and legal expense will increase. Also, decreases in consumer confidence, real estate values, and interest rates, usually associated with a downturn, could combine to make the types of loans we originate less profitable and could cause elevated levels of losses on our commercial and consumer loans. Current economic conditions may continue to deteriorate which would likely continue to adversely impact our results.
	•		Disruptions in the Global Financial Markets have Affected, and May Continue to Adversely Affect, Sovereign’s Business and Results of Operations.
			Dramatic declines in the housing market during 2008, with falling home prices and increasing foreclosures and unemployment, have resulted in significant write-downs of asset values by financial institutions, including government-sponsored entities and major commercial and investment banks. These write-downs, initially of mortgage-backed securities but spreading to credit default swaps and other derivatives, have caused many financial institutions to seek additional capital and to merge with other financial institutions. Disruptions in the global financial markets have also adversely affected the corporate bond markets, debt and equity underwriting and other elements of the financial markets. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, some lenders and institutional investors have reduced and, in some cases, ceased to provide funding to certain borrowers, including other financial institutions. The impact on available credit, increased volatility in the financial markets and reduced business activity has adversely affected, and may continue to adversely affect, Sovereign’s businesses, capital, liquidity or other financial condition and results of operations, access to credit and the trading price of Sovereign preferred stock or debt securities.
	•		Sovereign May Experience Further Write-Downs of its Financial Instruments and Other Losses Related to Volatile and Illiquid Market Conditions.
			Market volatility, illiquid market conditions and disruptions in the credit markets have made it extremely difficult to value certain of Sovereign’s assets. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these assets in future periods. In addition, at the time of any sales of these assets, the price Sovereign ultimately realizes will depend on the demand and liquidity in the market at that time and may be materially lower than their current fair value. Any of these factors could require Sovereign to take further write-downs in respect of these assets, which may have an adverse effect on the Company’s results of operations and financial condition in future periods.
	•		Liquidity is Essential to Sovereign’s Businesses, and Sovereign Relies on External Sources, Including Government Agencies to Finance a Significant Portion of its Operations.
			Adequate liquidity is essential to Sovereign’s businesses. The Company’s liquidity could be materially adversely affected by factors Sovereign cannot control, such as the continued general disruption of the financial markets or negative views about the financial services industry in general. In addition, Sovereign’s ability to raise funding could be impaired if lenders develop a negative perception of the Company’s short-term or long-term financial prospects, or a perception that the Company is experiencing greater liquidity risk. Recent regulatory measures, such as the FDIC’s temporary guarantee of the newly issued senior debt are designed to stabilize the financial markets and the liquidity position of financial institutions such as Sovereign. It is unclear whether, or for how long, these facilities will be extended and what impact termination of any of these facilities could have on Sovereign’s ability to access funding in the future. Sovereign’s credit ratings are also important to its liquidity. A reduction in Sovereign’s credit ratings could adversely affect its liquidity, widen its credit spreads or otherwise increase its borrowing costs.
	•		Recently Enacted Legislation Authorizing the U.S. Government to Take Direct Action Within the Financial Services Industry, and Other Legislation and Regulation Currently Under Consideration, May Not Stabilize the U.S. Financial System in the Near Term.
			On October 3, 2008, the Emergency Economic Stabilization Act of 2008 (EESA) was signed into law. In addition, on February 17, 2009, the American Recovery and Reinvestment Act of 2009 (ARRA) was signed by President Obama. The purpose of these U.S. government actions is to stabilize and provide liquidity to the U.S. financial markets and jumpstart the U.S. economy. The U.S. government is currently considering, and may consider in the future, additional legislation and regulations with similar purposes. The EESA, ARRA and other governmental programs may not have their intended impact of stabilizing, providing liquidity to or restoring confidence in the financial markets. Further, the discontinuation and/or expiration of these or other governmental programs could result in a worsening of current market conditions.
	•		The Preparation of Sovereign’s Financial Statements Requires the Use of Estimates That May Vary From Actual Results.
			The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the financial statements. One example of a significant critical estimate is the level of the allowance for credit losses. Due to the inherent nature of this estimate, Sovereign cannot provide absolute assurance that it will not significantly increase the allowance for credit losses and/or sustain credit losses that are significantly higher than the provided allowance.

	•		The Preparation of Sovereign’s Tax Returns Requires the Use of Estimates & Interpretations of Complex Tax Laws and Regulations and Are Subject to Review By Taxing Authorities.
			Sovereign is subject to the income tax laws of the U.S., its states and municipalities and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and the relevant Governmental taxing authorities. In establishing a provision for income tax expense and filing returns, the Company must make judgments and interpretations about the application of these inherently complex tax laws. Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. 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”) recently examined the Company’s federal income tax returns for the years 2002 through 2005. The IRS completed this review in 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 billion. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign was subject to an additional $87.6 million and $22.5 million, respectively, of foreign taxes related to these financing transactions and claimed a corresponding foreign tax credit. The IRS issued a notification of adjustment disallowing the foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these transactions; disallowing deductions for issuance costs and interest expense related to the transaction which would result in an additional tax liability of $24.9 million; and assessed interest and penalties, the combined amount of which totaled approximately $71.0 million. In addition, the IRS has commenced its audit for the years 2006 and 2007. We expect that in the future the IRS will propose to disallow the foreign tax credits taken in 2006 and 2007 of $87.6 million and $22.5 million, respectively; disallow deductions for issuance costs and interest expense which would result in an additional tax liability of $37.1 million; and to assess interest and penalties. Sovereign expects that it will need to litigate this matter with the IRS. Sovereign continues to believe that it is entitled to claim these foreign tax credits and deductions and also believes that its recorded tax reserves for this position of $58.3 million adequately provides for any potential exposure to the IRS related to this item and other tax assessments. However, as the Company continues to go through the IRS administrative process, and if necessary litigation, we will continue to evaluate the appropriate tax reserve levels for this position and any changes made to the tax reserves may materially affect Sovereign’s income tax provision, net income and regulatory capital in future periods.
	•		Changing Interest Rates May Adversely Affect Our Profits.
			To be profitable, we must earn more money from interest on loans and investments and fee-based revenues than the interest we pay to our depositors and creditors and the amount necessary to cover the cost of our operations. Rising interest rates may hurt our income because they may reduce the demand for loans and the value of our investment securities and our loans, and increase the amount that we must pay to attract deposits and borrow funds. If interest rates decrease, our net interest income could be negatively affected if interest earned on interest-earning assets, such as loans, mortgage-related securities, and other investment securities, decreases more quickly than interest paid on interest-bearing liabilities, such as deposits and borrowings. This would cause our net interest income to go down. In addition, if interest rates decline, our loans and investments may prepay earlier than expected, which may also lower our income. Interest rates do and will continue to fluctuate, and we cannot predict future Federal Reserve Board actions or other factors that will cause rates to change. If the yield curve steepens or flattens, it could impact our net interest income in ways management may not accurately predict.
	•		We Experience Intense Competition for Loans and Deposits.
			Competition among financial institutions in attracting and retaining deposits and making loans is intense. Our most direct competition for deposits has come from commercial banks, savings and loan associations and credit unions doing business in our areas of operation, as well as from nonbanking sources, such as money market mutual funds and corporate and government debt securities. Competition for loans comes primarily from commercial banks, savings and loan associations, consumer finance companies, insurance companies and other institutional lenders. We compete primarily on the basis of products offered, customer service and price. A number of institutions with which we compete have greater assets and capital than we do and, thus, may have a competitive advantage.
	•		We Are Subject to Substantial Regulation Which Could Adversely Affect Our Business and Operations.
			As a financial institution, we are subject to extensive regulation, which materially affects our business. Statutes, regulations and policies to which we and Sovereign Bank are subject may be changed at any time, and the interpretation and the application of those laws and regulations by our regulators is also subject to change. There can be no assurance that future changes in regulations or in their interpretation or application will not adversely affect us.
			The regulatory agencies having jurisdiction over banks and thrifts have under consideration a number of possible rulemaking initiatives which impact bank and thrift and bank and thrift holding company capital requirements. Adoption of one or more of these proposed rules could have an adverse effect on us and Sovereign Bank.
			Existing federal regulations limit our ability to increase our commercial loans. We are required to maintain 65% of our assets in residential mortgage loans and certain other loans, including small business loans. We also cannot have more than 20% of our total assets in commercial loans that are not secured by real estate, however, only 10% can be large commercial loans not secured by real estate, more than 10% in small business loans, or more than four times our risk based capital in commercial real estate loans. A small business loan is one with an original amount of $2 million or less, and a large commercial loan is a loan with an original loan amount of more than $2 million. Our existing strategy is to focus loan growth on commercial loans which generally have higher yields and profitability. We may be limited in the amount of commercial loan growth that we can achieve based on the above regulations.
	•		Changes in Accounting Standards Could Impact Reported Earnings.
			The accounting standard setters, including the FASB, SEC and other regulatory bodies, periodically change the financial accounting and reporting standards that govern the preparation of Sovereign’s consolidated financial statements. These changes can be hard to predict and can materially impact how it records and reports its financial condition and results of operations. In some cases, Sovereign could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements.

	•		We Rely on Third Parties for Important Products and Services.
			Third party vendors provide key components of our business infrastructure such as loan and deposit servicing systems, internet connections and network access. Any problems caused by these third parties, including as a result of their not providing us their services for any reason or their performing their services poorly, could adversely affect our ability to deliver products and services to our customers and otherwise to conduct our business. Replacing these third party vendors could also entail significant delays and expense.
	•		Our Framework for Managing Risks May Not be Effective in Mitigating Risk and Loss to Our Company.
			Our risk management framework is made up of various processes and strategies to manage our risk exposure. Types of risks to which we are subject include liquidity risk, credit risk, market risk, interest rate risk, operational risk, legal risk, compliance risk, reputation risk and fiduciary risk, among others. Our framework to manage risk, including the framework’s underlying assumptions, may not be effective under all conditions and circumstances. If our risk management framework proves ineffective, we could suffer unexpected losses and could be materially adversely affected.
	•		Our Disclosure Controls and Procedures May Not Prevent or Detect All Errors or Acts of Fraud.
			Our disclosure controls and procedures are designed to reasonably assure that information required to be disclosed by us in reports we file or submit under the Exchange Act is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Any disclosure controls and procedures or internal controls and procedures, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met.
			These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual acts of some persons, by collusion of two or more people or by any unauthorized override of the controls. Accordingly, because of the inherent limitations in our control system, misstatements due to error or fraud may occur and not be detected.
	•		Integration Risks Exist Related to the Acquisition of the Company by Santander.
			On January 30, 2009, Sovereign was acquired by Santander. Sovereign may not be integrated successfully into the existing businesses of Santander or the integration may be more difficult, time-consuming or costly than expected. The combined company may not realize, to the extent or at the time we expect, revenue synergies and cost savings from the transaction. Deposit attrition, operating costs, customer losses and business disruptions following the transaction, including difficulties in maintaining relationships with employees, could be greater than expected.

Item 1B— Unresolved Staff Comments

None.

Item 2 — Properties

Sovereign Bank utilizes 833 buildings that occupy a total of 6.2 million square feet, including 237 owned properties with 1.8 million square feet and 596 leased properties with 4.4 million square feet. Eight major buildings contain 1.2 million square feet, which serve as the headquarters or house significant operational and administrative functions:

Columbia Park Operations Center — Dorchester, Massachusetts

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

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

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

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

601 Penn Street Loan Processing Center — Reading, Pennsylvania

1130 Berkshire Boulevard Administrative Offices — Wyomissing, Pennsylvania

1125 Berkshire Boulevard Operations Center — Wyomissing, Pennsylvania

The majority of the eight properties of Sovereign outlined above are utilized by our Shared Services Consumer Bank segment and for general corporate purposes by our Other segment. The remaining 825 properties consist primarily of bank branches and lending offices used by our Retail Banking segments.

Item 3 — Legal Proceedings

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

In the first quarter of 2008 a voluntary mediation was held in connection with a claim made against Sovereign related to an investment advisor in Massachusetts who defrauded numerous victims over a long period of time. The fraud reportedly amounted to tens of millions of dollars. The investment advisor’s companies had accounts at Sovereign. The court appointed an ancillary receiver to pursue claims against Sovereign and another bank, and the ancillary receiver filed a complaint against Sovereign. Some of the victims joined in the action as plaintiffs, and some of the claims are putative class action claims. The ancillary receiver recently filed a motion seeking class certification. Little progress was made towards a settlement at the voluntary mediation that was held in the first quarter of 2008 and the trial for this claim was held in December 2008. The court ruled that Sovereign did not have any liability related to this matter.

In the first quarter of 2008, a former employee filed a putative class action in Pennsylvania federal court alleging that the Company violated ERISA in connection with the management of certain plans. The plaintiff alleges that the Company knew or should have known that the Company’s stock was not a prudent investment for the Company’s retirement plan beginning on or about January 1, 2007. The complaint also alleges that the Company provided the putative class and the investing community with inadequate disclosure concerning the Company’s financial condition, resulting in the stock having an inflated value until the Company’s disclosures in January 2008. In April 2008, a similar putative class action was filed in the same court by another former employee. The complaint in the second action asserts that the Company caused retirement plan assets to be invested in the Company’s stock when it was imprudent to do so, caused the plan to purchase the stock while not disclosing alleged financial problems and to pay above market interest rates for a Company loan, and failed to provide complete and accurate information to participants in the plan. In July 2008, counsel for the respective plaintiffs filed a consolidated amended complaint that expanded upon the allegations set forth in the prior two actions. The class period in the consolidated amended complaint was also expanded to include the period from January 1, 2002 to present. The Company believes that the claims are without merit and intends to vigorously defend the claims.

On October 13, 2008, Sovereign and Santander entered into the Transaction Agreement whereby Santander agreed to acquire all the outstanding shares of Sovereign not currently owned by it. Sovereign received various purported class action complaints from purported shareholders alleging that Sovereign’s directors breached their fiduciary duties by entering into the Transaction Agreement. Certain of these lawsuits also allege that Santander and certain directors of the Company serving by designation by Santander pursuant to the Investment Agreement (the “Santander Directors”) breached their fiduciary duties and that the remainder of Sovereign’s directors aided and abetted the Santander Directors’ breaches of fiduciary duties. All of the complaints seek an injunction preventing the consummation of the transaction contemplated by the Transaction Agreement.

On January 21, 2009, a settlement agreement was reached between the parties which covered all persons who owned shares of Sovereign common stock from October 13, 2008 to and including the effective date of the Proposed Transaction between Santander and Sovereign. A summary of the key terms of the settlement agreement was filed on a Form 8-K filed on January 22, 2009 with the SEC.

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

None.

Item 4A — Executive Officers of the Registrant

Certain information, including principal occupation during the past five years, relating to the principal executive officers of Sovereign, as of the date of this filing are set forth below:

Gabriel Jaramillo — Age 58. Mr. Jaramillo became Chairman of the Board, President and Chief Executive Officer of the Company on January 30, 2009 and also currently serves as Chairman of each of the Executive and Risk Management Committees of the Board. He has served as a Director of Sovereign Bancorp since July 16, 2008. Mr. Jaramillo has 34 years of experience within the financial sector and served in various executive positions with Grupo Santander since 1996. Prior to his appointment to Sovereign, he most recently served as Advisor to the Chairman of Grupo Santander and was President of Banco Santander Brazil.

Kirk W. Walters — Age 53. Mr. Walters was appointed to the Sovereign Board on January 30, 2009, and also currently serves as a member of the Executive and Risk Management Committees of the Board. Mr. Walters became the Senior Executive Vice President, Chief Financial Officer and Chief Administration Officer of the Company on January 3, 2009. From September 30, 2008 to January 3, 2009, he served as the Interim President, Interim Chief Executive Officer and Chief Financial Officer of the Company. From March 3, 2008 to September 30, 2008, he served as the Chief Financial Officer of the Company. Mr. Walters joins Sovereign from Chittenden Corporation, headquartered in Burlington, VT, which was acquired by People’s United Financial, Inc., headquartered in Bridgeport, CT, in January 2008. At Chittenden, Mr. Walters served as Executive Vice President and Chief Financial Officer since 1996. Prior to joining Chittenden, he worked at Northeast Federal Corporation in Hartford, CT, from 1989-95 in a series of executive positions, including Chairman, Chief Executive Officer, President and Chief Operating Officer. From 1984-89, Mr. Walters worked for California Federal Bank in a variety of financial positions, including Senior Vice President and Controller. He began his career as an accountant at Coopers & Lybrand in Los Angeles.

Patrick J. Sullivan — Age 53. Mr. Sullivan was appointed to the position of Managing Director of Commercial Banking in 2008. Prior to being promoted to Managing Director of Commercial Banking, Mr. Sullivan was President and CEO of Massachusetts and New Hampshire. Mr. Sullivan has 30 years of experience in the banking industry and has held a variety of executive and management positions. He joined Sovereign in June of 2000 as Executive Vice President, Managing Director of Commercial Banking and Specialized Lending. Previously, he was President and Chief Executive Officer of Howard Bank.

Roy J. Lever — Age 57. Mr. Lever was appointed to the position of Managing Director of Retail Banking in 2008. Prior to joining Sovereign, Mr. Lever served nearly 33 years in a variety of senior positions with Bank of America and Fleet Bank. Most recently, he was a Senior Vice President for Global Consumer and Small Business Banking at Bank of America and where he had responsibility for the bank’s compliance, risk and operations at more than 6,000 branches.

PART II

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

During the 2008 fiscal year through January 29, 2009, Sovereign’s common stock was traded on the New York Stock Exchange (“NYSE”) under the symbol “SOV.” As of January 30,2009, all shares of Sovereign common stock were acquired by Santander and delisted from the NYSE, following which there is currently no established public trading market. As of the date of this filing, Santander was the sole holders of the Company common stock.

Market and dividend information for Sovereign’s common stock appear in Item 7 — Table 13 “Selected Consolidated Financial Data” of this Form 10-K. No dividends were paid on Sovereign’s common shares during 2008. In addition, for certain limitations on the ability of Sovereign Bank to pay dividends to Sovereign, see Part I, Item I, “Business Supervision and Regulation — Regulatory Capital Requirements” and Note 15 at Item 8, “Financial Statements and Supplementary Data.” For information regarding Sovereign’s equity compensation plans, see Part III — Item 11, “Equity Compensation Plan Information During and Prior to 2008.”

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended December 31, 2008:

Average

Total Number of

Maximum Number of

Total

Price

Shares Purchased as

Shares that may be

Number of

Paid

Part of Publicly

Purchased Under

Shares

Per

Announced Plans or

the Plans or

Period

Purchased

Share

Programs (1)

Programs (1)

10/1/08 through 10/31/08

704

$

7.46

Not Applicable

19,500,000

11/1/08 through 11/30/08

169

$

4.31

Not Applicable

19,500,000

12/1/08 through 12/31/08

720

$

2.70

Not Applicable

19,500,000

Item 6 — Selected Financial Data

		SELECTED FINANCIAL DATA
		AT OR FOR THE YEAR ENDED DECEMBER 31,
		2008				2007				2006				2005				2004
(Dollars in thousands, except per share data)
Balance Sheet Data
Total assets		$	77,093,668			$	84,746,396			$	89,641,849			$	63,678,726			$	54,489,026
Loans held for investment, net of allowance			54,300,618				56,522,575				54,505,645				43,072,670				36,102,598
Loans held for sale (1)			327,332				547,760				7,611,921				311,578				137,478
Investment securities			10,020,110				15,142,392				14,877,640				12,557,328				11,546,877
Deposits and other customer accounts			48,438,573				49,915,905				52,384,554				37,977,706				32,555,518
Borrowings and other debt obligations			20,816,224				26,126,082				26,849,717				18,720,897				16,140,128
Stockholders’ equity		$	5,596,714			$	6,992,325			$	8,644,399			$	5,810,699			$	4,988,372
Summary Statement of Operations
Total interest income		$	3,923,164			$	4,656,256			$	4,326,404			$	2,962,587			$	2,255,917
Total interest expense			2,019,853				2,792,234				2,504,856				1,330,498				819,327
Net interest income			1,903,311				1,864,022				1,821,548				1,632,089				1,436,590
Provision for credit losses (1) (2)			911,000				407,692				484,461				90,000				127,000
Net interest income after provision for credit losses(5)			992,311				1,456,330				1,337,087				1,542,089				1,309,590
Total non-interest income (1) (2)			(818,743	)			354,396				285,574				602,664				450,525
General and administrative expenses			1,541,409				1,345,838				1,289,989				1,089,204				942,661
Other expenses (2) (3)			265,793				1,874,600				313,541				163,429				236,232
(Loss)/Income before income taxes			(1,633,634	)			(1,409,712	)			19,131				892,120				581,222
Income tax provision (benefit) (9)			723,576				(60,450	)			(117,780	)			215,960				127,670
Net (Loss)/Income		$	(2,357,210	)		$	(1,349,262	)		$	136,911			$	676,160			$	453,552
Share Data
Common shares outstanding at end of period (in thousands)			663,946				481,404				473,755				358,018				345,775
Basic (loss)/earnings per share		$	(3.98	)		$	(2.85	)		$	0.30			$	1.77			$	1.34
Diluted (loss)/earnings per share		$	(3.98	)		$	(2.85	)		$	0.30			$	1.69			$	1.29
Common share price at end of period		$	2.98			$	11.40			$	25.39			$	20.59			$	21.48
Dividends declared per common share		$	—			$	.320			$	.300			$	.170			$	.115
Selected Financial Ratios
Book value per common share (4)		$	8.14			$	14.12			$	17.83			$	15.46			$	13.74
Common dividend payout ratio (5)			N/A				N/A				92.11	%			9.02	%			8.21	%
Return on average assets (6)			(2.99	)%			(1.62	)%			0.17	%			1.11	%			.90	%
Return on average equity (7)			(31.27	)%			(15.40	)%			1.82	%			11.92	%			10.74	%
Average equity to average assets (8)			9.55	%			10.52	%			9.46	%			9.34	%			8.36	%

Management’s Discussion and Analysis

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

EXECUTIVE SUMMARY

Sovereign, is a $77 billion financial institution as of December 31, 2008, with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, and Maryland. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including deposit and loan services, sales of loans and investment securities, capital markets products and bank-owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility-related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by the economic environment, including interest rates, consumer and business confidence and spending, as well as the competitive conditions within our geographic footprint. On January 30, 2009, Sovereign was acquired by Santander.

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 and diversified loan portfolio and products. Our weaknesses have included operating returns and capital ratios that are lower than certain of our peers. We have also not achieved our growth targets with respect to low cost core deposits.

We took proactive steps during the second quarter of 2008 to improve our capital position by raising $1.4 billion of common equity and $500 million of subordinated debt at Sovereign Bank. Furthermore, at September 30, 2008, we contributed $800 million of cash from our holding company in order to enhance our Bank’s capital ratios. Our capital position was negatively impacted in the second half of 2008 by the impairment charge on our Fannie Mae and Freddie Mac preferred stock of $575 million, an other than temporary impairment charge of $308 million on certain non-agency mortgage backed securities and the loss on the sale of our entire collateralized debt obligations (“CDO”) portfolio of $602 million combined with higher credit losses due to the continuing negative economic environment. The above items resulted in Sovereign recording a pre-tax loss of $1.6 billion in 2008. In 2007, Sovereign had a $1.3 billion pre-tax loss. As a result, Sovereign was in a cumulative loss position for the past three years and we expect that on a stand alone basis, without any consideration given to the merger transaction with Santander in accordance with U.S. accounting principles, 2009 results would continue to be negatively impacted by the difficult economic credit environment thus making it difficult to generate taxable income in the near term. Therefore, it was determined that on a stand alone basis it was more likely than not that deferred tax assets of $1.43 billion were not realizable and as such a valuation allowance was recorded via a charge to income tax expense. Our tangible common equity to tangible assets and tier 1 leverage for the Parent Company was 2.57% and 5.73% at December 31, 2008 compared to 4.04% and 5.89% at December 31, 2007, respectively. The Bank’s total risk based capital ratio was 10.20% compared to 10.40% a year ago. Our capital levels and ratios are in excess of the levels required to be considered well-capitalized. We continue to strengthen our balance sheet and position the Company for any further weakening in economic conditions by increasing the amount of loan loss reserves on our balance sheet. Reserves for credit losses as a percentage of total loans have increased to 2.10% at December 31, 2008 from 1.28% at December 31, 2007.

In order to further improve our operating returns, we continue to focus on acquiring and retaining customers by demonstrating convenience through our locations, technology and business approach while offering innovative and easy-to-use products and services. We are focused on a number of initiatives to improve the customer experience. During 2007, customer service personnel received refresher service training and we migrated back to having all customer service functions being domestically based. We realigned our consumer and commercial infrastructure by consolidating our commercial and retail banking management structure. We also rationalized and simplified our retail deposit product set by reducing the number of retail checking products we offer.

In the fourth quarter of 2007, we piloted a new retail deposit strategy called “Customer First” in certain markets within our footprint. The goal of Customer First is to increase deposit retention and growth rates and increase the number of products and services our customers maintain and use at Sovereign. Customer First, which is a sales model/methodology that drives consistent team member behavior in each of our 755 community banking offices, was implemented throughout our entire branch network in the first quarter of 2008. Additionally, in the first quarter of 2008, Sovereign hired a senior level executive who reports to our Chief Executive Officer to lead the Company’s Retail Banking Division. We experienced improved productivity within retail banking and improved deposit retention during the first half of 2008. In the third quarter of 2008, we experienced decreases in deposit levels, primarily in high cost money market and certificate of deposit accounts reflecting intense price competition in the marketplace for deposits and the uncertainty of the banking industry. We believe some of the deposit decreases were also due to unprecedented market events such as the failure of Washington Mutual, Inc., which was seized by the FDIC and the accelerated sale of Wachovia Corporation to Wells Fargo & Company. These events as well as other financial institution failures have led to an increase in deposit attrition, particularly for account balances in excess of FDIC insurance limits. We believe that the recent actions by the US government in early October (which included increasing deposit insurance to $250,000 per depositor interest bearing account and unlimited insurance on non-interest bearing accounts) as well as our transaction with Santander, helped the Company reclaim deposits as we were able to increase deposit balances at December 31, 2008 by $5.3 billion from September 30, 2008. Although we grew our total deposits, a large percentage of the growth was in higher cost money market and time deposit accounts which has put pressure on our net interest margin.

Market Conditions and Credit

In 2008, conditions in the housing market continued to deteriorate and there was a significant tightening of available credit in the marketplace. Declining real estate values and financial stress on borrowers resulted in higher delinquencies and greater charge-offs in 2008 compared to 2007. Credit spreads significantly widened on various asset classes in the secondary marketplace which has led to a reduction in liquidity for these asset classes.

These changing market conditions impacted our financial results in 2008 in a number of ways. We continued to see higher levels of losses on our remaining correspondent home equity portfolio due to a reduction in housing values and limited availability of credit in the marketplace which reduced refinancing options for these loan customers. Residential charge-offs totaled $26.2 million in 2008 ($14.0 million of which was related to our Alt-A portfolio which totaled $2.7 billion at December 31, 2008) compared to $7.5 million in 2007. In response to the deteriorating economic conditions and higher credit losses experienced in 2008, Sovereign increased its residential loan loss reserve to $105.8 million or 0.93% of total residential loans at December 31, 2008 compared to $38.3 million or 0.29% at December 31, 2007.

In addition to our residential and Alt-A residential loan portfolios, we saw elevated levels of losses in our auto loan portfolio in 2008. During 2007, Sovereign expanded its indirect auto loan business in the Southeastern and Southwestern United States (“the Southeast and Southwest production offices”). When we decided to expand our auto loan business into the Southeast and Southwest, we expected to see higher levels of losses than what we had historically experienced for our auto loan business in our geographic footprint given that it was a new market and economic conditions were different in these markets as compared to the Northeast. However, we had believed that our pricing was adjusted to consider this expected difference in risk. The Southeast and Southwest production offices experienced significant growth in auto loan balances in 2007. However, credit losses were significantly higher than our expectations and were the primary reasons for additional provisions for credit losses that were recorded in the second half of 2007. Charge-offs on our auto portfolio totaled $175.7 million during 2008 compared to $76.2 million in 2007. Additionally, $115.6 million of these losses were related to the Southeast and Southwest production offices. At December 31, 2008, our total auto loan portfolio was $5.3 billion of which $1.8 billion consisted of loans originated in the Southeast and Southwest production offices. At December 31, 2008 our total allowance for loan losses for the auto portfolio was $140.0 million.

Effective January 31, 2008, Sovereign ceased originating new auto loans from the Southeast and Southwest production offices. In January 2009, Sovereign ceased originating indirect auto loans within its geographic footprint as well. Sovereign has increased its reserves on its auto lending portfolios significantly over the past two years. We believe the additional provisions responds to the increased risk in our auto loan portfolio. However, deterioration in the economy of the regions where we extended these loans could have a significant continued adverse impact on the amount of credit losses we experience in 2009.

In addition to increasing the provision for credit losses for the auto loan and residential mortgage portfolios, Sovereign also increased the provision for credit losses to cover exposures in its commercial portfolio, as well as increased charge-offs. Our commercial reserves as a percentage of commercial loans increased to 2.37% at December 31, 2008, from 1.40% at December 31, 2007. This was due to an increase in the level of criticized and non-performing loans from the prior year and weakening market conditions. Additionally, we recorded additional provisions in 2008 due to growth of $0.6 billion on our commercial real estate and commercial and industrial loan portfolios.

Our total allowance for credit losses as a percentage of total loans increased to 2.10% at December 31, 2008 compared to 1.28% at December 31, 2007. We believe the reserves we have established are adequate to provide for inherent losses in our portfolio at this time. Although the credit quality of our loan portfolio will most likely have the most significant impact on our financial performance in 2009, we believe the recent steps we have taken with regards to our auto loan portfolio will reduce the credit risk in our consumer portfolio. Additionally, in 2008, we curtailed certain commercial lending related to the homebuilding industry which we believe will reduce the risk in our commercial loan portfolio.

The disruption in the residential real estate market also had a significant impact on Fannie Mae (FNMA) and Freddie Mac (FHLMC). On September 7, 2008 the U.S. Treasury, the Federal Reserve and the Federal Housing Finance Agency (FHFA) announced that the FHFA was putting Fannie Mae and Freddie Mac under conservatorship and giving management control to their regulator, the FHFA. In connection with this action, the dividends on our preferred shares were eliminated thereby significantly reducing the value of this investment which resulted in an other than temporary impairment charge we recorded in the third quarter of 2008 of $575 million.

The deteriorating economic conditions also have significantly impacted the fair value of certain non-agency mortgage backed securities. The collateral for these securities consists of residential loans originated by a diverse group of private label issuers. For the period ended December 31, 2008, it was concluded that the Company would not recover all of its outstanding principal on five bonds in our non-agency mortgage backed portfolio with a book value of $654.3 million whose fair value was $346.4 million. This resulted in a $307.9 million other than temporary impairment charge.

Sovereign also has an equity method investment in a multi-family loan broker that was determined to be impaired at December 31, 2008. This broker refers borrowers seeking financing of their multi-family and/or commercial real estate loans to Sovereign as well as other financial institutions. Substantially all of Sovereign’s multi-family loan originations are obtained through this relationship. Although this broker remained profitable in 2008, their earnings have declined from recent periods due to the current economic slowdown. Additionally, we believe earnings in future periods will remain under pressure due to the current recessionary environment. As a result, it was concluded that the fair value of this equity method investment was significantly below its carrying value and as a result recorded an impairment charge of $95 million which was recorded in “Minority interest expense and equity method investments” on the Consolidated Statement of Operations.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The banking industry has experienced significant consolidation in recent years, which is likely to continue in future periods. Consolidation may affect the markets in which Sovereign operates as new or restructured competitors integrate acquired businesses, adopt new business practices or change product pricing as they attempt to maintain or grow market share. Recent merger activity involving national, regional and community banks and specialty finance companies in the Northeastern United States, have affected the competitive landscape in the markets we serve. 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 competitors, including loan and deposit pricing, customer expectations and the capital markets.

On January 30, 2009, the Company was acquired by Santander. We believe that the acquisition of the Company by Santander will further strengthen our financial position and enable us to continue to execute our strategy of focusing on our core retail and commercial customers in our geographic footprint.

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents a significant portion of the Company’s revenues. Accordingly, the interest rate environment has a substantial impact on Sovereign’s earnings. During the third quarter of 2008, we shortened the duration of our investment portfolio in order to mitigate the impact of interest rate changes on the market value of our balance sheet. Sovereign sold $4.2 billion of longer duration mortgage backed securities and $0.5 billion of longer duration municipal securities for a gain of $29.5 million. We reinvested $3.5 billion of these securities in shorter duration agency securities. Although this transaction reduces the risk of adverse market value changes in our available for sale investment portfolio due to changes in interest rates, this action, along with the elimination of the dividends received on our Fannie Mae and Freddie Mac preferred shares and FHLB stock reduced our net interest income in the fourth quarter and will continue to do so in future periods. Net interest margin in future periods 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, loan and investment prepayment rates and levels of non-accrual loans. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

The credit quality of our loan portfolio had a significant impact on our operating results for 2008. We have experienced deterioration in certain key credit quality performance indicators in 2008. We had charge-offs of $477.1 million in 2008 compared to $143.8 million in 2007. Our provision for credit losses was $911.0 million in 2008 compared to $407.7 million in 2007. The increases were driven by deterioration in our consumer and commercial portfolios.

During 2007, Sovereign expanded its indirect auto loan portfolio into the Southeastern and Southwestern United States (“out-of-market loans”). Sovereign originated $2.8 billion of out-of-market loans in 2007 at a weighted average yield of 8.04%. Effective January 31, 2008, Sovereign ceased originating new auto loans from these markets. We also strengthened our underwriting standards in the second half of 2007 on our entire auto loan portfolio. However, losses remained elevated on these portfolios in 2008 as the newly originated loans continue to season and the US economy entered into a recession. Sovereign decided to exit its in footprint indirect auto portfolio and ceased originating these loans in January 2009. For the twelve-month period ended December 31, 2008, net losses on our auto loan portfolio were $175.7 million compared to $76.2 million for the twelve months ending December 31, 2007. Continued deterioration in the economy of the regions where we extended these loans could have a significant adverse impact on the amount of credit losses we experience in future periods. At December 31, 2008, our total auto loan portfolio was $5.3 billion of which $1.8 billion consisted of loans originated in the Southeast and Southwest production offices. At December 31, 2008 our total allowance for loan losses for the auto portfolio was $140.0 million.

As discussed previously, conditions in the housing market significantly impacted various areas of our business. Certain segments of our consumer and commercial loan portfolios have exposure to the housing market. Sovereign has residential real estate loans totaling $11.4 billion at December 31, 2008 of which $2.7 billion is comprised of Alt-A residential loans. Residential loan losses have been increasing since the prior year and actual credit losses on these loans totaled $26.2 million in 2008 compared to $7.5 million in the prior year. Non-performing assets and past due loans have been increasing particularly for the Alt-A portion of the residential portfolio. The increased loss experience and asset quality trends led us to increase our reserves for our residential portfolio. Future losses in our residential loan portfolio will continue to be significantly influenced by home prices in the residential real estate market, unemployment and general economic conditions.

The homebuilder industry also has been impacted by a decline in new home sales and a reduction in the value of residential real estate which has decreased the profitability and liquidity of these companies. Declines in real estate prices in 2008 and 2007 have been the most pronounced in certain states where previous increases were the largest, such as California, Florida and Nevada. Additionally, foreclosures have increased sharply in various other areas due to increasing levels of unemployment. Sovereign provided financing to various homebuilder companies which is included in our commercial loan portfolio. The Company has been working on de-emphasizing this loan portfolio during 2008 which has resulted in it declining to $0.8 billion at December 31, 2008 compared to $1.1 billion a year ago. Approximately eighty five percent of these loans at December 31, 2008 are to builders in our geographic footprint which generally have had more stable economic conditions on a relative basis compared to the national economy. We continue to monitor this portfolio in future periods given recent market conditions and determine the impact, if any, on the allowance for loan losses related to these homebuilder loans.

Sovereign also has $6.5 billion of home equity loans and lines of credit (excluding our correspondent home equity loans). Net charge-offs on these loans for the twelve-month period ended December 31, 2008 was $21.1 million compared with $8.1 million for the corresponding period in the prior year. This portfolio consists of loans with an average FICO at origination of 777 and an average loan to value of 58%. We have total reserves of $39.1 million for this loan portfolio at December 31, 2008.

During 2008, we have continued to experience increases in non-performing assets in our commercial lending and commercial real estate portfolios as a result of worsening credit and economic conditions. Non-performing assets for these portfolios increased to $244.8 million and $319.6 million at December 31, 2008 from $85.4 million and $61.8 million at December 31, 2007. Charge-offs on these portfolios were $169.0 million and $32.8 million in 2008 compared to $34.9 million and $15.5 million in 2007. Given these changes, we increased our allowance for loan losses for these portfolios by approximately $222.8 million and $80.9 million during 2008. This increase was a significant component of our provision for credit losses of $911 million for the twelve-month period ended December 31, 2008. We expect that the difficult housing environment as well as deteriorating economic conditions will continue to impact our commercial lending and commercial real estate portfolios which may result in elevated levels of provisions for credit losses in future periods.

RESULTS OF OPERATIONS FOR THE YEARS ENDED DECEMBER 31, 2008 AND 2007

		YEAR ENDED DECEMBER 31,
(Dollars in thousands, except per share data)		2008				2007
Net interest income		$	1,903,311			$	1,864,022
Provision for credit losses			911,000				407,692
Total non-interest income			(818,743	)			354,396
General and administrative expenses			1,541,409				1,345,838
Other expenses			265,793				1,874,600
Net (loss)/income		$	(2,357,210	)		$	(1,349,262	)
Basic (loss)/earnings per share		$	(3.98	)		$	(2.85	)
Diluted (loss)/earnings per share		$	(3.98	)		$	(2.85	)

The major factors affecting comparison of earnings and diluted earnings per share between 2008 and 2007 were:

	•		Net interest income increased 2.1% during 2008 due to an expansion in net interest margin to 2.91% from 2.73% a year ago, partially offset by a $3.3 billion decline in earning assets.
	•		The increase in provision for credit losses in 2008 is related to the previously mentioned deterioration in our loan portfolios due to the current economic environment.
	•		Included in non-interest income:

	(1)		Net losses on investment securities of $1.5 billion and $176.4 million in 2008 and 2007, respectively. Our 2008 and 2007 results included other-than-temporary impairment charges of $575.3 million and $180.5 million, respectively, on FNMA and FHLMC preferred stock. Net losses on investment securities in 2008 also included a $602.3 million loss on the sale of our CDO portfolio and a $308 million other-than-temporary impairment charge on non-agency mortgage backed securities. See Note 6 for additional details.
	(2)		An increase in capital markets revenues of $43.1 million due to charges of $46.9 million related to customers who defaulted on repurchase agreements and other financing obligations during 2007.
	(3)		An increase in mortgage banking revenues in 2008 of $54.6 million due to a $119.9 million lower of cost or market adjustment related to the previously mentioned correspondent home equity loan transactions in the first quarter of 2007. Mortgage banking revenues included a $47.3 million residential MSR impairment in 2008 due to increased prepayment speed assumptions due to lower market interest rates.

	•		Increases in general and administrative expenses in 2008 were due primarily to increased cash based compensation of $87.9 million, which included severance charges of $11.1 million and a reduction in workforce severance charges of $15.8 million. REO and loan expenses also increased $17.6 million as a result of deteriorating credit conditions. Marketing expense increased $22.9 million due to the Customer First initiative during 2008 as well as advertising campaigns incurred in the fourth quarter of 2008 to reclaim deposits lost at the end of the third quarter and related to the Santander transaction. Additionally, deposit insurance premiums increased $28.5 million due to FDIC regulations to implement the Reform Act.
	•		Other expenses have decreased due primarily to non-deductible goodwill impairment charges of $943 million in our Metro New York reporting unit and $634 million in our Shared Services Consumer reporting unit in 2007. See Note 4 for additional details on this charge. Sovereign also recorded restructuring and ESOP termination charges of $102.1 million in 2007. 2008 results included an impairment charge of $95 million on our equity method investments. See Note 1 for details.
	•		Sovereign recorded an income tax expense of $723.6 million in 2008 compared to a benefit of $60.5 million in 2007. As previously discussed 2008 results included a valuation allowance of $1.43 billion due to the conclusion that it was more likely than not that our deferred tax assets were not realizable on a stand alone basis. 2007 tax results were significantly impacted by the aforementioned significant charges which magnified the impact of our favorable permanent tax-free items. See a later section of the MD&A for further discussion.

Net Interest Income. Net interest income for 2008 was $1.90 billion compared to $1.86 billion for 2007, or an increase of 2.1%. The increase in net interest income in 2008 was due to the reduction in market rates which reduced our deposit and borrowing costs in excess of reductions in yields on earning assets since we are liability sensitive.

Interest on investment securities and interest-earning deposits was $584 million for 2008 compared to $792 million for 2007. In connection with management’s plan that was announced at the end of 2006, Sovereign has been focused on reducing the size of its investment portfolio as a percentage of total assets. Our average investment portfolio declined by $2.5 billion during 2008 to 14.9% of our total average assets in 2008 compared to 17% in 2007. Additionally, the Company has been working on reducing the duration of its investment portfolio to reduce interest rate risk. The average life of our investment portfolio has declined to 4.62 years at December 31, 2008 compared to 5.24 years at December 31, 2007. Reducing the average life of our investment portfolio has negatively impacted the overall yield on this asset class; however, it reduces the impact that changes in interest rates have on the market value of our balance sheet.

Interest on loans was $3.34 billion and $3.86 billion for 2008 and 2007, respectively. The average balance of loans was $57.5 billion with an average yield of 5.84% for 2008 compared to an average balance of $58.0 billion with an average yield of 6.69% for 2007. The decrease in average yields year to year is due primarily to decreased yields on our commercial loan portfolios which is due to decreases in the one-month and three-month LIBOR rates throughout 2008. At December 31, 2008, approximately 31% of our total loan portfolio reprices monthly or more frequently.

Interest on total deposits was $952 million for 2008 compared to $1.63 billion for 2007. The average balance of deposits was $40.3 billion with an average cost of 2.36% for 2008 compared to an average balance of $44.4 billion with an average cost of 3.67% for 2007. Additionally, the average balance of non-interest bearing deposits increased to $6.5 billion in 2008 from $6.4 billion in 2007. The decrease in interest expense is due to the impact of Fed rate cuts in 2008. The decrease in the average balance of deposits was primarily due to a decision to de-emphasize non-core wholesale deposits.

Interest on borrowings and other debt obligations was $1.07 billion for 2008 compared to $1.16 billion for 2007. The average balance of total borrowings and other debt obligations was $22.7 billion with an average cost of 4.70% for 2008 compared to an average balance of $22.2 billion with an average cost of 5.24% for 2007. The decrease in the cost of funds on borrowings and other debt obligations resulted principally from the lower rates on short-term sources of funding including repurchase agreements and overnight FHLB advances due to an increase in short-term interest rates. Part of the increase in average balances is the result of the issuance of $1.6 billion of senior unsecured debt in December 2008 under the FDIC’s Temporary Liquidity Guarantee Program (“TLG Program”), which consisted of $1.35 billion in 3 year fixed rate unsecured notes at 2.75% issued by the Bank and $250 million in 3.5 year fixed rate senior unsecured notes at 2.5% issued by Sovereign. This debt is backed by the full faith and credit worthiness of the U.S. government. In order to obtain this guarantee, an upfront payment of $41.5 million and $8.7 million was made to the FDIC. These amounts were deferred and are being amortized over the contractual life of the debt. This cost, along with other transaction costs and a slight discount on the issuance of these notes results in these borrowings having an effective rate of 3.92% and 3.73%, respectively.

Table 1 presents a summary on a tax equivalent basis of Sovereign’s average balances, the yields earned on average assets and the cost of average liabilities for the years indicated (in thousands):

Table 1: Net Interest Margin

		YEAR ENDED DECEMBER 31,
		2008												2007												2006
		Average								Yield/				Average								Yield/				Average								Yield/
		Balance				Interest				Rate				Balance				Interest				Rate				Balance				Interest				Rate
Interest-earning assets:
Interest-earning deposits		$	256,268			$	4,285				1.67	%		$	307,596			$	16,562				5.38	%		$	285,382			$	13,897				4.87	%
Investment securities(1)
Available for sale			10,498,218				621,906				5.92				12,971,273				804,025				6.20				11,217,296				658,966				5.87
Held to maturity			—				—				—				—				—				—				2,248,565				125,886				5.60
Other			930,926				23,786				2.56				901,197				51,645				5.73				849,040				51,414				6.06
Total investments			11,685,412				649,977				5.56				14,180,066				872,232				6.15				14,600,283				850,163				5.82
Loans:
Commercial loan			27,501,518				1,560,936				5.68				25,422,607				1,823,144				7.17				20,833,022				1,489,484				7.15
Multi-family			4,628,080				275,504				5.95				4,657,978				296,126				6.36				3,612,737				224,290				6.21
Consumer:
Residential mortgage			12,234,402				687,691				5.62				14,525,467				825,685				5.68				15,770,676				888,546				5.63
Home equity loans and lines of credit			6,509,952				367,645				5.65				6,868,727				469,760				6.84				10,119,375				654,760				6.47
Total consumer loans secured by real estate			18,744,354				1,055,336				5.63				21,394,194				1,295,445				6.06				25,890,051				1,543,306				5.96
Auto loans			6,308,417				440,309				6.98				6,187,487				433,172				7.00				4,457,932				266,806				5.98
Other			303,131				23,136				7.63				360,486				31,248				8.67				452,029				37,201				8.23
Total Consumer			25,355,902				1,518,781				5.99				27,942,167				1,759,865				6.30				30,800,012				1,847,313				6.00
Total loans			57,485,500				3,355,221				5.84				58,022,752				3,879,135				6.69				55,245,771				3,561,087				6.45
Allowance for loan losses			(836,217	)			—				—				(533,263	)			—				—				(489,775	)			—				—
Net loans(1)(2)			56,649,283				3,355,221				5.92				57,489,489				3,879,135				6.75				54,755,996				3,561,087				6.50
Total interest-earning assets			68,334,695				4,005,198				5.86				71,669,555				4,751,367				6.63				69,356,279				4,411,250				6.36
Non-interest-earning assets			10,347,204				—				—				11,646,477				—				—				10,139,116				—				—
Total assets		$	78,681,899			$	4,005,198				5.09	%		$	83,316,032			$	4,751,367				5.70	%		$	79,495,395			$	4,411,250				5.55	%
Interest-bearing liabilities:
Deposits:
Retail and commercial deposits		$	31,253,414			$	744,856				2.38	%		$	31,228,313			$	968,509				3.10	%		$	28,083,633			$	711,033				2.53	%
Wholesale deposits			3,529,553				89,404				2.53				6,751,606				357,603				5.29				7,809,654				404,648				5.18
Government deposits			3,181,711				81,288				2.55				3,826,924				193,066				5.05				3,632,773				182,046				5.01
Customer repurchase agreements			2,346,152				36,040				1.54				2,545,304				108,137				4.25				1,639,453				74,470				4.54
Total deposits			40,310,830				951,588				2.36				44,352,147				1,627,315				3.67				41,165,513				1,372,197				3.33
Total borrowings and other debt obligations			22,740,672				1,068,265				4.70				22,247,100				1,164,919				5.24				23,377,692				1,132,659				4.85
Total interest bearing liabilities			63,051,502				2,019,853				3.20				66,599,247				2,792,234				4.19				64,543,205				2,504,856				3.88
Non-interest-bearing DDA			6,548,894				—				—				6,386,359				—				—				6,020,184				—				—
Non-interest-bearing liabilities			1,563,748				—				—				1,568,869				—				—				1,412,368				—				—
Total liabilities			71,164,144				2,019,853				2.84				74,554,475				2,792,234				3.75				71,975,757				2,504,856				3.48
Stockholders’ equity			7,517,755				—				—				8,761,557				—				—				7,519,638				—				—
Total liabilities and stockholders’ equity		$	78,681,899			$	2,019,853				2.57	%		$	83,316,032			$	2,792,234				3.35	%		$	79,495,395			$	2,504,856				3.15	%
Net interest spread(3)											2.66	%											2.44	%											2.48	%
Taxable equivalent interest income/net interest margin							1,985,345				2.91	%							1,959,133				2.73	%							1,906,394				2.75	%
Tax equivalent basis adjustment							(82,032	)											(95,111	)											(84,846	)
Net interest income						$	1,903,311											$	1,864,022											$	1,821,548
Ratio of interest-earning assets to interest-bearing liabilities											1.08	x											1.08	x											1.07	x

Table 2 presents, on a tax equivalent basis, the relative contribution of changes in volumes and in rates to changes in net interest income for the periods indicated. The change in interest income not solely due to changes in volume or rate has been allocated in proportion to the absolute dollar amounts of the change in each (in thousands):

Table 2: Volume/Rate Analysis

		YEAR ENDED DECEMBER 31,
		2008 VS. 2007												2007 VS. 2006
		INCREASE/(DECREASE)												INCREASE/(DECREASE)
		Volume				Rate				Total				Volume				Rate				Total
Interest-earning assets:
Interest-earning deposits		$	(2,392	)		$	(9,885	)		$	(12,277	)		$	1,130			$	1,535			$	2,665
Investment securities available for sale			(147,782	)			(34,337	)			(182,119	)			107,239				37,820				145,059
Investment securities held to maturity															(62,943	)			(62,943	)			(125,886	)
Investment securities other			1,651				(29,510	)			(27,859	)			3,068				(2,837	)			231
Net loans(1)			(55,954	)			(467,960	)			(523,914	)			182,149				135,899				318,048
Total interest-earning assets											(746,169	)											340,117
Interest-bearing liabilities:
Deposits			(137,518	)			(538,209	)			(675,727	)			110,871				144,246				255,117
Borrowings			25,373				(122,027	)			(96,654	)			(56,435	)			88,696				32,261
Total interest-bearing liabilities											(772,381	)											287,378
Net change in net interest income		$	(92,332	)		$	118,544			$	26,212			$	176,207			$	(123,468	)		$	52,739

Provision for Credit Losses. The provision for credit losses is based upon actual credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimation of losses inherent in the current loan portfolio. The provision for credit losses for 2008 was $911.0 million compared to $407.7 million for 2007. The provision in 2008 was impacted by the following items discussed below.

During 2008, we have continued to experience increases in non-performing assets in our commercial lending and commercial real estate portfolios. Non-performing assets for these portfolios increased to $244.8 million and $319.6 million at December 31, 2008 from $85.4 million and $61.8 million at December 31, 2007. Charge-offs on these portfolios were $169.0 million and $32.8 million in 2008 compared to $34.9 million and $15.5 million in 2007. Given these changes, we increased our allowance for loan losses for these portfolios by approximately $222.8 million and $80.9 million during 2008. This increase was a significant component of our provision for credit losses of $911 million for the twelve-month period ended December 31, 2008. A large portion of these increases is tied to companies that are in housing related industries. We have decreased the amount of loan originations to these borrower types in 2008; however, we expect that the difficult housing environment as well as deteriorating economic conditions will continue to impact our commercial lending and commercial real estate portfolios which may result in elevated levels of provisions for credit losses in future periods.

It was determined during 2008 that the U.S. economy entered into a recession in December 2007. When we established our allowance for loan loss at the end of 2007 we anticipated that economic conditions would continue to weaken. However, the contraction in the U.S. economy in the latter half of 2008 has been at a pace not seen in approximately 30 years. This harsh environment further depressed asset values and led to increases in unemployment which are anticipated to continue into 2009. Net charge offs increased substantially in 2008 to $477.1 million from $143.8 million. Given the current and anticipated economic weakness, Sovereign increased its provision for credit losses by $503 million from the prior year. Our allowance for credit losses to total loans coverage ratio now stands at 2.10% which is a historically high level for the company. Further instability in residential real estate prices and increases in unemployment particularly within our geographic footprint may lead to continued elevated levels of provisions for credit losses in future periods.

Our provision for credit losses in 2007 was impacted by the following items discussed below.

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

In 2007, Sovereign recorded $50.5 million of additional reserves to cover higher expected losses on the correspondent home equity portfolio that was not sold due to adverse market conditions in the housing market. In 2007, Sovereign also experienced further deterioration in the credit quality of certain commercial loans due to weakening market conditions. As a result of market conditions, an increase in criticized and non-accrual loans and growth of $2 billion in our commercial real estate loans and commercial industrial loans, Sovereign increased the provision for credit losses by approximately $59 million for our commercial portfolio.

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

The ratio of net loan charge-offs to average loans, including loans held for sale, was 0.83% for 2008, compared to 0.25% for 2007. The consumer loans secured by real estate net charge-off rate was 0.36% for 2008, compared to 0.07% for 2007. The consumer loans not secured by real estate (primarily auto loans) net charge-off rate was 2.80% for 2008 and 1.19% for 2007. Commercial loan net charge-offs as a percentage of average commercial loans were 0.70% for 2008, compared to 0.20% for 2007. Charge-off trends for our entire portfolio have been increasing throughout 2008 and were 1.32% in the fourth quarter.

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

Table 3: Reconciliation of the Allowance for Credit Losses

		2008				2007				2006				2005				2004
Allowance for loan losses, beginning of period		$	709,444			$	471,030			$	419,599			$	391,003			$	315,790
Allowance acquired in acquisitions			—				—				97,824				28,778				64,105
Provision for loan losses (2)			874,140				394,646				487,418				89,501				121,391
Allowance released in connection with loan sales or securitizations			(3,745	)			(12,409	)			(4,728	)			(8,010	)			—
Charge-offs:
Commercial			238,470				65,670				56,916				40,935				77,499
Consumer secured by real estate			75,978				26,809				463,902				24,125				12,219
Consumer not secured by real estate			277,266				126,385				73,958				71,906				63,530
Total charge-offs (1)			591,714				218,864				594,776				136,966				153,248
Recoveries:
Commercial			13,378				15,187				14,097				13,100				12,825
Consumer secured by real estate			9,027				11,193				9,933				7,085				5,395
Consumer not secured by real estate			92,223				48,661				41,663				35,108				24,745
Total recoveries			114,628				75,041				65,693				55,293				42,965
Charge-offs, net of recoveries			477,086				143,823				529,083				81,673				110,283
Allowance for loan losses, end of period		$	1,102,753			$	709,444			$	471,030			$	419,599			$	391,003
Reserve for unfunded lending commitments, beginning of period			28,301				15,255				18,212				17,713				12,104
Provision for unfunded lending commitments (2)			36,860				13,046				(2,957	)			499				5,609
Reserve for unfunded lending commitments, end of period (3)			65,161				28,301				15,255				18,212				17,713
Total Allowance for credit losses		$	1,167,914			$	737,745			$	486,285			$	437,811			$	408,716
Net charge-offs to average loans (1)			.83	%			.25	%			.96	%			.20	%			.36	%

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

Non-interest Income/(Loss). Total non-interest income/(loss) was $(818.7) million for 2008 compared to $354.4 million for 2007. Several factors contributed to this change as discussed below.

Consumer banking fees were $312.6 million for 2008 compared to $295.8 million in 2007. This increase was primarily due to an increase of $15.2 million in deposit fees as we were able to implement certain pricing changes and reduced the amount of fee waivers granted to our customers. Commercial banking fees were $213.9 million for 2008 compared to $202.3 million in 2007. This increase of 5.8% was due to growth in average commercial loans which increased 8.2% in 2008.

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 multi-family 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 revenues had a net loss of $13.2 million for 2008 compared to a net loss of $67.8 million for 2007. The 2008 net loss was driven by a residential mortgage servicing rights impairment charge due to increased prepayment speed assumptions at year end from lower market interest rates. The 2007 net loss was due to charges related to the sale of our correspondent home equity portfolio. The table below summarizes the components of net mortgage banking revenues (in thousands):

		Twelve-months ended December 31,
		2008				2007
Impairments to mortgage servicing rights		$	(47,342	)		$	(1,415	)
Impairments to multi-family servicing rights			(5,916	)			—
Residential mortgage and multi-family servicing fees			50,002				42,197
Amortization of mortgage and multi-family servicing rights			(36,259	)			(36,806	)
Net gains under SFAS 133			6,205				51
Net gain recorded on commercial mortgage backed securitization			—				4,475
Gain on sales of mortgages			18,985				18,295
Gain on sales of multi-family loans			1,099				26,203
Loss related to correspondent home equity portfolio			—				(120,792	)
Total		$	(13,226	)		$	(67,792	)

During 2008, Sovereign sold $2.6 billion of multi-family loans and recorded gains of $1.1 million in connection with the sales compared to $3.7 billion of multi-family loans and related gains of $26.2 million in 2007. Current year results were negatively impacted by increases to recourse reserve levels of $19.7 million in the latter half of the year. In 2008 and 2007, Sovereign sold $3.2 billion and $3.1 billion of mortgage loans and recorded gains of $19.0 million and $18.3 million, respectively.

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

At December 31, 2008, Sovereign serviced approximately $13.1 billion of residential mortgage loans for others and our net mortgage servicing asset was $112.5 million, compared to $11.2 billion of loans serviced for others and a net residential mortgage servicing asset of $141.1 million, at December 31, 2007. The most important assumptions in the valuation of mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread we receive on holding escrow related balances. Increases in prepayment speeds (which are generally driven by lower long term interest rates) result in lower valuations of mortgage servicing rights, while lower prepayment speeds result in higher valuations. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights while lower spreads result in lower valuations. For each of these items, Sovereign must make assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model. For 2008, Sovereign recorded mortgage servicing right impairment charges of $47.3 million due to an increase in prepayment speed assumptions and changes in interest rates compared to impairment charges of $1.4 million in 2007.

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

		December 31, 2008				December 31, 2007				December 31, 2006
CPR speed			29.65	%			14.70	%			14.23	%
Escrow credit spread			4.35	%			5.12	%			4.85	%

Sovereign will periodically sell qualifying mortgage loans to FHLMC, GNMA, and FNMA 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. 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 multi-family loans sold to Fannie Mae reaching the maximum loss exposure for the portfolio as a whole ($249.8 million as of December 31, 2008) 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 Company has established a liability which represents the fair value of the retained credit exposure. This liability represents the amount that the Company estimates that it would have to pay a third party to assume the retained recourse obligation. The estimated liability represents the present value of the estimated losses that the portfolio is projected to incur based upon an industry-based default curve with a range of estimated losses. At December 31, 2008, Sovereign had a $38.3 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program.

At December 31, 2008 and December 31, 2007, Sovereign serviced $13.0 billion and $10.9 billion, respectively, of loans for Fannie Mae that had been sold to Fannie Mae pursuant to this program with a maximum potential loss exposure of $249.8 million and $206.8 million, respectively. As a result of retaining servicing, the Company had loan servicing assets of $14.7 million and $20.4 million at December 31, 2008 and 2007, respectively. Sovereign recorded servicing asset amortization of $7.7 million and $10.7 million related to the multi-family loans sold to Fannie Mae for 2008 and recognized servicing assets of $5.7 million.

Capital markets revenues increased to $23.8 million for 2008 compared to a net loss of $19.3 million in 2007. In 2007, we recorded charges of $46.9 million within capital markets revenue related to losses on repurchase agreements and other financing obligations that Sovereign provided to a number of mortgage companies who declared bankruptcy and/or defaulted on their agreements. These mortgage companies were impacted by adverse developments in the non-prime sector. The repurchase agreements and other financing obligations were secured by rated and non-rated investment securities and/or mortgage loans. The charge Sovereign recorded on the repurchase agreements and other financing obligations was necessary since the value of the underlying collateral was less than the outstanding amount of the repurchase agreement.

Income related to bank owned life insurance decreased to $76.0 million for 2008 compared to $85.9 million in 2007. This $9.9 million, or 11.5% decrease, was due to decreased death benefits in 2008 as well as lower interest rates received on our insurance policies.

Net losses on investment securities were $1.5 billion for 2008, compared to $176.4 million for 2007. Included in 2008 was an other-than-temporary impairment charge of $575 million on FNMA and FHLMC preferred stock, an other-than-temporary impairment charge of $308 million on certain non-agency mortgage backed securities and a $602 million loss on the sale of our CDO portfolio. On September 7, 2008, the U.S. Department of the Treasury, the Federal Reserve and the Federal Housing Finance Agency (FHFA) announced that the FHFA was putting Fannie Mae and Freddie Mac under conservatorship and giving management control to their regulator, the FHFA. In connection with this action, the dividends on our preferred shares were eliminated thereby significantly reducing the value of our investment. During the third quarter of 2008, Sovereign, in order to reduce risk in its investment portfolio, decided to sell its entire CDO portfolio. This portfolio had experienced significant volatility over the past year as a result of conditions in the credit markets. Finally, in the fourth quarter of 2008, it was determined that a principal loss on certain non-agency mortgage backed securities was likely which resulted in an other than temporary impairment charge. See Note 6 for further discussion and analysis of our determination that the unrealized losses in the investment portfolio at December 31, 2008 were considered temporary. In the first quarter of 2008, we recorded net cash proceeds of $14.1 million on the mandatory redemption of approximately half of our Visa Initial Public Offering (IPO) shares. Our remaining Visa shares are required to be held for 3 years pending settlement of other possible litigation that Visa and its member banks are exposed to. These shares are required to be valued at their historical cost of $0. In March 2011, we will no longer have any restrictions on these shares.

General and Administrative Expenses. Total general and administrative expenses were $1.54 billion for 2008 compared to $1.35 billion in 2007, or an increase of 14.5%. The increase in 2008 is primarily related to increases of $101.4 million, $28.5 million and $22.9 million in compensation and benefits, deposit insurance premiums and marketing expenses, respectively. Compensation costs were negatively impacted by severance charges of $25.8 million. Deposit insurance premiums were negatively impacted by increased assessments from the FDIC to replenish the agencies insurance reserve fund and marketing costs were higher than the prior year for deposit gathering initiatives throughout 2008 as well as adverting associated with the Santander acquisition of Sovereign. At December 31, 2008, Sovereign had total employees of 11,634 compared to 11,976 in 2007, a 2.8% decrease. Sovereign’s efficiency ratio, (all general and administrative expenses as a percentage of net interest income and total fees and other income) for 2008 was 60.7% compared to 56.2% for 2007.

Other Expenses. Total other expenses were $265.8 million for 2008 compared to $1.9 billion for 2007. In 2007, we recorded a $1.58 billion goodwill impairment charge related to the Company’s Metro New York and Consumer reporting units. See Note 4 for details on this impairment charge. Other expenses included amortization expense of core deposit intangibles of $103.6 million for 2008 compared to $126.7 million for 2007. This decrease is due to decreased core deposit intangible amortization expense on previous acquisitions. In 2008, Sovereign recorded legal and investment advisory fees of $12.8 million related to Santander’s acquisition of Sovereign. Additionally, in 2008, Sovereign recorded a $95 million charge related to an equity method investment as it was determined that this investment’s fair value was significantly below its cost. In 2007, Sovereign recorded restructuring charges of $62.0 million which was associated with executive and other employee severance arrangements and other restructuring charges activities. See Note 29 for details on these charges.

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

Other expense related to equity method investments includes an investment that Sovereign has in a synthetic fuel partnership that generates Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $26.2 million for 2007 and is included as expense in the line “Minority interest expense and equity method investment expense” in our consolidated statement of operations, while the alternative energy tax credits we received were included as a reduction of income tax expense. This investment matured at the end of 2007; therefore, Sovereign did not incur any expenses or receive any tax credits related to the Synthetic Fuel Partnership in 2008.

Income Tax Expense/(Benefit). Sovereign recorded a provision of $723.6 million for 2008 compared to a benefit of $60.5 million for 2007. The effective tax rate for 2008 was 44.3% compared to (4.3)% for 2007. Current year provision levels were negatively impacted by the previously discussed valuation allowance on deferred taxes. See Note 18 for a reconciliation of our effective tax rate to the statutory federal rate of 35%.

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

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) recently examined the Company’s federal income tax returns for the years 2002 through 2005. The IRS completed this review in 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 billion. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign was subject to an additional $87.6 million and $22.5 million, respectively, of foreign taxes related to these financing transactions and claimed a corresponding foreign tax credit. The IRS issued a notification of adjustment disallowing the foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these transactions; disallowing deductions for issuance costs and interest expense related to the transaction which would result in an additional tax liability of $24.9 million; and assessed interest and penalties, the combined amount of which totaled approximately $71.0 million. In addition, the IRS has commenced its audit for the years 2006 and 2007. We expect that in the future the IRS will propose to disallow the foreign tax credits taken in 2006 and 2007 of $87.6 million and $22.5 million, respectively; disallow deductions for issuance costs and interest expense which would result in an additional tax liability of $37.1 million; and to assess interest and penalties. Sovereign expects that it will need to litigate this matter with the IRS. Sovereign continues to believe that it is entitled to claim these foreign tax credits and deductions and also believes that its recorded tax reserves for this position of $58.3 million adequately provides for any potential exposure to the IRS related to this item and other tax assessments. However, as the Company continues to go through the IRS administrative process, and if necessary litigation, we will continue to evaluate the appropriate tax reserve levels for this position and any changes made to the tax reserves may materially affect Sovereign’s income tax provision, net income and regulatory capital 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. The difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business lines at the time of charge-off is allocated to each business line based on a risk profile of their loan portfolio. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. Where practical, the results are adjusted to present consistent methodologies for the segments. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

During the first quarter of 2008, as previously discussed in our 2008 first quarter Form 10-Q, certain changes to our executive management were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, we centralized the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

As a result of the changes discussed above, Sovereign now has four reportable segments. The Company’s segments are focused principally around the customers Sovereign serves. The Retail Banking Division is primarily comprised of our branch locations. Our branches offer a wide range of products and services to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. Our branches also offer certain consumer loans such as home equity loans and other consumer loan products. The Corporate Specialties Group segment is primarily comprised of mortgage banking, multi-family and national commercial real estate lending, automobile dealer floor plan lending group and indirect automobile lending. It also provides capital market services and cash management services to our customers. The Commercial Lending segment provides the majority of Sovereign’s commercial lending platforms such as commercial real estate loans, commercial industrial loans, leases to commercial customers and small business loans. The Other segment includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets and certain unallocated corporate income and expenses. For additional discussion of these business lines and the Company’s related accounting policies, see Note 27 of the Notes to the Consolidated Financial Statements.

The Retail Banking Division’s net interest income decreased $183.2 million to $1.04 billion in 2008. The decrease in net interest income was principally due to margin compression on a matched funded basis due to the recent Federal Reserve interest rate cuts which have reduced the spreads that our Retail Banking Division receives on their deposits. The net spread on a match funded basis for this segment was 2.23% in 2008 compared to 2.61% in 2007. The average balance of Retail Banking Division’s loans was $6.5 billion and $5.7 billion during 2008 and 2007, respectively. The average balance of deposits was $41.1 billion in 2008 compared to $42.2 billion in 2007. The provision for credit losses increased in 2008 to $93.4 million from $33.6 million in 2007 due to increased net loan charge-offs in 2008. General and administrative expenses (including allocated corporate and direct support costs) increased from $1.07 billion for 2007 to $1.10 billion for 2008. The increase in general and administrative expenses is due to increased marketing and deposit insurance premiums of $21.2 million and $26.4 million, respectively. The increase in deposit insurance premiums was due to the FDIC assessments on deposits that began in 2008 and the increase in marketing costs was related to the roll out of our “Customer First” initiative in the first half of 2008 as well as targeted campaigns in the fourth quarter of 2008 to reclaim deposits lost at the end of the third quarter.

The Corporate Specialty Group segment net interest income decreased $54.2 million to $385.1 million in 2008. The decrease in net interest income was principally due to the reduction in our loan portfolio. The net spread on a match funded basis for this segment was 1.31% in 2008 compared to 1.36% in 2007. The average balance of Corporate Specialty Group loans was $28.5 billion and $31.8 billion during 2008 and 2007, respectively. The average balance of deposits was $1.5 billion in 2008 compared to $1.4 billion in 2007. The increase in fees and other income of $80.7 million to $39.4 million for 2008 was primarily generated by increased mortgage banking revenues which was primarily due to the previously mentioned charge of $119.9 million on our correspondent home equity loan portfolio in 2007. The provision for credit losses increased in 2008 to $403.5 million from $253.0 million in 2007 due primarily to a higher level of losses on our indirect auto portfolio particularly related to out-of-market auto loans. Credit losses in this segment were much higher than anticipated due primarily to auto loans that were originated by our Southeast and Southwest production offices. General and administrative expenses (including allocated corporate and direct support costs) increased from $172.5 million for 2007 to $183.0 million for 2008. The net loss before income taxes for the Corporate Specialty Group segment decreased from a loss of $662.0 million in 2007 to a loss of $182.2 million in 2008 due to the $634 million goodwill impairment charge attributable to this segment in 2007.

The Commercial Lending segment net interest income increased $88.4 million to $520.1 million for 2008 compared to 2007 due to growth in our commercial loan portfolios due to our emphasis on this asset class and a de-emphasis on wholesale residential loans, investment securities and other lower yielding asset classes. The average balance of Commercial Lending segment loans was $22.3 billion in 2008 versus $20.4 billion during 2007. The net spread on a match funded basis for this segment was 2.36% in 2008 compared to 2.25% in 2007. Fees and other income have decreased by $3.8 million to $121.9 million principally due to decreased precious metals commercial banking fee income. The provision for credit losses increased by $292.9 million in 2008 to $414.1 million due to higher levels of commercial charge-offs in 2008 which was due to an increase in criticized assets, primarily in the construction lending, commercial real estate and commercial industrial lending portfolios. General and administrative expenses (including allocated corporate and direct support costs) increased from $182.7 million for 2007 to $211.7 million in 2008 due to increased salaries and bonuses related to the increased workforce to support the increase in commercial loans.

The net loss before income taxes for the Other segment increased from $522.2 million in 2007 to $1.7 billion in 2008. Net interest expense decreased from $230.0 million in 2007 to $41.6 million for 2008. The Other segment includes net losses on securities of $1.5 billion and $176.3 million in 2008 and 2007, respectively. The 2008 loss resulted from the previously discussed $602 million loss on the sale of our CDO portfolio, $308 million other-than-temporary impairment charge on non-agency mortgage backed securities and $575 million other-than-temporary impairment charge on FNMA and FHLMC preferred stock. The 2007 loss resulted from the previously discussed $180.5 million other-than-temporary impairment charge on FNMA and FHLMC preferred stock. The 2008 and 2007 results included charges associated with executive and other employee severance arrangements and certain other restructuring activities of $23.4 million and $62.0 million, respectively. Finally, the Other segment included $0 and $26.2 million of expense associated with the Synthetic Fuel Partnership in 2007 compared to none in 2008, a deferred tax asset valuation allowance of $1.43 billion and a $95 million impairment charge related to our equity method investments. The 2008 and 2007 results included amortization of intangibles of $103.6 million and $126.7 million, respectively.

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

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

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

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

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

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

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

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

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

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

Interest on borrowings and other debt obligations was $1.16 billion for 2007 compared to $1.13 billion for 2006. The average balance of total borrowings and other debt obligations was $22.2 billion with an average cost of 5.24% for 2007 compared to an average balance of $23.4 billion with an average cost of 4.85% for 2006. The increase in the cost of funds on borrowings and other debt obligations resulted principally from the higher rates on short-term sources of funding including repurchase agreements and overnight FHLB advances due to an increase in short-term interest rates. The decrease in average balances is the result of the balance sheet restructuring.

Provision for Credit Losses. The provision for credit losses is based upon actual credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimation of losses inherent in the current loan portfolio. The provision for credit losses for 2007 was $407.7 million compared to $484.5 million for 2006. Our provision for credit losses in 2006 includes the previously mentioned provision of $296.0 million on the transfer of $4.3 billion of correspondent home equity loans to held for sale status at December 31, 2006. See Note 7 for additional details. The provision in 2007 was impacted by the following items discussed below.

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

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

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

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

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

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

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

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

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

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

Capital markets revenues decreased to a loss of $19.3 million for 2007 compared to net gains of $17.6 million in 2006. In 2007, we recorded charges of $46.9 million within capital markets revenue related to losses on repurchase agreements and other financing obligations that Sovereign provided to a number of mortgage companies who declared bankruptcy and/or defaulted on their agreements. These mortgage companies have been impacted by adverse developments in the non-prime sector. The repurchase agreements and other financing obligations are secured by rated and non-rated investment securities and/or mortgage loans. The charge Sovereign recorded on the repurchase agreements and other financing obligations was necessary since the value of the underlying collateral was less than the outstanding amount of the repurchase agreement.

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

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

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

Other Expenses. Total other expenses were $1.9 billion for 2007 compared to $313.5 million for 2006. In 2007, we recorded a $1.58 billion goodwill impairment charge related to the Company’s Metro New York and Consumer reporting units. See Note 4 for details on this impairment charge. Other expenses included amortization expense of core deposit intangibles of $126.7 million for 2007 compared to $109.8 million for 2006. This increase is due to the full year effect of amortization expense associated with core deposit intangible established in connection with the Independence acquisition. In 2007, net merger-related expenses were $2.2 million, compared to $42.4 million in 2006 which was primarily associated with the Independence acquisition. In 2007, Sovereign recorded restructuring charges of $62.0 million, compared to $78.7 million in 2006 which was associated with executive and other employee severance arrangements and other restructuring charges activities. See Note 29 for details on these charges.

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

Other expense related to equity method investments includes an investment that Sovereign has in a synthetic fuel partnership that generates Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $26.2 million and $26.3 million for 2007 and 2006, respectively, and are included as expense in the line “Minority interest expense and equity method investment expense” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. This investment matured at the end of 2007; therefore, Sovereign will not incur any expenses or receive any tax credits related to the Synthetic Fuel Partnership in future periods.

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

Also impacting other expenses in 2006 were proxy and related professional fees of $14.3 million related to the Relational Investors LLC (“Relational”) matter which was settled. During 2007, Sovereign recouped $0.5 million of this charge from insurance carriers.

Income Tax Provision/(Benefit). The income tax benefit was $60.5 million for 2007 compared to a benefit of $117.8 million for 2006. The effective tax rate for 2007 was (4.3)% compared to (615.8)% for 2006. The current year tax rate differs from the statutory rate of 35% due to the fact that the $1.58 billion goodwill charge and the ESOP charge of $40.1 million are both not deductible for tax purposes. The impact of this on the effective tax rate is slightly mitigated by our favorable permanent tax-free items which are principally due to income from tax- exempt investments, non-taxable income related to bank-owned life insurance and tax credits received on low income housing partnerships and the Synthetic Fuel Partnership.

Line of Business Results. During the first quarter of 2008, the business unit profitably reporting unit system was reorganized to centralize the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

The Retail Banking Division’s net interest income increased $94.6 million to $1.2 billion in 2007. The increase in net interest income was principally due to increases in loan and deposit balances. The net spread on a match funded basis for this segment was 2.61% in 2007 compared to 2.87% in 2006. The average balance of Retail Banking Division’s loans was $5.7 billion and $4.5 billion during 2007 and 2006, respectively. The average balance of deposits was $42.2 billion in 2007 compared to $35.5 billion in 2006. The provision for credit losses increased in 2007 to $33.6 million from $14.8 million in 2006 due to increased net loan charge-offs in 2007. General and administrative expenses (including allocated corporate and direct support costs) increased from $929.4 million for 2006 to $1.1 billion for 2007.

The Corporate Specialty Group segment net interest income increased $12.8 million to $439.4 million in 2007. The increase in net interest income was principally due to increases in average loans. The net spread on a match funded basis for this segment was 1.36% in 2007 compared to 1.39% in 2006. The average balance of Corporate Specialty Group loans was $31.8 billion and $30.1 billion during 2007 and 2006, respectively. The average balance of deposits was $1.41 billion in 2007 compared to $704.1 million in 2006. The decrease in fees and other income of $116.0 million to $(41.3) million for 2007 was primarily generated by decreased mortgage banking revenues driven by the $119.9 million lower of cost or market adjustment related to the previously mentioned correspondent home equity loan transaction in 2007. The provision for credit losses decreased in 2007 to $253.0 million from $427.9 million in 2006 due primarily to the $296.0 million additional provision for our correspondent home equity portfolio in 2006. However, 2007 losses on our indirect auto portfolio totaled $76.2 million in 2007, compared to $30.5 million in 2006. Credit losses were much higher than anticipated due primarily to auto loans that were originated by our Southeast and Southwest production offices. General and administrative expenses (including allocated corporate and direct support costs) increased from $156.0 million for 2006 to $172.5 million for 2007.

The Commercial Lending segment net interest income increased $60.9 million to $431.8 million for 2007 compared to 2006 due to increases in average commercial assets. The average balance of Commercial Lending segment loans was $20.4 billion in 2007 versus $16.9 billion during 2006. The net spread on a match funded basis for this segment was 2.25% in 2007 compared to 2.33% in 2006. Fees and other income have increased by $11.9 million to $125.7 million principally due to an increase in commercial loan fee income. The provision for credit losses increased by $79.4 million in 2007 to $121.2 million compared to 2006 due to higher levels of commercial charge-offs in 2007 which was due to an increase in criticized assets, primarily in the construction lending, commercial real estate and commercial industrial lending portfolios. General and administrative expenses (including allocated corporate and direct support costs) increased from $162.5 million for 2006 to $182.7 million in 2007.

The net loss before income taxes for the Other segment decreased from $599.5 million in 2006 to $522.2 million in 2007. Net interest expense increased from $104.1 million in 2006 to $230.0 million for 2007. The Other segment includes net losses on securities of $176 million and $312 million in 2007 and 2006, respectively. The 2007 loss resulted from the previously discussed $180.5 million other-than-temporary impairment charge on FNMA and FHLMC preferred stock. The 2006 loss resulted from the previously discussed $67.5 million other-than-temporary impairment charge on the FNMA and FHLMC preferred stock in our investment portfolio, as well as the $238.3 million and $43.0 million of securities losses recorded in the second and fourth quarters of 2006. The 2007 and 2006 results included charges associated with executive and other employee severance arrangements and certain other restructuring activities of $62.0 million and $78.7 million, respectively. The 2007 and 2006 results also included net charges of $2.2 million and $42.4 million for merger and integration charges, respectively. Finally, the Other segment included $26.2 million and $26.3 million of expense associated with the Synthetic Fuel Partnership, as well as amortization of intangibles of $126.7 million and $109.8 million in 2007 and 2006, respectively.

Critical Accounting Policies

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

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

Allowance for Loan Losses and Reserve for Unfunded Lending Commitments. The allowance for loan losses and reserve for unfunded lending commitments represent management’s best estimate of probable losses inherent in the loan portfolio. The adequacy of Sovereign’s allowance for loan losses and reserve for unfunded lending commitments is regularly evaluated. This evaluation process is subject to numerous estimates and applications of judgment. Management’s evaluation of the adequacy of the allowance to absorb loan losses takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, amount of non-performing loans, and industry trends. During 2008 and 2007, we recorded significant increases to the provision for credit losses and the allowance for loan losses and reserve for unfunded lending commitments as a result of higher credit losses and deterioration in asset quality statistics for the commercial and consumer loan portfolios. Changes in these estimates could have a direct material impact on the provision for credit losses recorded in the income statement and could result in a change in the recorded allowance and reserve for unfunded lending commitments. For example, a change in the estimate resulting in a 5% to 10% difference in the allowance for loan losses and reserve for unfunded lending commitments would have resulted in an additional provision for credit losses of $58.4 million to $116.8 million as of December 31, 2008. The loan portfolio also represents the largest asset on our consolidated balance sheet. Note 1 to the consolidated financial statements describes the methodology used to determine the allowance for loan losses and reserve for unfunded lending commitments and a discussion of the factors driving changes in the amount of the allowance for loan losses and reserve for unfunded lending commitments is included in the Credit Risk Management section of this MD&A.

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

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

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

Because the values of these assets are sensitive to changes to assumptions, the valuation of retained interests is considered a critical accounting estimate. Note 1 and Note 23 to the consolidated financial statements include further discussion on the accounting for these assets and provide sensitivity analysis showing how the fair value of these assets would respond to adverse changes in the key assumptions utilized to value these assets.

Goodwill. The purchase method of accounting for business combinations requires the Company to make use of estimates and judgments to allocate the purchase price paid for acquisitions to the fair value of the assets acquired and liabilities assumed. The excess of the purchase price of an acquired business over the fair value of the identifiable assets and liabilities represents goodwill. Goodwill totaled $3.4 billion at December 31, 2008.

The Company follows SFAS No. 142, “Goodwill and Other Intangible Assets,” to account for its goodwill. This statement provides that goodwill and other indefinite lived intangible assets will not be amortized on a recurring basis, but rather will be subject to periodic impairment testing. Other than goodwill, Sovereign has no indefinite lived intangible assets.

The impairment test for goodwill requires the Company to compare the fair value of business reporting units to their carrying value including assigned goodwill. SFAS No. 142 requires an annual impairment test. In addition, goodwill is tested more frequently if changes in circumstances or the occurrence of events indicate impairment potentially exists. During 2007, Sovereign’s financial results were impacted by an increase in credit losses, slower than anticipated growth in low cost core deposits, and a continued unfavorable interest rate environment. Sovereign recorded a number of significant charges in 2007 as previously discussed which caused current year results to be less than our internal plan. These events, as well as decreases in valuations for all banks and the decision to cease originating loans from our Southeast and Southwest production offices, had a negative impact on the fair value of our segments.

Determining the fair value of its reporting units requires management to allocate assets and liabilities to such units and make certain judgments and assumptions related to various items, including discount rates, future estimates of operating results, etc. If alternative assumptions or estimates had been used, the fair value of each reporting unit determined by the Company may have been different. However, management believes that the estimates or assumptions used in the goodwill impairment analysis for its business units were reasonable. Additionally, management engaged a valuation specialist to assist management in its fair value assessment of its reporting units. As a result of the finalization of our 2007 goodwill impairment analysis, Sovereign recorded a goodwill impairment charge of $1.58 billion related to our Shared Services Consumer and Metro New York segments.

During the first quarter of 2008, as previously discussed in Sovereign’s 2008 first quarter Form 10-Q, certain changes to our executive management were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, Sovereign centralized the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

As a result of the changes discussed above, Sovereign now has four reportable segments. The Company’s segments are focused principally around the customers Sovereign serves. The Retail Banking Division is comprised of our branch locations. Our branches offer a wide range of products and services to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. Our branches also offer certain consumer loans such as home equity loans and other consumer loan products. The Corporate Specialties Group segment is primarily comprised of our mortgage banking group, our New York multi-family and national commercial real estate lending group, our automobile dealer floor plan lending group and our indirect automobile lending group. It also provides capital market services and cash management services. The Commercial Lending segment provides the majority of Sovereign’s commercial lending platforms such as commercial real estate loans, commercial industrial loans, leases to commercial customers and small business loans. The Other segment includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets and certain unallocated corporate income and expenses.

During 2008, Sovereign’s financial results were impacted by an increase in credit losses, and losses on our investment portfolio which caused current year results to be less than our internal plan. Additionally on October 13, 2008 we entered into a Transaction agreement with Santander which valued Sovereign at approximately $2.5 billion on the announcement date.

We utilize a discounted cash flow analysis to estimate the fair value of our reporting units using market based assumptions which valued the entire Company at a level consistent with the consideration paid by Santander. At December 31, 2008, the date of our annual required assessment, the fair value of our retail bank was in excess of its book value. This reporting unit has limited credit exposure and continues to be profitable. The fair value of our corporate specialty and commercial lending reporting units were negative due to the deterioration in their operating results in the current year and in particular the second half of 2008 from increased credit losses on their loan portfolios. Of these two segments, only our commercial segment had goodwill assigned to it. After completing step 2 of the goodwill impairment analysis, no goodwill charge was required due to the significant discount on the commercial loans that reside in this reporting unit which caused its implied fair value of goodwill to be in excess of its allocated goodwill amount of $342 million. At September 30, 2008, because there were indicators of impairment, we performed an interim evaluation and formed the same conclusion.

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

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

During 2008 and 2007, Sovereign had both fair value hedges and cash flow hedges recorded in the consolidated balance sheet as “other assets” or “other liabilities” as applicable. For both fair value and cash flow hedges, certain assumptions and forecasts related to the impact of changes in interest rates on the fair value of the derivative and the item being hedged must be documented at the inception of the hedging relationship to demonstrate that the derivative instrument will be effective in hedging the designated risk. If these assumptions or forecasts do not accurately reflect subsequent changes in the fair value of the derivative instrument or the designated item being hedged, Sovereign might be required to discontinue the use of hedge accounting for that derivative instrument. Once hedge accounting is terminated, all subsequent changes in the fair market value of the derivative instrument must be recorded in earnings, possibly resulting in greater volatility in Sovereign’s earnings. If Sovereign’s outstanding derivative positions that qualified as hedges at December 31, 2008, were no longer considered effective, and thus did not qualify as hedges, the impact in 2008 would have been to lower pre-tax earnings by approximately $332.8 million.

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

The Company periodically reviews the carrying amount of its deferred tax assets to determine if the establishment of a valuation allowance is necessary. If based on the available evidence, it is more likely than not that all or a portion of the Company’s deferred tax assets will not be realized in future periods, a deferred tax valuation allowance would be established. Consideration is given to all positive and negative evidence related to the realization of the deferred tax assets.

In evaluating this available evidence, management considers historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. The Company’s evaluation is based on current tax laws as well as management’s expectations of future performance on a standalone basis. We did not consider the potential economic benefits associated with our transaction with Santander.

SFAS No. 109 suggests that additional scrutiny should be given to deferred tax assets of an entity with cumulative pre-tax losses during the three most recent years. This is widely considered to be significant negative evidence that is objective and verifiable; and therefore, difficult to overcome. During the three years ended December 31, 2008, Sovereign had cumulative pre-tax losses and the company considered this factor in our analysis of deferred tax assets. Additionally, based on the continued economic uncertainty that persists at this time, we believed that it was probable that the Company would not generate significant pre-tax income in the near term on a standalone basis. As a result of these two significant facts, Sovereign recorded a $1.43 billion valuation allowance against its deferred tax assets for the year-ended December 31, 2008.

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

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) recently examined the Company’s federal income tax returns for the years 2002 through 2005. The IRS completed this review in 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 billion. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign was subject to an additional $87.6 million and $22.5 million, respectively, of foreign taxes related to these financing transactions and claimed a corresponding foreign tax credit. The IRS issued a notification of adjustment disallowing the foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these transactions; disallowing deductions for issuance costs and interest expense related to the transaction which would result in an additional tax liability of $24.9 million; and assessed interest and penalties, the combined amount of which totaled approximately $71.0 million. In addition, the IRS has commenced its audit for the years 2006 and 2007. We expect that in the future the IRS will propose to disallow the foreign tax credits taken in 2006 and 2007 of $87.6 million and $22.5 million, respectively; disallow deductions for issuance costs and interest expense which would result in an additional tax liability of $37.1 million; and to assess interest and penalties. Sovereign expects that it will need to litigate this matter with the IRS. Sovereign continues to believe that it is entitled to claim these foreign tax credits and deductions and also believes that its recorded tax reserves for this position of $58.3 million adequately provides for any potential exposure to the IRS related to this item and other tax assessments. However, as the Company continues to go through the IRS administrative process, and if necessary litigation, we will continue to evaluate the appropriate tax reserve levels for this position and any changes made to the tax reserves may materially affect Sovereign’s income tax provision, net income and regulatory capital in future periods.

Recent Acquisitions

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

Financial Condition

Loan Portfolio. Sovereign’s loan portfolio at December 31, 2008 was $55.7 billion and was comprised of $31.8 billion of commercial loans (includes $4.5 billion of multi-family loans), $18.3 billion of consumer loans secured by real estate and $5.6 billion of consumer loans not secured by real estate. This compares to $30.9 billion of commercial loans (including $4.2 billion of multi-family loans), $19.5 billion of consumer loans secured by real estate, and $7.3 billion of consumer loans not secured by real estate at December 31, 2007.

Commercial real estate loans and commercial and industrial loans grew by 2.2% or $594 million during 2008 to $27.3 billion. The increase in commercial loans has been driven by organic loan growth. The increase in commercial loans as a percentage of the total loan portfolio is consistent with management’s restructuring plan to de-emphasize lower yielding residential and multi-family loans and increase our commercial loan portfolio.

Multi-family loans increased by 6.6% or $280 million in 2008 to $4.5 billion. The increase from the prior year is due to a decrease of the amount of loans sold to Fannie Mae or the secondary markets. In the second quarter of 2007, Sovereign sold $687.7 million of this loan portfolio as part of a commercial mortgage backed securitization. In the first quarter of 2007, Sovereign sold $1.3 billion of this loan portfolio as part of the Company’s previously discussed balance sheet restructuring plan.

Consumer loans secured by real estate decreased by 6.3% or $1.2 billion in 2008 to $18.3 billion primarily as a result of a $780 million mortgage securitization in the second quarter of 2008, as well as a $102 million decline in our correspondent home equity portfolio.

Consumer loans not secured by real estate decreased by 23.1% or $1.7 billion in 2008 to $5.6 billion as a result of cessation of out-of-market auto lending on January 31, 2008. Additionally, the Company has tightened its underwriting standards on its in-market auto loans portfolio which slowed originations. Sovereign ceased originating substantially all indirect auto loans within its geographic footprint during the fourth quarter of 2008.

Table 4 presents the composition of Sovereign’s loan portfolio by type of loan and by fixed and variable rates at the dates indicated (in thousands):

Table 4: Composition of Loan Portfolio

		AT DECEMBER 31,
		2008								2007								2006								2005								2004
		BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT				BALANCE				PERCENT
Commercial real estate loans		$	13,181,623				23.7	%		$	12,306,914				21.3	%		$	11,514,983				18.4	%		$	7,209,180				16.5	%		$	5,824,133				15.9	%
Commercial and industrial loans			14,078,893				25.2				14,359,688				24.9				13,188,909				21.1				9,426,466				21.5				8,040,107				21.9
Multi-family (1)			4,526,111				8.1				4,246,370				7.3				5,768,451				9.2				—				—				—				—
Total Commercial Loans			31,786,627				57.0				30,912,972				53.5				30,472,343				48.7				16,635,646				38.0				13,864,240				37.8
Residential mortgages			11,417,108				20.5				13,341,193				23.1				17,404,730				27.8				12,462,802				28.4				8,497,496				23.2
Home equity loans and lines of credit			6,891,918				12.4				6,197,148				10.7				9,443,560				15.1				9,793,124				22.4				9,577,656				26.2
Total Consumer Loans secured by real estate			18,309,026				32.9				19,538,341				33.8				26,848,290				42.9				22,255,926				50.8				18,075,152				49.4
Auto loans			5,344,325				9.6				7,028,894				12.2				4,848,204				7.7				4,434,021				10.1				4,205,547				11.5
Other			290,725				0.5				299,572				0.5				419,759				0.7				478,254				1.1				486,140				1.3
Total Consumer Loans			23,944,076				43.0				26,866,807				46.5				32,116,253				51.3				27,168,201				62.0				22,766,839				62.2
Total Loans		$	55,730,703				100.0	%		$	57,779,779				100.0	%		$	62,588,596				100.0	%		$	43,803,847				100.0	%		$	36,631,079				100.0	%
Total Loans with:
Fixed rates		$	29,756,577				53.4	%		$	33,450,767				57.9	%		$	39,716,958				63.5	%		$	26,141,411				59.7	%		$	21,145,915				57.7	%
Variable rates			25,974,126				46.6				24,329,012				42.1				22,871,638				36.5				17,662,436				40.3				15,485,164				42.3
Total Loans		$	55,730,703				100.0	%		$	57,779,779				100.0	%		$	62,588,596				100.0	%		$	43,803,847				100.0	%		$	36,631,079				100.0	%