SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


þ		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarter ended March 31, 2006

~~for the quarter ended September 30, 2005~~


o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _________________to____________________.

~~for the transition period from~~to.

Commission File Number: 001-16581

SOVEREIGN BANCORP, INC.

(Exact name of Registrant as specified in its charter)


Pennsylvania		23-2453088



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


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

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesþ. Noo.

Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer or a non-accelerated filer (as defined in Rule 12b-2 of the Act) ~~Yes~~: Large accelerated filerþ~~. No~~Accelerated filero.
Non-accelerated filero

Indicate by check mark whether the Registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) Yeso. Noþ.

APPLICABLE ONLY TO CORPORATE ISSUERS:

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


Class		Outstanding at ~~October 31, 2005~~

		April 30, 2006

Common Stock (no par value)		~~357,157,919~~359,120,429 shares

FORWARD LOOKING STATEMENTS

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to shareholders (including its ~~2004~~2005 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the disclosure communications by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

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

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

	•		growth in earnings per share;

	•		return on equity;

	•		return on assets;

	•		efficiency ratio;

	•		Tier 1 leverage ratio;

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

	•		fee income as a percentage of total revenue;

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

	•		book value and tangible book value per share; and

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

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

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

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

	•		inflation, interest rate, market and monetary fluctuations;

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

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

FORWARD LOOKING STATEMENTS
(continued)

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

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

	•		Sovereign’s timely development of competitive new products and services in a changing environment and the acceptance of such products and services by customers;

	•		anticipated acquisitions and related financing transactions may not close on the expected closing date or it may not close at all;

	•		the conditions to closing anticipated acquisitions, including stockholder and regulatory approvals, may not be satisfied;

	•		the willingness of customers to substitute competitors’ products and services and vice versa;

	•		the ability of Sovereign and its third party vendors to convert and maintain Sovereign’s data processing and related systems on a timely and acceptable basis and within projected cost estimates;

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

	•		technological changes;

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

	•		changes in consumer spending and savings habits;

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

	•		regulatory or judicial proceedings;

	•		changes in asset quality;

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

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

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

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	September 30,			December 31,			March 31,			December 31,
	2005			2004			2006			2005
	(in thousands, except share data)						(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	1,438,240		$	1,160,922		$	997,447		$	1,131,936
Investment securities:
Available-for-sale		8,244,029			7,642,558			7,063,492			7,258,402
Held-to-maturity		4,500,881			3,904,319			4,936,066			4,647,627
Loans (including loans held for sale of $335,759 and $137,478 at September 30, 2005 and December 31, 2004, respectively)		42,691,639			36,631,079
Other investments								670,353			651,299
Loans (including loans held for sale of $504,803 and $311,578 at March 31, 2006 and December 31, 2005, respectively)								45,164,413			43,803,847
Allowance for loan losses		(436,828	)		(408,716	)		(421,860	)		(419,599	)


Net loans		42,254,811			36,222,363			44,742,553			43,384,248


Premises and equipment		401,868			353,337			408,119			412,017
Accrued interest receivable		265,120			226,012			275,343			286,300
Goodwill		2,714,073			2,125,081			2,715,217			2,716,826
Core deposit intangibles, net of accumulated amortization of $501,614 and $445,559 at September 30, 2005 and December 31, 2004, respectively		231,740			256,694
Core deposit intangibles, net of accumulated amortization of $536,599 and $519,380 at March 31, 2006 and December 31, 2005, respectively								196,756			213,975
Bank owned life insurance		1,006,820			885,807			1,027,403			1,018,125
Other assets		1,884,316			1,694,220			2,027,191			1,957,971


TOTAL ASSETS	$	62,941,898		$	54,471,313		$	65,059,940		$	63,678,726


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	37,332,591		$	32,555,518		$	38,820,147		$	37,977,706
Borrowings and other debt obligations		18,897,237			16,140,128			19,216,159			18,720,897
Advance payments by borrowers for taxes and insurance		36,276			30,542			60,392			49,313
Other liabilities		802,779			552,847			857,269			914,451


TOTAL LIABILITIES		57,068,883			49,279,035			58,953,967			57,662,367


Minority interests		205,176			203,906			206,141			205,660


STOCKHOLDERS’ EQUITY
Common stock; no par value; 800,000,000 shares authorized; 382,423,704 shares issued at September 30, 2005 and 350,261,512 shares issued at December 31, 2004		3,649,507			2,949,870
Common stock; no par value; 800,000,000 shares authorized; 382,764,597 shares issued at March 31, 2006 and 382,582,202 shares issued at December 31, 2005								3,657,038			3,657,543
Warrants and employee stock options issued		337,156			317,842			335,717			337,346
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 3,285,872 shares at September 30, 2005 and December 31, 2004		(23,707	)		(23,707	)
Treasury stock at cost; 21,046,007 shares at September 30, 2005 and 1,200,470 shares at December 31, 2004		(467,265	)		(19,136	)
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 2,957,285 shares at March 31, 2006 and December 31, 2005								(21,396	)		(21,396	)
Treasury stock at cost; 20,955,846 shares at March 31, 2006 and 21,606,549 shares at December 31, 2005								(466,328	)		(478,734	)
Accumulated other comprehensive loss		(170,619	)		(108,092	)		(211,760	)		(170,798	)
Retained earnings		2,342,767			1,871,595			2,606,561			2,486,738


TOTAL STOCKHOLDERS’ EQUITY		5,667,839			4,988,372			5,899,832			5,810,699


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	62,941,898		$	54,471,313		$	65,059,940		$	63,678,726

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three-Month Period					Nine-Month Period
	Ended September 30,					Ended September 30,				Three-Month Period
	2005		2004			2005		2004		Ended March 31,
	(in thousands, except									2006		2005
	per share data)									(in thousands, except, per share data
INTEREST INCOME:
Interest-earning deposits	$	2,022	$	1,505		$	6,151	$	3,013	$	2,116	$	2,233
Investment securities:
Available-for-sale		90,854		124,803			281,616		398,526		90,095		90,995
Held-to-maturity		47,624		46,470			137,834		107,168		53,553		45,119
Interest on loans		607,966		412,771			1,693,722		1,091,249		688,166		527,988
Other											5,603		3,889

TOTAL INTEREST INCOME		748,466		585,549			2,119,323		1,599,956		839,533		670,224


INTEREST EXPENSE:
Deposits and customer accounts		169,084		83,160			423,141		211,314		231,837		114,178
Borrowings and other debt obligations		183,817		139,439			499,564		370,837		203,738		148,700


TOTAL INTEREST EXPENSE		352,901		222,599			922,705		582,151		435,575		262,878


NET INTEREST INCOME		395,565		362,950			1,196,618		1,017,805		403,958		407,346
Provision for loan losses		20,000		25,000			64,000		100,000
Provision for credit losses											29,000		22,000

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		375,565		337,950			1,132,618		917,805

NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES											374,958		385,346


NON-INTEREST INCOME:
Consumer banking fees		74,992		62,771			214,610		174,828		60,798		60,349
Commercial banking fees		42,745		31,757			111,284		90,994		39,016		30,323
Net mortgage banking revenues		28,967		(4,080	)		62,446		17,783
Mortgage banking revenues											12,992		11,655
Capital markets revenue		5,382		3,409			13,768		13,395		3,889		4,686
Bank owned life insurance		12,066		9,922			35,887		29,136		11,327		10,903
Miscellaneous income		6,856		4,498			25,299		15,441		6,319		6,351


TOTAL FEES AND OTHER INCOME		171,008		108,277			463,294		341,577		134,341		124,267
Net gain on investment securities		1,675		20,247			13,009		38,957		—		7,979


TOTAL NON-INTEREST INCOME		172,683		128,524			476,303		380,534		134,341		132,246


GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		140,532		114,871			401,460		324,175		143,778		125,125
Occupancy and equipment expenses		61,096		54,976			185,314		161,452		64,193		62,870
Technology expense		21,349		18,935			61,623		55,873		21,566		18,668
Outside services		15,362		14,332			43,815		39,414		14,755		14,648
Marketing expense		14,455		11,983			37,259		33,434		10,222		11,047
Other administrative expenses		24,107		22,583			77,935		71,062		25,465		24,756


TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		276,901		237,680			807,406		685,410		279,979		257,114

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE ~~NINE-MONTH~~THREE-MONTH PERIOD ENDED ~~SEPTEMBER 30, 2005~~

MARCH 31, 2006
(unaudited)

(in thousands)


									Unallocated																								Unallocated
	Common								Common						Accumulated						Total			Common									Common						Accumulated						Total
	Shares					Warrants			Stock						Other						Stock-			Shares						Warrants			Stock						Other						Stock-
	Out-			Common		& Stock			Held by			Treasury			Comprehensive			Retained			Holders’			Out-			Common			& Stock			Held by			Treasury			Comprehensive			Retained			Holders’
	standing			Stock		Options			ESOP			Stock			Income/(Loss)			Earnings			Equity			standing			Stock			Options			ESOP			Stock			Income/(Loss)			Earnings			Equity
Balance, December 31, 2004		345,775		$	2,949,870	$	317,842		$	(23,707	)	$	(19,136	)	$	(108,092	)	$	1,871,595		$	4,988,372
Balance, December 31, 2005																									358,018		$	3,657,543		$	337,346		$	(21,396	)	$	(478,734	)	$	(170,798	)	$	2,486,738		$	5,810,699


Comprehensive income:
Net income		—			—		—			—			—			—			510,665			510,665			—			—			—			—			—			—			141,398			141,398
Change in unrealized gain/loss, net of tax:
Investment securities available for sale		—			—		—			—			—			(83,899	)		—			(83,899	)		—			—			—			—			—			(59,587	)		—			(59,587	)
Cash flow hedge derivative financial instruments		—			—		—			—			—			21,372			—			21,372			—			—			—			—			—			18,625			—			18,625

Total comprehensive income																																														100,436

Total comprehensive income																						448,138
Stock and stock options issued in connection with business acquisitions		29,813			645,940		35,636			—			—			—			—			681,576
Stock issued in connection with employee benefit and incentive compensation plans		2,828			53,697		(19,683	)		—			12,645			—			—			46,659			1,069			(505	)		(2,856	)		—			17,432			—			—			14,071
Employee stock options earned		—			—		3,361			—			—			—			—			3,361			—			—			1,227			—			—			—			—			1,227
Dividends paid on common stock		—			—		—			—			—			—			(39,493	)		(39,493	)		—			—			—			—			—			—			(21,575	)		(21,575	)
Stock repurchased		(20,325	)		—		—			—			(460,774	)		—			—			(460,774	)		(236	)		—			—			—			(5,026	)		—			—			(5,026	)


Balance, September 30, 2005		358,091		$	3,649,507	$	337,156		$	(23,707	)	$	(467,265	)	$	(170,619	)	$	2,342,767		$	5,667,839
Balance, March 31, 2006																									358,851		$	3,657,038		$	335,717		$	(21,396	)	$	(466,328	)	$	(211,760	)	$	2,606,561		$	5,899,832

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Nine-Month Period						Three-Month Period
	Ended September 30,						Ended March 31,
	2005			2004			2006			2005
	(in thousands)						(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	510,665		$	316,123		$	141,398		$	146,151
Adjustments to reconcile net income to net cash provided by operating activities, net of acquisitions:
Provision for loan losses		64,000			100,000
Provision for credit losses								29,000			22,000
Depreciation and amortization		125,565			120,439			40,397			41,446
Net amortization/accretion of investment securities and loan premiums and discounts		56,129			39,795			27,415			15,624
Net gain on sale of loans								(9,504	)		(6,631	)
Net gain on investment securities		(13,009	)		(38,957	)		—			(7,979	)
Net (gain) loss on real estate owned and premises and equipment		(317	)		(203	)		972			(660	)
Loss on debt extinguishments		—			63,261
Stock-based compensation		24,197			16,769			7,316			10,897
Origination and purchases of loans held for sale, net of repayments								(506,927	)		(306,411	)
Proceeds from sales of loans held for sale								313,638			299,661
Net change in:
Loans held for sale		(198,281	)		63,427
Accrued interest receivable		(39,108	)		(9,328	)		10,957			(32,837	)
Other assets and bank owned life insurance		97,626			(190,642	)		(34,948	)		118,632
Other liabilities		199,490			110,258			(54,679	)		108,515

Net cash provided by operating activities		826,957			590,942			(34,965	)		408,408


CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of available for sale investment securities		2,287,170			3,076,479			17,055			445,237
Proceeds from repayments and maturities of investment securities:
Available-for-sale		1,196,649			1,539,047			175,903			328,877
Held-to-maturity		443,297			332,198			93,604			121,662
Net change in FHLB stock		(119,679	)		(149,540	)		(103,237	)		2,199
Purchases of available-for-sale investment securities		(3,672,919	)		(4,902,275	)		(9,308	)		(578,025	)
Purchases of held-to-maturity investment securities		(1,023,411	)		(447,099	)		(380,662	)		—
Proceeds from sales of loans		5,546,775			1,713,895			2,267,839			648,100
Purchase of loans		(4,981,500	)		(3,474,299	)		(2,687,847	)		(1,389,605	)
Net change in loans other than purchases and sales		(3,876,106	)		(2,096,968	)		(791,159	)		(367,904	)
Proceeds from sales of premises and equipment		13,177			10,869			1,558			7,685
Purchases of premises and equipment		(68,175	)		(70,285	)		(15,779	)		(20,741	)
Proceeds from sales of real estate owned		5,991			9,126			1,019			3,133
Net cash received/(paid) from business combinations		281,229			(231,269	)
Net cash received from business combinations								—			324,203

Net cash used in investing activities	$	(3,967,502	)	$	(4,690,121	)		(1,431,014	)		(475,179	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase/(decrease) in deposits and other customer accounts	$	1,895,196		$	844,681			843,146			1,194,584
Net increase/(decrease) in borrowings		1,537,718			3,064,266			494,614			(1,454,010	)
Proceeds from senior notes and credit facility		800,000			997,710			—			250,000
Proceeds from issuance of Contingent Convertible Trust Preferred Equity Income Redeemable Securities and warrants		—			285,435
Repayments of borrowings and other debt obligations		(350,000	)		(773,360	)		—			(50,000	)
Net increase in advance payments by borrowers for taxes and insurance		3,516			4,910			11,079			1,954
Cash dividends paid to stockholders		(39,493	)		(27,153	)		(21,575	)		(10,400	)
Proceeds from issuance of common stock		28,892			24,394			3,766			8,253
Treasury stock repurchases, net of proceeds		(457,966	)		(5,962	)		460			(52,858	)

Net cash provided by financing activities		3,417,863			4,414,921			1,331,490			(112,477	)

Net change in cash and cash equivalents		277,318			315,742			(134,489	)		(179,248	)
Cash and cash equivalents at beginning of period		1,160,922			950,302			1,131,936			1,160,922

Cash and cash equivalents at end of period	$	1,438,240		$	1,266,044		$	997,447		$	981,674

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(dollars in thousands, except per share amounts)

(Unaudited)

(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

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

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

The preparation of these financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. Actual results could differ from those estimates.

The results of operations for any interim periods are not necessarily indicative of the results which may be expected for the entire year.

In accordance with banking regulatory reporting guidance issued in the first quarter of 2006, Sovereign ~~adopted~~reclassified prepayment fees and late fees on loans from non-interest income to interest income. Prior periods were reclassified to conform to the expense recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” for stock based employee compensation awards during 2002. Sovereign estimates the fair value of stock options issued to employees using a Black-Scholes option pricing model and expenses this value over the vesting periods. Reductions to compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted periodically based on actual forfeiture experience. The impact of not adopting SFAS No. 123 prior to 2002 to Sovereign’s net income and earnings per share for the three-month and nine-month periods ended September 30, 2005 and 2004 was not material.current period presentation.

(2) EARNINGS PER SHARE

Basic earnings per share is calculated by dividing net income by the weighted average common shares outstanding, excluding options and warrants. The dilutive effect of our options is calculated using the treasury stock method and the dilutive effect of our warrants that were issued in connection with our contingently convertible debt issuance ~~in February 2004~~ is calculated under the if-converted method for diluted earnings per share purposes.

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


	Three-Month Period				Nine-Month Period				Three-Month Period
	Ended September 30,				Ended September 30,				Ended March 31,
	2005		2004		2005		2004		2006		2005
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income as reported and for basic EPS	$	181,043	$	82,542	$	510,665	$	316,123	$	141,398	$	146,151
Contingently convertible trust preferred interest expense, net of tax		6,344		6,310		19,074		14,895		6,327		6,394

Net Income for diluted EPS	$	187,387	$	88,852	$	529,739	$	331,018	$	147,725	$	152,545


WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares		360,299		335,603		365,623		314,365		358,930		368,860
Dilutive effect of:
Warrants		26,094		26,082		26,089		20,827		26,111		26,082
Stock options		6,717		6,097		6,511		5,886		5,784		6,397

Weighted average diluted shares		393,110		367,782		398,223		341,078		390,825		401,339


EARNINGS PER SHARE:
Basic	$	0.50	$	0.25	$	1.40	$	1.01	$	0.39	$	0.40
Diluted	$	0.48	$	0.24	$	1.33	$	0.97	$	0.38	$	0.38

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

~~(4)~~(3) INVESTMENT SECURITIES ~~HELD-TO-MATURITY~~ (continued)

The following table discloses the age of gross unrealized losses in ~~our~~Sovereign’s total investment portfolio (held to maturity and available for sale) as of ~~September 30,~~March 31, 2006 and December 31, 2005 (in thousands):


	At September 30, 2005												At March 31, 2006
	Less than 12 months				12 months or longer				Total				Less than 12 months					12 months or longer					Total
			Unrealized				Unrealized				Unrealized				Unrealized					Unrealized					Unrealized
	Fair Value		Losses		Fair Value		Losses		Fair Value		Losses		Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	32,946	$	413	$	22,842	$	441	$	55,788	$	854	$	20,295	$	(327	)	$	30,830	$	(524	)	$	51,125	$	(851	)
Debentures of FHLB, FNMA and FHLMC		151,339		2,573		19,803		205		171,142		2,778		55,891		(1,390	)		103,863		(1,878	)		159,754		(3,268	)
Corporate debt and asset-backed securities		64,448		462		—		—		64,448		462		61,477		(2,912	)		4		—			61,481		(2,912	)
Equity securities		933,405		29,845		—		—		933,405		29,845		920,953		(37,296	)		—		—			920,953		(37,296	)
State and municipal securities		1,128,035		20,143		—		—		1,128,035		20,143		1,482,373		(35,645	)		—		—			1,482,373		(35,645	)
Mortgage-backed Securities:
U.S. government agencies		1,229,997		32,969		10,287		181		1,240,284		33,150		581,897		(23,662	)		541,147		(20,508	)		1,123,044		(44,170	)
FHLMC and FNMA debt securities		1,322,555		26,704		2,152,747		74,977		3,475,302		101,681		672,628		(29,797	)		2,883,855		(163,559	)		3,556,483		(193,355	)
Non-agencies		2,125,760		38,247		719,658		19,467		2,845,418		57,714
Non-agency securities														1,255,093		(34,641	)		1,789,629		(79,306	)		3,044,722		(113,948	)


Total investment securities available for sale and held to maturity	$	6,988,485	$	151,356	$	2,925,337	$	95,271	$	9,913,822	$	246,627	$	5,050,607	$	(165,670	)	$	5,349,328	$	(265,775	)	$	10,399,935	$	(431,445	)

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

(3) INVESTMENT SECURITIES (continued)

As of ~~September 30, 2005,~~March 31, 2006, management has concluded that the unrealized losses above on its debt securities (which totaled ~~345~~401 individual securities) are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for the time necessary to recover its ~~cost. These losses are on securities that~~cost and will ultimately recover its cost at maturity (i.e. these investments have contractual ~~maturity dates~~maturities that ensure Sovereign will ultimately recover its cost). At March 31, 2006 and December 31, 2005 the unrealized losses greater than 12 months were primarily limited to mortgage backed securities. In making its other than temporary impairment evaluation, Sovereign considered the fact that the principal and interest on these securities are ~~primarily related to market interest rates.~~

from U.S. Government and Government Agencies as well as issuers that are investment grade (Aaa rated). The change in the unrealized losses on the ~~equity~~U.S. Government and Government Agencies mortgage-backed securities, ~~above (which consisted of 9 securities) are related to preferred stock issuances of the~~Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) securities and the ~~Federal Home Loan Mortgage Corporation (“FHLMC”). These~~non-agency mortgage-backed securities ~~have~~were caused by changes in interest rates. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the ability and intent to hold those investments until a ~~combined effective yield~~recovery of ~~8.10% since~~fair value, which may be maturity, the ~~majority~~Company does not consider those investments to be other-than-temporarily impaired.

As of ~~the dividends received are tax-exempt.~~March 31, 2006, Sovereign held 9 securities totaling $907 million of perpetual preferred stock of FHLMC and FNMA which had an unrealized loss of $36.7 million. These losses are ~~primarily~~ related to ~~increased credit~~liquidity spreads due to negative events on the issuers of these securities ~~and to a lesser extent~~as well as market interest rates. These securities ~~remain~~have experienced changes in prices month-to-month based on movements in credit spreads and interest rates and as recently as February 28, 2006 these investment securities were in a net unrealized gain position of $1.7 million. We perform an analysis of the individual securities each quarter and evaluate the prospects of the issuers when considering whether an other than temporary impairment exists. As of March 31, 2006, each of the individual securities was investment grade and we believe that both the duration and severity of loss ~~are~~were not significant. Management expects that this volatility will continue and has concluded that the above unrealized losses are temporary in nature. However, if the severity ~~and~~or duration of the losses increase or if the securities become ~~non-investment grade,~~downgraded, we may be required to ~~write-down these securities~~recognize an other than temporary impairment charge in future periods.

(4) OTHER INVESTMENTS

Other investments of $670 million and $651 million at March 31, 2006 and December 31, 2005, respectively, represent Sovereign’s investment in the stock of the Federal Home Loan Bank (FHLB) of Boston and Pittsburgh. Although FHLB stock is an equity interest in a FHLB, it does not have a readily determinable fair value for purposes of FASB Statement No. 115, because its ownership is restricted and it lacks a market. FHLB stock can be sold back only at its par value of $100 per share and only to the FHLBs or to another member institution.

1314

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars~~2005, hedge ineffectiveness of $0.2 million was recorded in ~~thousands, except per share amounts)~~
~~(Unaudited)~~

~~(8) DERIVATIVES (continued)~~earnings associated with fair value hedges.

Cash Flow Hedges. Sovereign hedges exposures to changes in cash flows associated with forecasted interest payments on variable-rate liabilities, through the use of pay-fixed, receive variable interest rate swaps. For the ~~nine-months~~three-months ended ~~September 30,~~March 31, 2006 and 2005, ~~and 2004,~~ no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. No gains or losses deferred in accumulated other comprehensive income were reclassified into earnings during the ~~nine-months~~three-months ended ~~September 30,~~March 31, 2006 or 2005 ~~or 2004~~ as a result of discontinuance of cash flow hedges for which the forecasted transaction was not probable of occurring. As of ~~September 30, 2005,~~March 31, 2006, Sovereign expects approximately ~~$3.0~~$1.2 million of the deferred net after-tax loss on derivative instruments included in accumulated other comprehensive income to be reclassified to earnings during the next twelve months.

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

Those derivatives include mortgage banking interest rate lock commitments and forward sale commitments used for risk management purposes and derivatives executed with commercial banking customers, primarily interest rate swaps and foreign currency contracts.

~~Shown below is a summary of the derivatives designated as hedges under SFAS No. 133 at September 30, 2005~~ The Company also enters into precious metals customer forward arrangements and ~~December 31, 2004 (dollars in thousands):~~

Weighted Average
Notional Receive Pay Life
Amount Asset Liability Rate Rate (Years)
September 30, 2005

Fair value hedges:
Receive fixed – pay variable interest rate swaps $ 2,688,590 $ 37 $ 52,590 4.40 % 4.27 % 4.2
Cash flow hedges:
Pay fixed – receive floating interest rate swaps 1,650,000 21,774 2,815 3.65 % 3.34 % 1.0

Total derivatives used in SFAS 133 hedging relationships $ 4,338,590 $ 21,811 $ 55,405 4.11 % 3.91 % 3.0

December 31, 2004

Fair value hedges:
Receive fixed – pay variable interest rate swaps $ 1,638,590 $ 1,725 $ 27,332 4.75 % 3.12 % 5.8
Cash flow hedges:
Pay fixed – receive floating interest rate swaps 1,850,000 8,858 8,916 2.16 % 3.59 % 1.6

Total derivatives used in SFAS 133 hedging relationships $ 3,488,590 $ 10,583 $ 36,248 3.37 % 3.37 % 3.5

forward sale agreements.

1617

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

(8) DERIVATIVES (continued)

Shown below is a summary of the derivatives designated as hedges under SFAS No. 133 at March 31, 2006 and December 31, 2005 (dollars in thousands):


							Weighted Average
	Notional						Receive			Pay			Life
	Amount		Asset		Liability		Rate			Rate			(Years)
March 31, 2006
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	2,055,000	$	—	$	72,523		4.22	%		5.08	%		3.7
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		3,650,000		43,206		558		4.66	%		4.17	%		1.8


Total derivatives used in SFAS 133 hedging relationships	$	5,705,000	$	43,206	$	73,081		4.51	%		4.50	%		2.5


December 31, 2005
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	2,440,000	$	—	$	52,885		4.05	%		4.54	%		3.4
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		3,650,000		21,295		2,730		4.38	%		4.17	%		2.0


Total derivatives used in SFAS 133 hedging relationships	$	6,090,000	$	21,295	$	55,615		4.25	%		4.32	%		2.5

Summary information regarding other derivative activities at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004~~2005 follows (in thousands):


	September 30,			December 31,			March 31,			December 31,
	2005			2004			2006			2005
	Net Asset			Net Asset			Net Asset			Net Asset
	(Liability)			(Liability)			(Liability)			(Liability)
Mortgage banking derivatives:
Forward commitments to sell loans	$	1,152		$	(640	)	$	1,484		$	(538	)
Interest rate lock commitments		(70	)		220			15			475


Total mortgage banking risk management		1,082			(420	)		1,499			(63	)

Swaps receive fixed		8,037			50,273			(36,979	)		(4,955	)
Swaps pay fixed		14,155			(29,509	)		60,890			27,919


Net Customer related interest rate swaps		22,192			20,764			23,911			22,964

Precious metals forward sale commitments								(51,580	)		(47,982	)
Precious metals forward settlement arrangements								50,275			46,430
Foreign exchange		261			(177	)		798			740


Total activity	$	23,535		$	20,167		$	24,903		$	22,089

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

(8) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of and for the ~~nine-months~~three-months ended ~~September 30, 2005:~~March 31, 2006:


		~~Income Statement~~
		~~Effect For The~~
	Balance Sheet Effect at	~~Nine-months~~Income Statement Effect For The Three-months Ended
Derivative Activity	~~September 30, 2005~~March 31, 2006	~~September 30, 2005~~March 31, 2006
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to borrowings and CDs of ~~$28.0~~$35.5 million and ~~$24.6~~$37.0 million, respectively, and an increase to other liabilities of ~~$52.6~~$72.5 million.	Resulted in ~~an increase~~a decrease of net interest income of ~~$11.6~~$4.7 million.

Cash flow hedges:

Pay fixed-receive floating interest rate swaps	Increase to other assets, other liabilities, and stockholders’ equity of ~~$21.8~~$43.2 million, ~~$2.8~~$0.6 million and ~~$12.3~~$27.7 million, respectively, and decrease to deferred taxes of ~~$6.6~~$14.9 million.	Resulted in a decrease in net interest income of ~~$17.3~~$0.9 million.

Other hedges:

Forward commitments to sell loans	Increase to other assets of ~~$1.2~~$1.5 million.	Increase to mortgage banking revenues of ~~$1.8~~$2.0 million.

Interest rate lock commitments	Decrease to mortgage loans of ~~$0.1 million.~~$15 thousand.	Decrease to mortgage banking revenues of ~~$0.3~~$0.5 million.

Net Customer Related Swaps	Increase to other assets of ~~$22.2~~$23.9 million.	Increase in capital markets revenue of ~~$1.5~~$0.8 million.

Forward commitments and forward settlement arrangements on precious metals	Decrease to other assets of $1.3 million	Decrease to commercial banking fees of $3.6 million.

Foreign exchange	Increase to other assets of ~~$0.3~~$0.8 million.	Increase to commercial banking revenues of ~~$0.4~~$0.1 million.

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

(8) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of December 31, ~~2004~~2005 and for the ~~nine-months~~three-months ended ~~September 30, 2004:~~March 31, 2005:


	Balance Sheet Effect at	Income Statement Effect For The ~~Nine~~Three
Derivative Activity	December 31, ~~2004~~2005	Months Ended ~~September 30, 2004~~March 31, 2005
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to borrowings and CDs of ~~$19.9~~$24.0 million and ~~$5.7~~$28.9 million, respectively, and an increase to other ~~assets and other~~ liabilities of ~~$1.7 million, and $27.3 million, respectively.~~$52.9 million.	Resulted in an increase of net interest income of ~~$36.1~~$5.7 million.

Cash flow hedges:

Pay fixed-receive floating interest rate swaps	Increase to other assets, ~~and~~ other liabilities, ~~of $8.9 million with no net effect on~~and stockholders’ equity of $21.3 million, $2.7 million, and $12.1 million, respectively and a decrease to deferred ~~taxes.~~taxes of $6.5 million	Resulted in a decrease in net interest income of ~~$40.0~~$8.1 million.

Other hedges:

Forward commitments to sell loans	~~Decrease~~Increase to other liabilities of ~~$0.6~~$0.5 million.	Increase to mortgage banking revenues of ~~$1.0~~$2.4 million.

Interest rate lock commitments	Increase to mortgage loans of ~~$0.2~~$0.5 million.	Decrease to mortgage banking revenues of ~~$0.7~~$0.2 million.

Net Customer Related Swaps	Increase to other assets of ~~$20.8~~$23.0 million.	Decrease in capital markets revenue of ~~$1.9~~$0.2 million.

Forward commitments and forward settlement arrangements on precious metals	Decrease to other assets of $1.6 million	Increase to commercial banking fees of $15.1 million.

Foreign Exchange	~~Decrease~~Increase to other assets of ~~$0.2~~$0.7 million.	Increase to commercial banking revenues of ~~$0.2~~$0.1 million.

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

(11) BUSINESS SEGMENT INFORMATION

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

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


	Mid-Atlantic		New England		Shared			Shared
For the three-month period ended	Banking		Banking		Services			Services								Mid-Atlantic		New England		Shared			Shared
September 30, 2005	Division		Division		Consumer			Commercial			Other			Total
March 31, 2006																Banking Division		Banking Division		Services Consumer			Services Commercial			Other			Total

Net interest income (expense)	$	149,312	$	170,874	$	75,317		$	60,389		$	(60,327	)	$	395,565	$	140,901	$	163,685	$	87,915		$	54,267		$	(42,810	)	$	403,958
Fees and other income		34,359		41,669		44,687			35,776			14,517			171,008		32,797		40,535		16,363			30,529			14,117			134,341
Provision for loan losses		5,058		1,188		12,115			1,247			392			20,000		3,288		3,447		19,174			3,091			—			29,000
General and administrative expenses		95,381		106,644		34,877			29,362			10,637			276,901		96,995		109,164		37,683			26,978			9,159			279,979
Depreciation/Amortization		3,900		3,644		9,270			1,119			24,475			42,408		3,623		4,141		7,145			1,210			24,278			40,397
Income (loss) before income taxes		83,232		104,712		69,983			65,557			(84,692	)		238,792		73,415		91,609		42,966			54,727			(78,189	)		184,528
Intersegment revenues (expense)⁽¹⁾		111,204		154,696		(204,821	)		(86,139	)		25,060			—		122,105		158,872		(243,751	)		(110,697	)		73,471			—
Total Average Assets	$	6,587,485	$	5,774,949	$	21,744,560		$	10,419,557		$	17,056,303		$	61,582,854	$	6,185,175	$	5,526,470	$	23,963,481		$	10,655,357		$	17,709,110		$	64,039,593

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


For the three-month period ended	Mid-Atlantic		New England		Shared			Shared
March 31, 2005	Banking Division		Banking Division		Services Consumer			Services Commercial			Other			Total

Net interest income (expense)	$	138,826	$	157,277	$	90,614		$	53,951		$	(33,322	)	$	407,346
Fees and other income		29,924		38,002		21,203			22,823			12,315			124,267
Provision for loan losses		6,032		1,870		12,739			1,359			—			22,000
General and administrative expenses		89,362		100,650		38,474			24,436			4,192			257,114
Depreciation/Amortization		3,455		4,369		3,508			729			29,385			41,446
Income (loss) before income taxes		73,461		92,760		53,494			50,979			(74,005	)		196,689
Intersegment revenues (expense)⁽¹⁾		101,080		139,770		(177,343	)		(56,880	)		(6,627	)		—
Total Average Assets	$	6,442,172	$	5,469,541	$	20,049,632		$	8,747,529		$	16,850,428		$	57,559,302

~~(11) BUSINESS SEGMENT INFORMATION (continued)~~

Mid-Atlantic New England Shared Shared
For the three-month period ended Banking Banking Services Services
September 30, 2004 Division Division Consumer Commercial Other Total

Net interest income $ 112,852 $ 138,556 $ 78,636 $ 42,506 $ (9,600 ) $ 362,950
Fees and other income 29,896 39,263 5,062 23,547 10,509 108,277
Provision for loan losses 5,185 1,535 9,634 4,121 4,525 25,000
General and administrative expenses 77,058 98,784 25,084 28,914 7,840 237,680
Depreciation/Amortization 3,483 3,937 6,595 655 26,775 41,445
Income (loss) before income taxes 60,505 77,499 46,143 33,018 (117,453 ) 99,712
Intersegment revenues (expense)⁽¹⁾
90,492 117,694 (130,651 ) (44,234 ) (33,301 ) —
Total Average Assets $ 4,574,595 $ 5,160,573 $ 16,543,946 $ 8,102,669 $ 19,093,670 $ 53,475,453

Mid-Atlantic New England Shared Shared
For the nine-month period ended Banking Banking Services Services
September 30, 2004 Division Division Consumer Commercial Other Total

Net interest income (expense) $ 324,993 $ 351,383 $ 203,449 $ 122,255 $ 15,725 $ 1,017,805
Fees and other income 88,941 108,922 40,077 68,977 34,660 341,577
Provision for loan losses 22,010 11,126 28,628 23,640 14,596 100,000
General and administrative expenses 236,748 270,477 74,630 83,963 19,592 685,410
Depreciation/Amortization 10,233 10,313 23,345 1,890 74,658 120,439
Income (loss) before income taxes 155,177 178,701 132,382 83,628 (142,685 ) 407,203
Intersegment revenues (expense)⁽¹⁾
257,738 309,066 (347,997 ) (115,836 ) (102,971 ) —
Total Average Assets $ 4,497,277 $ 4,219,976 $ 14,452,497 $ 7,667,209 $ 18,293,432 $ 49,130,391


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

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

(12) RECENT ACCOUNTING PRONOUNCEMENTS

In December 2003, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position 03-3 “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” This statement addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in non-homogenous loans acquired in a transfer if those differences are attributable, at least in part, to credit quality. This statement limits the yield that may be accreted (“accretable yield”) to the excess of the investor’s estimate of undiscounted expected principal, interest, and other cash flows (cash flows expected at acquisition to be collected) over the investor’s initial investment in the loan. This statement requires that the excess of contractual cash flows over cash flows expected to be collected (“nonaccretable difference”) not be recognized as an adjustment of yield, loss accrual, or valuation allowance. This statement prohibits investors from displaying accretable yield and nonaccretable difference in the balance sheet. Subsequent increases in cash flows expected to be collected generally should be recognized prospectively through adjustment of the loan’s yield over its remaining life. Decreases in cash flows expected to be collected should be recognized as impairment. This statement prohibits “carrying over” or creation of valuation allowances in the initial accounting of all non-homogeneous loans acquired in a transfer that are within the scope of this statement, and is effective for loans acquired in fiscal years beginning after December 15, 2004. The adoption of this pronouncement did not have a material impact on Sovereign’s results of operations or financial position.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123(R), a revision of FASB statement No. 123, “Accounting for Stock-Based Compensation.” This statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. SFAS 123(R) requires that the cost resulting from all share based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for such arrangements with employees and non-employees. Since Sovereign previously adopted the fair value recognition provisions of SFAS No. 123, ~~in 2002,~~ the ~~impact~~adoption of SFAS No. 123(R) isdid not ~~anticipated to be~~have a material ~~when adopted~~impact on ~~January 1, 2006.~~Sovereign’s results of operations or financial position. See Note 17 for additional details.

In May 2005, the Financial Accounting Standards Board (FASB) issued SFAS No. 154, “Accounting Changes and Error Corrections”. This statement requires retrospective application to prior periods financial statements of a voluntary change in accounting principle unless it is impractical. Previously, most voluntary changes in accounting principle were recognized by recording the cumulative effect in net income in the period of change. SFAS No. 154 is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, ~~2005.~~2005 and its adoption did not have a material impact on Sovereign’s results of operations or financial position.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars~~ In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments”. This statement permits fair value measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in ~~thousands, except per share amounts)~~
~~(Unaudited)~~

~~(13) PURCHASE OF WAYPOINT FINANCIAL CORPORATION (“WAYPOINT”)~~securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative instrument. This statement will be effective for Sovereign for all financial instruments acquired or issued after January 1, 2007 although early adoption is permitted. Sovereign adopted this pronouncement on January 1, 2006 which did not have any impact on our results of operations or financial position.

~~On January 21, 2005, Sovereign completed~~In March 2006, the ~~acquisition~~Financial Accounting Standards Board (FASB) issued Statement No. 156, “Accounting for Servicing of ~~Waypoint~~ Financial ~~Corp. (“Waypoint”)~~Assets”, which amends FASB Statement No. 140, “Accounting for ~~approximately $950 million. A cash payment~~Transfers and Servicing of ~~$269.9 million was made in connection with the transaction with the remaining consideration consisting~~Financial Assets and Extinguishments of ~~the issuance~~Liabilities”. This Statement permits an entity (for each class of ~~29.8 million shares of common stock and stock options (to convert outstanding Waypoint stock options into Sovereign stock options). The preliminary purchase price was allocated to acquired~~separately recognized servicing assets and servicing liabilities) to either continue to amortize servicing assets or servicing liabilities in proportion to and over the period of ~~Waypoint~~net servicing income or net servicing loss and assess the servicing assets or liabilities for impairment or increased obligation based on fair value at each reporting date, or measure servicing assets or servicing liabilities at fair value at each reporting date and report changes in fair value in earnings in the period in which the change occurs. In addition, the statement clarifies when a servicer should separately recognize servicing assets and servicing liabilities, requires all separately recognized servicing assets and servicing liabilities to be initially measured at fair value, if practicable, and at its initial adoption, permits a one-time reclassification of available-for-sale securities to trading securities by entities with recognized servicing rights, without calling into question the treatment of other available-for-sale securities under Statement 115, provided that the available-for-sale securities are identified in some manner as offsetting the entity’s exposure to changes in fair value of servicing assets or servicing liabilities elected to be subsequently measured at fair value. Finally, the statement requires separate presentation of servicing assets and servicing liabilities subsequently measured at fair value in the statement of the financial position and additional disclosures for all separately recognized servicing assets and servicing liabilities. This statement is effective as of the beginning of an entity’s first fiscal year that begins after September 15, 2006. Sovereign will adopt this Statement on January ~~21, 2005. Sovereign~~1, 2007 and is inevaluating the ~~process~~impact of ~~finalizing these values and as such the allocation of the purchase price is subject to revision. (dollars in millions):~~

Assets
Investments $ 379.2
Loans 2,604.1
Less allowance for loan losses (26.5 )

Total loans, net 2,577.6
Cash acquired, net of cash paid 324.2
Premises and equipment, net 34.2
Bank Owned Life Insurance 97.0
Prepaid expenses and other assets 263.9
Core deposit intangible 31.1
Goodwill 598.5

Total assets $ 4,305.7

Liabilities
Deposits:
Core $ 1,503.7
Time 1,384.6

Total deposits 2,888.3
Borrowings and other debt obligations 668.2
Other liabilities (1) 67.6

Total liabilities $ 3,624.1


~~(1)~~		Includes liabilities of $11.6 million directly associated with the transaction which were recorded as part of the purchase price. The major components of this liability consisted of $2.9 million related to branch consolidation, $4.1 million related to accruals established for contractual disputes, and $2.1 million representing amounts to be paid to Waypoint senior executives for severance and acceleration of certain retirement benefits earned by employees at the date of the acquisition.

~~In connection with the Waypoint acquisition, Sovereign recorded net charges against~~this pronouncement on its ~~earnings for the nine-month period ended September 30, 2005 for merger related expenses of $16.7 million pre-tax ($10.9 million net of tax).~~

~~These merger-related expenses include the following (in thousands):~~

Branch and office consolidations $ 2,396
System conversions 5,831
Retail banking conversion costs and other 8,511

Total $ 16,738

financial statements.

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

(13) ~~PURCHASE OF WAYPOINT FINANCIAL CORPORATION (“WAYPOINT”) (continued)~~MERGER RELATED AND INTEGRATION CHARGES

The ~~branch~~following is a summary of amounts charged to earnings and ~~office consolidation charge relates to lease obligations for Sovereign branch and office locations that were vacated by Sovereign in~~ the first quarter of 2005 as a result of the Waypoint acquisition since management determined that these locations would no longer be required due to branch overlap or the creation of excess office space. This charge was based on the present values of the remaining lease obligations, or portions thereof, that were associated with lease abandonments, net of the estimated fair value of sub-leasing the properties. The fair value was estimated by comparing current market lease rates for comparable properties. If the actual proceeds from any subleases on these properties are different than our estimate, then the difference will be reflected as either additional merger related expense or a reversal thereof. These obligations will be paid over their lease expiration terms, which range from 2005 through 2009.

The system conversion costs are related to transferring Waypoint’s customer data from their core application system to Sovereign’s core application systems. These conversions were completed in the first quarter of 2005. The retail banking conversion costs consist primarily of replacing and/or converting customer account data such as welcoming kits, ATM cards, checks, credit cards, etc.

~~The~~ status of reserves related to business ~~acquisitions are summarized as follows~~combinations (in thousands):

First Essex Seacoast Waypoint
acquisition Acquisition acquisition Total
Reserve balance at December 31, 2004 $ 15,826 $ 51,222 $ — $ 67,048
Charge recorded in earnings at the time of acquisition — — 24,681 24,681
Amount provided/(reversed) in purchase accounting (Goodwill)⁽¹⁾
— (27,352 ) 11,609 (15,743 )
Payments (3,836 ) (7,780 ) (14,737 ) (26,353 )
Changes in estimates⁽²⁾
(1,305 ) (2,441 ) (7,943 ) (11,689 )

Reserve balance as of September 30, 2005 $ 10,685 $ 13,649 $ 13,610 $ 37,944


	First Essex			Seacoast			Waypoint
	acquisition			Acquisition			acquisition			Total
Reserve balance at December 31, 2005	$	9,839		$	12,748		$	10,335		$	32,922
Payments		(837	)		(932	)		(998	)		(2,767	)
Changes in estimates⁽¹⁾		—			(1,606	)		(1,029	)		(2,635	)

Reserve balance as of March 31, 2006	$	9,002		$	10,210		$	8,308		$	27,520


	For the three-month
	period ended March 31,
	2006			2005
Merger related and integration charges (reversals)(1)	$	(2,798	)	$	23,191

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars~~(1) Sovereign recorded merger and integration reversals in ~~thousands, except per share amounts)~~
~~(Unaudited)~~the first quarter due to favorable conversion costs and other merger-related items being lower than amounts initially estimated. In addition to the Seacoast and Waypoint reversals above, Sovereign recorded a reversal of $0.2 million related to an acquisition that the Company acquired in 2002.

(14) RETAINED INTERESTS IN ASSET SECURITIZATIONS

As described more fully in our annual report filed on Form 10-K, Sovereign has securitized certain financial assets to qualified special purpose entities which were deconsolidated in accordance with SFAS No. 140. Shown below are the types of assets underlying the securitizations for which Sovereign owns a retained interest and the related balances and delinquencies at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, and the net credit losses for the ~~nine-month~~three-month period ended ~~September 30, 2005~~March 31, 2006 and the year ended December 31, ~~2004~~2005 (in thousands):

September 30, 2005 December 31, 2004
Principal Net Principal Net
Total 90 Days Credit Total 90 Days Credit
Principal Past Due Losses Principal Past Due Losses/(Recoveries)
Securitized Assets:
Mortgage Loans $ 24,299 $ 1,460 $ 7 $ 43,248 $ 1,315 $ 69
Home Equity Loans 187,379 20,804 5,072 243,593 28,990 10,697
Automotive Floor Plan Loans 963,948 — — 579,000 — (44 )

Total Securitized $ 1,175,626 $ 22,264 $ 5,079 $ 865,841 $ 30,305 $ 10,722

Loans Held in Portfolios
Mortgage Loans $ 11,198,366 $ 8,497,495
Home Equity Loans 10,301,161 9,577,657
Automotive Floor Plan Loans 295,999 868,769

Total Held in Portfolio $ 21,795,526 $ 18,943,921

In December 2002, Sovereign securitized approximately $565 million of residential mortgage loans, converting them into investment certificates. Sovereign recognized a gain at the time of sale of $0.4 million associated with approximately 11% of the certificates that were sold to third parties. The majority of the certificates retained are AAA rated securities and are classified as investments available for sale. We also retained subordinated certificates in this transaction that totaled $29.4 million whose value is subject to credit risk and prepayment risk. These subordinated certificates are classified as retained interests in securitizations and are classified as investments available for sale on Sovereign’s Consolidated Balance Sheet.

Sovereign offers dealer floor plan financing to automotive dealerships. In 2000, Sovereign securitized approximately $600 million of dealer floor plan receivables under a revolving securitization structure, which matures in October of 2005.

In September 2005, Sovereign entered into a new twelve-month revolving securitization structure with its existing qualified special purpose trust that allows Sovereign to securitize up to $1.2 billion of receivables. Sovereign retained servicing responsibilities for the loans in the trust and maintained other retained interests in the securitized loans. These retained interests included an interest-only strip, a cash reserve account and a subordinated note. The Company estimated the fair value of these retained interests by determining the present value of the expected future cash flows using modeling techniques that incorporate management’s best estimates of key assumptions, including prepayment speeds, credit losses and discount rates. The investors and the trusts have no recourse to the Company’s assets, other than the retained interests, if the off-balance sheet loans are not paid when due. Sovereign receives annual contractual servicing fees of 1% for servicing the securitized loans. However, no servicing asset or liability was recorded for these rights since the contractual servicing fee approximates its market value.

During the third quarter Sovereign securitized $832.5 million of receivables under the new revolving securitization structure and recorded a $3.9 million gain, which was included in commercial banking revenues. The 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. The transaction costs involved in this securitization are being amortized over the twelve-month revolving period in accordance with SFAS No. 140.


	March 31, 2006						December 31, 2005
			Principal		Net				Principal		Net
	Total		90 Days		Credit		Total		90 Days		Credit
	Principal		Past Due		Losses		Principal		Past Due		Losses
Mortgage Loans	$	13,264,878	$	54,488	$	160	$	12,575,319	$	55,941	$	932
Home Equity Loans and lines of credit		10,051,156		90,498		12,000		9,966,031		102,112		22,253
Automotive Floor Plan Loans		1,468,856		—		—		1,468,176		832		—


Total Owned and Securitized	$	24,784,890	$	144,986	$	12,160	$	24,009,526	$	158,885	$	23,185


Less:
Securitized Mortgage Loans	$	103,105		1,411		1	$	112,517	$	1,737	$	154
Securitized Home Equity Loans		158,921		18,974		1,346		172,907		20,635		5,989
Securitized Automotive Floor Plan Loans		1,021,698		—		—		1,021,698		—		—


Total Securitized Loans	$	1,283,724		20,385		1,347	$	1,307,122	$	22,372	$	6,143


Net Loans	$	23,501,166		124,601		10,813	$	22,702,404	$	136,513	$	17,042

2524

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

(14) RETAINED INTERESTS IN ASSET SECURITIZATIONS (continued)

At ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, key economic assumptions and the sensitivity of the fair value of the retained interests to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows (dollars in thousands):


							2000		2005
				Home			Auto		Auto								Home			Auto
	Mortgage			Equity			Floor Plan		Floor Plan					Mortgage			Equity			Floor Plan
	Loans			Loans			Loans(1)		Loans			Total		Loans			Loans			Loans			Total
Components of Retained Interest and Servicing Rights:
Accrued Interest Receivable														$	—		$	—		$	6,916		$	6,916
Subordinated interest retained	$	29,406		$	—		$	21,000	$	40,767		$	91,173		27,271			—			52,655			79,926
Servicing rights		1,411			1,135			—		—			2,546		1,288			440			—			1,728
Interest only strips		—			10,802			131		2,204			13,137		—			8,335			3,080			11,415
Cash reserve		—			—			8,026		4,077			12,103		—			—			7,954			7,954


Total Retained Interests and Servicing Rights	$	30,817		$	11,937		$	29,157	$	47,048		$	118,959	$	28,559		$	8,775		$	70,605		$	107,939


Weighted-average life (in yrs)		1.12			1.72					0.34					0.95			1.59			0.35
Prepayment speed assumption (annual rate)
As of the date of the securitization		40	%		22	%				45	%				40	%		22	%		50	%
As of December 31, 2004		40	%		27	%				N/A
As of September 30, 2005		40	%		24	%				45	%
As of December 31, 2005															40	%		23	%		45	%
As of March 31, 2006															40	%		22	%		45	%
Impact on fair value of 10% adverse change	$	(36	)	$	(147	)			$	(90	)			$	(84	)	$	(68	)	$	(84	)
Impact on fair value of 20% adverse change	$	(67	)	$	(290	)			$	(195	)			$	(253	)	$	(146	)	$	(139	)
Expected credit losses (annual rate)
As of the date of the securitization		0.12	%		0.75	%				0.25	%				0.12	%		0.75	%		0.25	%
As of December 31, 2004		0.12	%		1.59	%				N/A
As of September 30, 2005		0.12	%		1.63	%				0.25	%
As of December 31, 2005															0.12	%		1.74	%		0.25	%
As of March 31, 2006															0.12	%		1.67	%		0.25	%
Impact on fair value of 10% adverse change	$	(15	)	$	(477	)			$	(36	)			$	(10	)	$	(237	)	$	(47	)
Impact on fair value of 20% adverse change	$	(30	)	$	(928	)			$	(72	)			$	(21	)	$	(450	)	$	(94	)
Residual cash flows discount rate (annual)
As of the date of the securitization		9	%		12	%				8	%				9	%		12	%		8	%
As of December 31, 2004		9	%		12	%				N/A
As of September 30, 2005		9	%		12	%				8	%
As of December 31, 2005															9	%		12	%		8	%
As of March 31, 2006															9	%		12	%		8	%
Impact on fair value of 10% adverse change	$	(23	)	$	(235	)			$	(65	)			$	(15	)	$	(164	)	$	(111	)
Impact on fair value of 20% adverse change	$	(45	)	$	(465	)			$	(130	)			$	(29	)	$	(324	)	$	(222	)

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

~~(16) SUBSEQUENT EVENT~~(15) PROXY AND RELATED PROFESSIONAL FEES

Sovereign incurred $14.3 million of proxy and professional fees in the first quarter. These fees were related to certain advertisements and legal and professional fees incurred in connection with the Relational matter that was discussed in Item 3 and Note 19 on our Form 10-K filed on March 16, 2006.

On ~~October~~March 22, 2006, Sovereign Bancorp, Inc. reached an agreement with Relational Investors LLC (“Relational”) in connection with the settlement of a pending proxy contest in connection with Sovereign’s 2006 annual meeting of shareholders and related litigation, and Sovereign’s pending transactions with Banco Santander Central Hispano, S.A. and Independence Community Bank Corp, Inc. A copy of the settlement agreement was filed as Exhibit 10.1 to Sovereign’s Form 8-K filed on March 24, ~~2005,~~2006.

(16) RECENT EVENTS

On April 24, 2006, Sovereign announced, subject to receiving all required regulatory approvals, that it expects to close its pending acquisition of Independence Community Bank Corp. (“Independence”) for approximately $3.6 billion and the $2.4 billion placement of common stock to Banco Santander Central Hispano, S.A. (“Santander”) under their previously announced ~~that they had entered into an~~ Investment Agreement, dated as of October 24, 2005 (the “Investment Agreement”), which sets forth the terms and conditions pursuant to which, among other things, (i) Santander will purchase from Sovereign 19.8% of Sovereign’s common stock for $2.4 billion in cash, (ii) Santander can increase its ownership up to 24.9% after the initial closing subject to certain standstill restrictions, and (iii) Santander can, after two years, under certain circumstances, acquire 100% of Sovereign in a negotiated transaction. We expect this agreement to close in the third quarter of on or before June 1, 2006. The proceeds of the investment will be used to acquire the common stock of ~~Independence Community Bank Corp. (“Independence”) as discussed below. Additionally, Santander has also agreed to provide nonvoting equity~~Independence.

On May 1, 2006, Sovereign issued and ~~debt financing~~sold, in ~~an aggregate amount not to exceed $1.2 billion at prevailing market rates if requested by Sovereign in order to assist Sovereign with the funding~~a registered offering, 8,000,000 of its ~~acquisition~~depositary shares, each representing a 1/1000th ownership interest in a share of Sovereign’s Series C Non-Cumulative Perpetual Preferred Stock (Preferred Stock), for approximately $200 million. Sovereign intends to use the proceeds from the issuance and sale of its depositary shares to finance a portion of the purchase price for Independence. In addition to the $200 million of Preferred Stock, Sovereign will be issuing approximately $600 million of trust preferred obligations and will utilize approximately $400 million of available cash to fund the remaining Independence purchase price.

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

~~On October 24,~~As of December 31, 2005, ~~Sovereign and~~ Independence ~~announced that they~~ had entered into an Agreement and Plan of Merger, dated as of October 24, 2005 (the “Merger Agreement”), which sets forth the terms and conditions pursuant to which Independence will be merged with and into Sovereign (the “Merger”). Under the terms of the Merger Agreement, shareholders of Independence will be entitled to receive $42.00 in cash, in exchange for each share of Independence common stock.

~~Independence has~~ approximately ~~$18.5~~$19.1 billion in assets, $12.2 billion in net loans, ~~$3.5~~$3.6 billion in investments, ~~$10.5~~$10.9 billion in deposits, ~~$5.4~~$5.6 billion of borrowings and other debt obligations and $2.3 billion of stockholders’ equity. Independence is ~~headquarted~~headquartered in Brooklyn, New York, with ~~123~~125 branches located in the greater New York City metropolitan area, which includes the five boroughs of New York City, Nassau and Suffolk Counties and New Jersey. Management expects that this acquisition will fortify our presence as a leading banking company in the Northeast by connecting our Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York. Sovereign expects to complete the merger in the third quarter of 2006; however, completion of the merger is subject to a number of customary conditions, including but not limited to, the approval of the Merger Agreement by Independence shareholders and the receipt of required regulatory approvals.

A more detailed summary description of the Investment Agreement and the ~~Merger Agreement is~~Sovereign/Independence merger agreement are set forth in Sovereign’s Current Report on Form 8-K filed with the SEC on October 27, 2005, which Form 8-K includes the full text of both the Investment Agreement and the ~~Merger Agreement~~Sovereign/Independence merger agreement as Exhibits 10.1 and 10.2, respectively.

~~On November 7, 2005, the Company learned of a purported class action lawsuit (the “Lawsuit”) filed by three alleged~~Sovereign announced that its previously announced 5% stock dividend, which was scheduled to be distributed on May 22, 2006 to shareholders of ~~Independence Community Bank Corp. (“Independence”) against Independence~~record on May 1, 2006 was postponed by one month. The newly issued shares will be issued in book form with cash paid in lieu of fractional shares. All share and per share amounts will reflect the ~~members~~effect of this stock dividend on the record date of June 1, 2006.

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

(17) STOCK BENEFIT PLANS

Sovereign adopted the expense recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” for stock based employee compensation awards issued on or after January 1, 2002. Sovereign continues to account for all options granted prior to January 1, 2002, in accordance with the intrinsic value model of APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Sovereign estimates the fair value of option grants using a Black-Scholes option pricing model and, for options issued subsequent to January 1, 2002, expenses this value over the vesting periods as required in SFAS No. 123. Reductions in compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted periodically based on actual forfeiture experience. Effective January 1, 2006, Sovereign adopted SFAS 123R which did not have a material impact on Sovereign’s financial statements.

For purposes of calculating the estimated fair value of stock options under SFAS No. 123 and SFAS 123R, the fair value for these options was estimated at the date of grant using a Black-Scholes option pricing model with the following assumptions:


	GRANT DATE YEAR
	2006			2005			2004
Expected volatility		.273 – .276			.280 – .293			.296 – .317
Expected life in years		6.00			6.00			6.00
Stock price on date of grant	$	20.98–21.91		$	20.37–24.10		$	20.37–$22.72
Exercise price	$	20.98–21.91		$	20.37–24.10		$	20.37–$22.72
Weighted average exercise price	$	20.98		$	23.22		$	22.56
Weighted average fair value	$	6.70		$	7.90		$	8.01
Expected dividend yield		1.15% – 1.46	%		0.53% – 1.11	%		.45% – .55	%
Risk-free interest rate		4.63% – 4.98	%		3.91% – 4.45	%		2.80% – 4.23	%
Vesting period in years		5			5			5

Expected volatility is based on the historical volatility of Sovereign’s stock price. Sovereign utilizes historical data to predict options’ expected lives. The risk-free interest rate is based on the yield on a U.S. treasury bond with a similar maturity of the expected life of the option.

Sovereign has plans, which are shareholder approved, that grant restricted stock and stock options for a fixed number of shares to key officers, certain employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Sovereign believes that such awards better align the interest of its ~~board~~employees with those of ~~directors. The Lawsuit alleges Independence’s directors breached their fiduciary duty by agreeing~~its shareholders. Sovereign’s stock options expire not more than 10 years and one month after the date of grant and generally become fully vested and exercisable within a five year period after the date of grant and, in certain limited cases, based on the attainment of specified targets. Restricted stock awards vest over a period of three to ~~the proposed sale of Independence to the Company. The Lawsuit also names the Company~~five years. Stock option and restricted stock awards provide for accelerated vesting in certain circumstances, such as a ~~defendant, claiming that~~change in control and in certain cases upon an employee’s retirement. Sovereign records compensation expense over the ~~Company aided and abetted~~shorter of the ~~alleged breaches of fiduciary duty by Independence’s directors. Although~~contractual vesting term or the ~~Company has not been served with a complaint relating to the Lawsuit, the Company believes the allegations made~~employee’s retirement date in the ~~Lawsuit~~event the award vests. These circumstances are ~~without merit and~~defined in the ~~Company intends to seek dismissal.~~plan agreements.

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

The following table summarizes Sovereign’s stock options outstanding at March 31, 2006:


	OPTIONS OUTSTANDING
						Weighted
				Weighted		Average
				Average		Remaining
				Exercise		Contractual
	Shares			Price		Life
Outstanding at December 31, 2005		14,134,104		$	12.33
Granted		896,372			20.98
Exercised		(506,923	)		10.26
Expired		(12,086	)		13.07
Forfeited		(87,133	)		17.02

Outstanding at March 31, 2006		14,424,334			12.92		5.64
Exercisable at March 31, 2006		9,303,806			10.59		4.43

The total intrinsic value of options outstanding and exercisable at March 31, 2006, totaled $131.3 million and $105.3 million, respectively. The weighted average grant date fair value of options granted during the quarter ended March 31, 2006 was $6.70. The total intrinsic value of options exercised during the quarter ended March 31, 2006 was $5.7 million. Sovereign recognized pre-tax compensation expense associated with stock options of $1.2 million for the three-month period ended March 31, 2006 and 2005, respectively.

Cash received from option exercises for all share-based payment arrangements for the quarter ended March 31, 2006 was $5.2 million. At March 31, 2006, Sovereign had $16.9 million of unrecognized compensation cost related to employee stock option awards that will be recognized over a weighted average period of 3.5 years.

Subsequent to September 2005, Sovereign issued approximately 1,000,000 of treasury shares at a weighted average cost of $22.10 to satisfy option exercises. Prior to September 2005, Sovereign had a practice of issuing new authorized shares to satisfy option exercises and, as such, did not repurchase shares on the open market to fund them.

The table below summarizes the changes in Sovereign’s unvested restricted stock during the past year.


Unvested restricted stock	Shares (In thousands)			Weighted average grant date fair value
Total non-vested restricted stock at December 31, 2005		2,058,533			$22.53
Restricted stock granted in 2006		1,420,324			20.99
Vested restricted stock in 2006		(353,860	)		19.49
Non-vested shares forfeited in 2006		(186,987	)		23.39

Total non-vested restricted stock at March 31, 2006		2,938,010			22.09

Since 2001, Sovereign has issued shares of restricted stock to certain key officers and employees that vest over a three-year or five-year period. Pre-tax compensation expense associated with this plan of $3.1 million and $4.4 million was recorded during the three-month period ended March 31, 2006 and 2005, respectively. As of March 31, 2006, there was $46.7 million of total unrecognized compensation cost related to restricted stock awards. This cost is expected to be recognized over a weighted average period of 3.3 years. The weighted average grant date fair value of restricted stock granted in 2006 and 2005 was $20.99 per share and $23.44 per share, respectively.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

EXECUTIVE SUMMARY

Sovereign is a ~~$63~~$65 billion financial institution with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, Maryland, and Delaware. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including: deposit and loan services, sales of residential loans and investment securities, capital markets products, cash management products, and bank owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by various factors including the economic environment, including interest rates, consumer and business confidence and spending, as well as competitive conditions.

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

Management has implemented strategies to address these weaknesses. With respect to our capital position which has prevented us from buying back any significant amount of stock for the past several years, we have strengthened our ratios significantly over the last several years through the generation of earnings. During the third quarter of 2004, Sovereign redeemed $500 million of Senior Notes which had a coupon of 10.50% ($400 million of these fixed rate notes had been swapped to convert the obligations to floating rate obligations and as a result the effective yield on the $500 million was approximately 8.18%). This obligation was the last remaining high cost debt issued by Sovereign in connection with the Fleet/Bank Boston branch acquisition. Sovereign redeemed this obligation with cash on hand and by issuing $300 million of new Senior Notes that bear interest at three-month Libor plus 33 basis points. This lower financing rate reflects, in part, the improved credit ratings our holding company has recently obtained. As a result of these strategies, as well as Sovereign’s consistent ability to generate equity through earnings and a reduction in Sovereign’s investment portfolio as a percentage of total assets, Sovereign’s capital ratios met all of the quantative thresholds necessary to be classified as well capitalized under regulatory guidelines. Additionally, because Sovereign was able to internally generate equity through earnings in 2005 and prior years which resulted in increased capital availability, Sovereign repurchased twenty million shares of common stock through September 30, 2005 under previously announced stock repurchase programs. Additionally, we have been able to increase our cash dividend payout ratios. Management continues to evaluate the optimum allocation of capital.

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

To strengthen our position in certain micro-markets, we continue to investigate strategic acquisitions. ~~In February 2004, we completed the acquisition of First Essex Bancorp, Inc. (“First Essex”).~~ On ~~July 23, 2004, we completed the acquisition of Seacoast Financial Services Corporation (“Seacoast”) and on~~ January 21, 2005, we completed the acquisition of Waypoint Financial Corp. (“Waypoint”). On October 24, 2005, Sovereign entered into a definitive agreement to purchase Independence Community Bank Corp. (“Independence”) ~~an $18.5~~a $19.1 billion financial institution that we expect will fortify our presence in the Northeast and strengthen our franchise value. The majority of the proceeds to finance this acquisition will be received from an equity investment that Banco Santander Central Hispano, S. A. (“Santander”) will make in Sovereign common stock. We anticipate closing this transaction on or before June 1, 2006. See Note 16 for further details. Sovereign also may develop and construct new community banking offices to strengthen our market position. The ability to grow through acquisition is significantly dependent upon our capital levels, stock price and the merger and acquisition environment for banking institutions.

Although first quarter results were challenged by the current interest rate environment, Sovereign completed a number of important transactions during the quarter which we believe will strengthen Sovereign’s franchise. In the first quarter we announced that we will be putting Sovereign’s brand on nearly 1,300 ATM machines in CVS Pharmacy locations in the Northeast. This will more than double the number of our branded ATM locations and provide greater convenience for our customers and help gain greater penetration among the student segment. We also announced an agreement with OPEN from American Express, the company’s small business unit, to offer co-branded American Express Cards to Sovereign’s small business customers. This relationship will generate an additional source of fee revenue for Sovereign and will enable us to leverage the American Express brand to help Sovereign generate core deposits and build and retain small-business relationships. We also entered into an alliance with ADP, the country’s leading payroll services provider. With this partnership, ADP will provide approximately 200 dedicated reps throughout our footprint to assist our commercial relationship managers in providing payroll solutions for our business customers.

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

2829

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

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

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents ~~approximately seventy to seventy five percent~~a substantial portion of the Company’s revenues. Accordingly, the interest rate environment has a ~~substantial~~significant impact on ~~Sovereign��s~~Sovereign’s earnings. Sovereign currently has a ~~neutral~~slightly liability sensitive interest rate risk position. The impact of the flattening of the yield curve that has been experienced in 2005 and the first quarter of 2006 has negatively impacted our margin since the spread between our longer-term assets and our shorter-term liabilities has contracted. In the first quarter of 2005, the average interest rate spread between the 2-year Treasury note and the 10-year note was 85 basis points which compressed to negative 3 basis points in the first quarter of 2006 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities. We would expect to benefit from any substantial sustained increase in long-term interest rates if ~~continued growth in low cost~~this occurs, and if we continue to grow low-cost core ~~deposits occurs.~~deposits. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

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

RESULTS OF OPERATIONS

General

Net income was ~~$181.0~~$141.4 million, or ~~$0.48 per diluted share, and $510.7 million, or $1.33~~$0.38 per diluted share for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 as compared to ~~$82.5~~$146.2 million, or ~~$0.24 per diluted share, and $316.1 million, or $0.97~~$0.38 per diluted share for the three-month period ended March 31, 2005.

Sovereign recorded proxy and ~~nine-month periods~~related professional fees of $14.3 million pretax for the three-month period ended ~~September 30, 2004.~~March 31, 2006 ($9.3 million net of tax, or $0.02 per diluted share). However, due to the recent settlement with Relational, Sovereign does not expect any significant costs related to this matter in future periods. See Note 15 for additional discussion.

Sovereign closed the Waypoint acquisition during the first quarter of 2005, incurring net ~~pretax~~ merger related charges of $24.7 million pretax for the three-month period ended March 31, 2005 ($16.0 million net of tax, or $0.04 per diluted share). During the second and third quarters of 2005, Sovereign reversed pretax charges of $5.9 million and $2.0 million, respectively related to conversion costs and other items that were lower than initially estimated for previous acquisitions. See Note 13 for further details on the components of these merger related charges.

During the first quarter of 2004, Sovereign completed the acquisition of First Essex. In connection with this acquisition, Sovereign recorded an additional loan loss provision of $6 million pretax ($3.9 million net of tax) to conform First Essex’s allowance for loan losses to Sovereign’s reserve policies and merger related expenses of $23.6 million pretax ($15.3 million net of tax). The impact of these charges reduced earnings per share by $0.06 per diluted share.

In the third quarter of 2004, Sovereign recorded a pretax loss of $65.5 million ($42.6 million net of tax or $0.12 per diluted share) to redeem certain high cost debt obligations that had been issued in connection with the Fleet/Bank Boston branch acquisition. We felt it was prudent to redeem these financing transactions, even in light of the significant charge we incurred, since the absence of this obligation improved net interest margin and net income in subsequent periods.

Sovereign also recorded pretax merger related and integration charges of $27.9 million ($18.2 million net of tax or $0.05 per diluted share) in connection with the Seacoast acquisition during the third quarter of 2004.

2930

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
~~NINE-MONTH~~THREE-MONTH PERIOD ENDED ~~SEPTEMBER 30,~~MARCH 31, 2006 AND 2005 ~~AND 2004~~
(in thousands)


	2005								2004								2006								2005
				Tax								Tax								Tax								Tax
	Average			Equivalent		Yield/			Average			Equivalent		Yield/			Average			Equivalent		Yield/			Average			Equivalent		Yield/
	Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate			Balance			Interest		Rate
EARNING ASSETS
INVESTMENTS	$	12,093,200		$	461,037		5.08	%	$	14,645,912			538,827		4.90	%	$	12,715,041		$	168,049		5.29	%	$	12,128,935		$	153,197		5.06	%
LOANS:
Commercial loans		15,698,330			696,827		5.93	%		12,171,171			433,788		4.69	%		16,884,583			290,843		6.98	%		14,870,517			207,098		5.64	%
Consumer:
Consumer loans
Residential mortgages		10,160,711			403,313		5.29	%		5,549,520			221,298		5.32	%		12,777,623			176,652		5.53	%		9,167,485			122,953		5.37	%
Home equity loans and lines of credit		10,151,595			402,393		5.30	%		7,352,876			267,437		4.86	%		9,673,570			151,660		6.32	%		10,002,411			134,955		5.45	%

Total consumer loans secured by real estate		20,312,306			805,706		5.29	%		12,902,396			488,735		5.05	%		22,451,193			328,312		5.87	%		19,169,896			257,908		5.41	%

Auto loans		4,322,967			164,936		5.10	%		3,765,366			149,463		5.30	%		4,409,850			61,383		5.65	%		4,305,100			54,935		5.18	%
Other		550,965			31,073		7.54	%		451,538			24,822		7.32	%		476,946			9,185		7.81	%		578,520			10,247		7.18	%

Total consumer		25,186,238			1,001,715		5.31	%		17,119,300			663,020		5.16	%		27,337,989			398,880		5.87	%		24,053,516			323,090		5.41	%

Total loans(1)		40,884,568			1,698,542		5.55	%		29,290,471			1,096,808		4.97	%		44,222,572			689,723		6.29	%		38,924,033			530,188		5.50	%
Allowance for loan losses		(439,881	)		—		—			(364,857	)		—		—			(419,386	)		—		—			(416,637	)		—		—

																															—
NET LOANS		40,444,687			1,698,542		5.61	%		28,925,614			1,096,808		5.03	%		43,803,186			689,723		6.35	%		38,507,396			530,188		5.56	%

TOTAL EARNING ASSETS		52,537,887			2,159,579		5.49	%		43,571,526			1,635,635		4.99	%		56,518,227			857,772		6.11	%		50,636,331			683,385		5.44	%
Other assets		7,247,966			—		—			5,558,865			—		—			7,521,366			—		—			6,922,971			—		—

																															—
TOTAL ASSETS	$	59,785,853		$	2,159,579		4.82	%	$	49,130,391			1,635,635		4.43	%	$	64,039,593		$	857,772		5.40	%	$	57,559,302		$	683,385		4.78	%


FUNDING LIABILITIES
Deposits and other customer related accounts:
Core deposits and other related accounts	$	21,474,388		$	226,063		1.41	%	$	18,178,671		$	111,393		0.82	%	$	21,753,021		$	118,863		2.22	%	$	20,967,468		$	61,089		1.18	%
Time deposits		9,313,316			197,078		2.83	%		6,390,430			99,921		2.09	%		11,597,261			112,974		3.95	%		8,659,080			53,089		2.49	%

TOTAL DEPOSITS		30,787,704			423,141		1.84	%		24,569,101			211,314		1.15	%		33,350,282			231,837		2.82	%		29,626,548			114,178		1.56	%

BORROWED FUNDS:
FHLB advances		11,761,895			351,972		4.00	%		8,701,974			245,027		3.72	%		13,551,387			143,083		4.27	%		10,910,131			104,938		3.89	%
Fed funds and repurchase agreements		1,382,706			31,918		3.08	%		2,833,640			31,153		1.46	%		613,518			6,635		4.33	%		1,441,246			9,538		2.66	%
Other borrowings		4,190,575			115,674		3.69	%		3,785,105			94,657		3.31	%		4,415,349			54,020		4.93	%		4,155,507			34,224		3.32	%

TOTAL BORROWED FUNDS		17,335,176			499,564		3.85	%		15,320,719			370,837		3.20	%		18,580,254			203,738		4.43	%		16,506,884			148,700		3.64	%

TOTAL FUNDING LIABILITIES		48,122,880			922,705		2.56	%		39,889,820			582,151		1.95	%		51,930,536			435,575		3.39	%		46,133,432			262,878		2.31	%
Demand deposit accounts (1)		5,278,467			—		—			4,562,465			—		—

Demand deposit accounts																		5,086,989			—		—			5,162,704			—		—
Other liabilities		723,684			—		—			681,635			—		—			1,125,329			—		—			674,463			—		—

TOTAL LIABILITIES		54,125,031			922,705		2.28	%		45,133,920			582,151		1.71	%		58,142,854			435,575		3.03	%		51,970,599			262,878		2.05	%
STOCKHOLDERS’ EQUITY		5,660,822			—		—			3,996,471			—		—			5,896,739			—		—			5,588,703			—		—

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	59,785,853			922,705		2.06	%	$	49,130,391			582,151		1.65	%	$	64,039,593			435,575		2.75	%	$	57,559,302			262,878		1.85	%

NET INTEREST INCOME				$	1,236,874							$	1,053,484							$	422,197							$	420,507

NET INTEREST SPREAD (2)							2.93	%							3.04	%
NET INTEREST SPREAD (1) (2)																							2.72	%							3.13	%


NET INTEREST MARGIN (3)							3.14	%							3.23	%
NET INTEREST MARGIN (1) (3)																							3.00	%							3.34	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Net Interest Income

Net interest income for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 was ~~$395.6~~$404.0 million ~~and $1.2 billion~~ compared to ~~$363.0~~$407.3 million ~~and $1.0 billion~~ for the same ~~periods~~period in ~~2004.~~2005. The ~~increase~~decrease in net interest income for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005,~~March 31, 2006, compared to the corresponding ~~periods~~period in the prior year, resulted from ~~growth~~the flattening yield curve, which became inverted during the first quarter of 2006. As previously discussed the spread between the 2-year Treasury note and the 10-year note was 85 basis points in ~~earning assets which more than offset~~ the ~~decline~~first quarter of 2005 and compressed to negative 3 basis points in ~~yield.~~the first quarter of 2006 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities.

Net interest margin was ~~3.04% and 3.14%~~3.00% for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~3.17% and 3.23%~~3.34% for the same ~~periods~~period in ~~2004.~~2005. Net interest margin has contracted from the comparable ~~2004~~2005 levels due to unfavorable mix changes in our deposit costs and the flattening yield curve which has typically led to replacement yields on new asset production being lower than yields on maturing assets as well as short-term funding costs increasing at a faster rate than yields on interest earning assets. Additionally, Sovereign has recently seen loan growth outpacing core deposit growth resulting in Sovereign placing additional reliance on borrowing obligations to fund asset growth.

Interest on investment securities and interest earning deposits was ~~$140.5 million and $425.6~~$151.4 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~$172.8 million and $508.7~~$142.2 million for the same ~~periods~~period in ~~2004.~~2005. The average balance of investment securities was ~~$12.1~~$12.7 billion with an average tax equivalent yield of ~~5.08%~~5.29% for the ~~nine-month~~three-month period ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$14.6~~$12.1 billion with an average yield of ~~4.90%~~5.06% for the same period in ~~2004.~~2005. The increase in yield is primarily due to a rise in market interest ~~rates and to a lesser extent a $2.0 billion reduction of lower yielding investment securities executed in the fourth quarter of 2004.~~rates.

Interest on loans was ~~$608~~$688.2 million ~~and $1.7 billion~~ for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~$412.7~~$528.0 million ~~and $1.1 billion~~ for the same ~~periods~~period in ~~2004.~~2005. The average balance of loans was ~~$40.9~~$44.2 billion with an average yield of ~~5.55%~~6.29% for the ~~nine-month~~three-month period ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$29.3~~$38.9 billion with an average yield of ~~4.97%~~5.50% for the same period in ~~2004.~~2005. Average balances of commercial ~~and consumer~~ loans in ~~2005~~2006 increased ~~$3.5~~$2.0 billion, ~~and $8.1 billion, respectively,~~ as compared to ~~2004~~2005 primarily due to loan originations ~~loan purchases~~ and the full quarter impact of loans acquired from ~~First Essex, Seacoast and~~ Waypoint. Average residential mortgages increased $4.6 billion due to loan purchases, increased origination activity and loans acquired from First Essex, Seacoast and Waypoint acquisitions. Average home equity loans and lines of credit increased $2.8 billion due to loan purchases, increased origination activity and loans acquired from the First Essex, Seacoast and Waypoint acquisitions. Commercial loan yields have increased ~~124~~134 basis points due to the rise in short-term interest rates which has particularly increased the yields on our variable rate loan products. Average residential mortgages increased $3.6 billion due to loan purchases and increased origination activity. Average home equity loans and lines of credit decreased $329 million due to loan sales of $503 million in September 2005 and $898 million of sales in December 2005. Approximately ~~30%~~17% of our home equity loans and lines are variable rate assets which has led to a 4487 basis point increase in yields due to the rise in market interest. ~~However, longer-term rates have stayed flat which has negatively impacted our residential mortgage loan yields.~~

Interest on deposits and related customer accounts was ~~$169.1 million and $423.1~~$231.8 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~$83.2 million and $211.3~~$114.2 million for the same ~~periods~~period in ~~2004.~~2005. The average balance of deposits was ~~$30.8~~$33.4 billion with an average cost of ~~1.84%~~2.82% for the ~~nine-month~~three-month period ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$24.6~~$29.6 billion with an average cost of ~~1.15%~~1.56% for the same period in ~~2004.~~2005. The increase in the balance of deposits is due to ~~the First Essex, Seacoast and Waypoint acquisitions and organic growth.~~increased time deposit growth which has become a more favorable funding alternative as costs on shorter term borrowing obligations continue to increase. The increase in average cost year to year is due primarily to the Federal Reserve’s increases to short term interest rates over the past year ~~(which were partially passed on to our customers)~~and resultant increases in customer deposit yields as well as changes in the mix of ~~deposits.~~deposits to higher cost time deposits which have now become a more favorable funding alternative to shorter term borrowing obligations.

Interest on borrowed funds was ~~$183.8 million and $499.6~~$203.7 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~$139.4 million and $370.8~~$148.7 million for the same ~~periods~~period in ~~2004.~~2005. The average balance of borrowings was ~~$17.3~~$18.6 billion with an average cost of ~~3.85%~~4.43% for the ~~nine-month~~three-month period ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$15.3~~$16.5 billion with an average cost of ~~3.20%~~3.64% for the same period in ~~2004.~~2005. The increase in the cost of funds ~~is primarily~~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 ~~increases~~an increase in ~~market~~short-term interest rates.

First quarter 2006 results benefited from Sovereign executing a series of callable advances totaling $2.7 billion with the FHLB. These advances provide favorable variable funding (currently at 2.14%) during the non-call period which ranges from 6 to 18 months. After the non-call period, the interest rates ~~partially offset~~on these advances resets to a fixed rate of interest with certain caps and floors. Based on the current interest rate environment, these instruments may be called by ~~prepayments~~the FHLB upon the expiration of ~~high cost debt obligations that had been issued in connection with~~ the ~~Fleet/Bank Boston branch acquisition.~~non call period.

3132

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for loan losses for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 was ~~$20 million and $64~~$29 million compared to ~~$25 million and $100~~$22 million for the same ~~periods~~period in ~~2004. The provision for the nine-months ended September 30, 2004 included a charge of $6.0 million to conform the acquired First Essex allowance for loan losses to Sovereign’s reserve policy.~~2005. The provision for loan losses for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 includes a ~~lower~~higher level of provision versus ~~2004~~2005 due to ~~improvements in credit quality~~higher charge-offs in the first quarter of 2006 primarily as a result of higher commercial loan ~~portfolio that have primarily resulted from improved risk management practices as well as the current economic environment. These factors have resulted~~charge-offs and increased charge-offs in ~~improved charge-off statistics.~~our correspondent home equity loan portfolio. Net loan charge-offs for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 were ~~$19.5 million and $58.5~~$28.3 million compared to ~~$20.5 million and $85.4~~$19.6 million for the comparable ~~periods~~period in the prior year. This equates to an annualized net loan charge-off to average loan ratio of ~~0.18% and~~0.26% for the three-months ended March 31, 2006 compared to 0.20% for the ~~three-months and nine-months ended September 30, 2005 compared to 0.25% and 0.39% for the~~ comparable ~~periods~~period in the prior year. Non-performing assets were ~~$181.1 million or 0.42% of total loans at September 30, 2005, compared to $160.1~~$200.5 million or 0.44% of total loans at ~~December~~March 31, ~~2004 and $168.9~~2006, compared to $205.6 million or ~~0.48%~~0.47% of total loans at ~~September 30, 2004.~~December 31, 2005 and $186.9 million or 0.46% of total loans at March 31, 2005. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance as deemed necessary.

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


	Nine-month Period Ended					Three-month Period Ended
	September 30,					March 31,
	2005			2004		2006			2005
Allowance, beginning of period	$	408,716		$	327,894
Allowance for loan losses, beginning of period						$	419,599		$	391,003
Charge-offs:

Commercial		32,822			62,618		12,947			9,237
Consumer secured by real estate		14,777			9,329		12,143			3,001
Consumer not secured by real estate		51,361			44,222		20,023			18,487


Total Charge-offs		98,960			116,169		45,113			30,725


Recoveries:
Commercial		10,429			8,915		4,743			2,529
Consumer secured by real estate		5,287			4,218		1,330			1,127
Consumer not secured by real estate		24,780			17,649		10,742			7,481


Total Recoveries		40,496			30,782		16,815			11,137


Charge-offs, net of recoveries		58,464			85,387		28,298			19,588
Provision for loan losses		64,000			100,000
Allowance released in connection with dealer floor plan securitization		(6,202	)		—
Provision for loan losses (1)							30,559			23,498
Acquired allowance for loan losses from business acquisitions		28,778			64,105		—			26,533


Allowance, end of period	$	436,828		$	406,612
Allowance for loan losses, end of period						$	421,860		$	421,446

Reserve for unfunded lending commitments, beginning of period							18,212			17,713
Provision for unfunded lending commitments (1)							(1,559	)		(1,498	)
Reserve for unfunded lending commitments, end of period							16,653			16,215

Total Allowance for credit losses						$	438,513		$	437,661

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

~~Consumer banking fees were $75.0 million and $214.6~~Non-Interest Income

Total non-interest income was $134.3 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005 as~~March 31, 2006 compared to ~~$62.7 million and $174.8~~$132.2 million for the same periods in 2004, representing an increase of 19.5% and 22.8%. The increase year over year was due primarily to growth in deposit fees to $162.1 million for the nine-month period ended September 30, 2005 compared to deposit fees of $144.6 million for the corresponding period in ~~the prior year. Average core deposit balances have grown $3.3 billion or 18% since September 30, 2004 due primarily to the First Essex, Seacoast~~2005. Excluding securities gains, total fees and ~~Waypoint acquisitions, specific product initiatives, municipal deposit growth and promotions which resulted in an increase in the number of core deposit accounts and balances.~~

~~Commercial banking fees were $42.7 million and $111.3 million~~other income for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 were $134.3 million as compared to ~~$31.8 million and $91.0~~$124.3 million for the same ~~periods~~period in ~~2004, representing an~~2005. The majority of this increase ~~of 34.6% and 22.3% over the prior periods. This~~ was ~~primarily~~ due to ~~higher loan~~commercial banking fees ~~resulting from~~which increased $8.7 million or 29% percent, reflecting the strong growth in the commercial loan portfolio (resulting from the First Essex, Seacoast and Waypoint acquisitions as well as organic growth), and increased cash management fee income. The three-month period ended September 30, 2005 also includes a net gain of $3.9 million on our dealer floor plan revolving securitization. See Note 14 for additional details on this securitization.portfolio.

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


	Three-months ended September 30,						Nine-months ended September 30,						Three-months ended March 31,
	2005			2004			2005			2004			2006			2005
Recoveries/(Impairments) to mortgage servicing rights	$	6,837		$	(9,401	)	$	2,026		$	(3,527	)
Recoveries to mortgage servicing rights													$	—		$	3,954
Mortgage servicing fees		5,418			4,877			15,762			14,365			5,974			4,763
Amortization of mortgage servicing rights		(5,279	)		(3,534	)		(13,048	)		(14,513	)		(3,834	)		(4,092	)
Net gains/(losses) under SFAS 133		717			(112	)		1,684			(1,909	)
Net gains under SFAS 133														1,090			653
Sales of mortgage loans, mortgage backed securities and home equity loans		21,274			4,090			56,022			23,367			9,762			6,377


Total mortgage banking revenues	$	28,967		$	(4,080	)	$	62,446		$	17,783		$	12,992		$	11,655

Mortgage banking revenue is contingent upon loan growth and market conditions. Due to strong loan originations, increased loan purchases and favorable market conditions, Sovereign has experienced a higher level of gains from the sale of loans compared to the prior year. Additionally, in September 2005, Sovereign sold $503 million of home equity loans and recorded a net gain of $13.1 million. Sovereign also recorded a $6.8 million mortgage servicing rights impairment reversal for the three-months ended September 30, 2005 primarily because of slower prepayment speed assumptions as compared to June 30, 2005. The most important assumptions in the valuation of mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread we receive on holding escrow related balances. Increases in prepayment speeds (which are generally driven by lower long term interest rates) result in lower valuations of mortgage servicing rights, while lower prepayment speeds result in higher valuations. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights while lower spreads result in lower valuations. For each of these items, Sovereign must make assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

September 30, 2005 December 31, 2004 September 30, 2004 December 31, 2003
CPR speed 15.80 % 16.53 % 17.30 % 19.51 %
Escrow credit spread 4.01 % 3.92 % 3.75 % 4.00 %

At ~~September 30, 2005,~~March 31, 2006, Sovereign serviced approximately $7.2 billion of mortgage loans for others and our net mortgage servicing asset was ~~$87.5~~$90.6 million, compared to ~~$6.3~~$7.2 billion of loans serviced for others and a net mortgage servicing asset of ~~$74.0~~$91.1 million, at December 31, ~~2004. Our valuation allowance on our mortgage servicing asset at September 30, 2005 is $3.9 million.~~2005.

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 held to maturity or 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 revenues 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.

Bank owned life insurance income represents the increase in the cash surrender value of life insurance policies for certain employees where the Bank is the beneficiary of the policies as well as the receipt of insurance proceeds. The increase in Bank Owned Life Insurance income is due to certain death benefits received by Sovereign for the three-month ~~and nine-month periods ended September 30, 2005.~~

Miscellaneous income was $6.9 million and $25.3 million for the three-month and nine-month periods ended September 30, 2005 compared with $3.2 million and $15.4 million for the corresponding periods in the prior year. The results for the nine-month period ended September 30, 2005 included $3.9 million of premium income recognized on written call options related to mortgage-backed securities. Also included in the results for the nine-month period ended September 30, 2005 was a $1.9 million gain on the sale of a marketing trademark to a third party.March 31, 2006.

~~The~~There were no net gains on sales of investment securities ~~were $1.7 million and $13.0 million~~ for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to ~~$20.2 million and $40.5~~$8.0 million for the same ~~periods~~period in ~~2004. The~~2005. We do not anticipate any significant security gains in 2006 due to the current interest rate ~~environment has resulted in lower levels of security gains in 2005 as compared to 2004.~~environment.

General and Administrative Expenses

General and administrative expenses for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 were ~~$276.9 million and $807.4~~$280.0 million compared to ~~$237.7 million and $685.4~~$257.1 million for the same ~~periods~~period in ~~2004.~~2005. General and administrative expenses increased in ~~2005~~2006 primarily due to ~~the First Essex, Seacoast and Waypoint acquisitions, as well as~~ increased compensation and benefit costs associated with the hiring of additional team ~~members.~~members and the full quarter impact of expenses associated with the Waypoint acquisition. Average full time equivalents during the first quarter of 2006 rose to 9,584 from 9,138 for the comparable prior year period.

Other Expenses

Other expenses consist primarily of amortization of core deposit intangibles, minority interest expense, merger related and integration charges, ~~and~~ equity method investment ~~expense.~~expense and proxy and related professional fees. Other expenses were ~~$32.6 million and $123.4~~$44.8 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005,~~March 31, 2006, compared to ~~$129.1 million and $205.7~~$63.8 million for the same ~~periods~~period in ~~2004.~~2005. The reasons for the variances are discussed below.

Expense associated with amortization of core deposit intangibles increased by $6.0 million during the three-month period and increased $1.1 million during the nine-month period ending September 30, 2005, compared to the corresponding period in the prior year. The increase from 2004 was related to the amortization associated with the First Essex, Seacoast and Waypoint acquisitions. Net merger-related and integration charges of $16.7 million related to the Waypoint acquisition were recorded in the nine-month period ended September 30, 2005. The three-month period ended September 30, 2005 included a $2.0 million reversal of merger-related and integration charges as a result of actual merger and integration costs being lower than the amount initially estimated at the time of the Waypoint acquisition. Total merger-related and integration costs for the ~~nine~~three months ended ~~September 30, 2005 of $12.7 million~~March 31, 2006 consisted of ~~the $16.7 million recorded for the Waypoint acquisition net of $4.0~~$2.8 million of reversals associated with previous acquisitions whose actual costs were lower than initially estimated. Merger-related and integration charges of ~~$23.6~~$23.2 million related to the ~~First Essex~~Waypoint acquisition ~~were recorded in the nine-month period ended September 30, 2004 and charges of $27.9 million~~ were recorded in the three-month period ended ~~September 30, 2004 in connection with the Seacoast acquisition.~~March 31, 2005. See Note 13 for additional details.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Sovereign has an investment in a synthetic fuel partnership that generates IRC Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Our investment balance totaled ~~$36.5~~$28.4 million at ~~September 30, 2005.~~March 31, 2006. Sovereign is amortizing this investment through December 31, 2007, which is the period through which we expect to receive alternative energy tax credits. Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled ~~$7.7~~$6.7 million and ~~$21.9~~$6.8 million for the three-month periods ended March 31, 2006 and ~~nine-month period ended September 30,~~ 2005, respectively and are included as expense in the line “Equity method investments” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. We anticipate receiving tax credits in excess of our recorded investment over the remaining life of the partnership. The alternative energy tax credit is reduced and ultimately eliminated based on a formula tied to the annual average wellhead price per barrel of domestic crude oil which is not subject to regulation by the United States. To the extent that the average price of crude oil exceeds certain levels resulting in a phase out and/or an elimination of the alternative energy tax credits, Sovereign’s investment in the synthetic fuel partnership could become impaired. The alternative energy tax credit has never been phased out. However, the recent ~~dramatic market shifts~~volatility in oil prices ~~have~~has raised the possibility of a phase out in ~~future periods, although Sovereign has concluded that it is not likely at this time.~~2006 and 2007. Sovereign will continue to monitor oil price increases in the future and their related impact on our investment and recognition of alternative energy tax credits.

Also impacting other expenses were ~~the lease~~proxy and ~~contract termination charges~~related professional fees of ~~$5.2~~$14.3 million recorded in the three-month period ended March 31, ~~2005 and a $1.2 million accrual reversal in~~2006. Due to the ~~third quarter of 2005~~recent settlement with Relational we do not anticipate any additional significant costs related to ~~the previously mentioned reduced contract termination penalty negotiated~~ this ~~past quarter.~~matter. See Note 15 for further discussion related to this settlement.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Income Tax Provision

The income tax provision was ~~$57.7 million and $167.4~~$43.1 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005,~~March 31, 2006, compared to ~~$17.2 million and $91.1~~$50.5 million for the same ~~periods~~period in ~~2004.~~2005. The effective tax rate for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 was ~~24.2% and 24.7%~~23.4% compared to ~~17.2% and 22.4%~~25.7% for the same ~~periods~~period in ~~2004.~~2005. The effective tax rate differs from the statutory rate of 35% primarily due to income from tax-exempt investments, income related to bank-owned life insurance, tax credits associated with low income housing investment partnerships and the Synthetic Fuel Partnership. The effective tax rate in 2005 is higher than the prior year rate due to a reduction in the proportion of permanent favorable tax differences to pre-tax book income in 2005 compared to 2004. The effective tax rate in the third quarter of 2004 was favorably impacted by the previously mentioned debt extinguishment and Seacoast merger and integration charges.

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

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) is currently examining the Company’s federal income tax returns for the years 2002 through 2004. We anticipate that the IRS will complete this review in the second half of 2006. Sovereign believes that it has adequately provided for its ~~recorded~~ tax liabilities, ~~adequately provide for~~including the ~~probable~~ outcome of ~~these assessments; however, revisions~~the IRS review. However, completion of ~~our estimate of accrued income taxes~~the IRS review and their conclusion on Sovereign’s tax positions included in the tax returns for 2002-2004 could materially effect our ~~operating results for any given quarter.~~

~~Line of Business Results~~

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

3536

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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~~Effective in the first quarter of 2006, the difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business lines at the time of charge-off is ~~included~~allocated to each business line based on a risk profile of their loan portfolio. Previously, this amount was recorded in ~~Other.~~the Other segment. Prior periods have been reclassified to conform to the current period presentation. 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. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

The Mid-Atlantic Banking Division’s net interest income increased ~~$36.5 million and $110.5~~$2.1 million to ~~$149.3 million and $435.5~~$140.9 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to the corresponding ~~periods~~period in the preceding year. ~~The increase in net interest income was principally due to earning asset growth.~~ The average balance of loans was ~~$6.3~~$6.0 billion with an average yield of ~~5.88%~~6.90% for the ~~nine-months~~three-months ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$4.2~~$6.1 billion with an average yield of ~~4.90%~~5.58% for the corresponding period in the preceding year. The average balance of deposits was ~~$14.9~~$15.3 billion at a cost of ~~1.49%~~2.24% for the ~~nine-months~~three-months ended ~~September 30, 2005,~~March 31, 2006, compared to ~~$12.8~~$14.7 billion at a cost of ~~0.98%~~1.32% for the same ~~periods~~period a year ago. The reason for the increase in the loan and deposit average balances is due ~~primarily~~ to organic growth and to a lesser extent the full quarter impact of the Waypoint ~~acquisition and the~~acquisition. The increase in rates is primarily driven by the increase in market interest rates between these two time periods. The increase in fees and other income of ~~$4.5 million and $10.1~~$2.9 million was due to loan and deposit fees that grew due to the increased balances of these items. The provision for loan losses decreased ~~$0.1~~$2.7 million for the three-months ended ~~September 30, 2005, and declined $4.8 million for the nine-months ended September 30, 2005~~March 31, 2006 due to ~~improvements~~lower charge-offs in the ~~credit quality of our~~division’s loan ~~portfolio, improved risk management practices and improving economic conditions.~~portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from ~~$77.1 million and $236.7~~$89.4 million for the three-months ~~and nine-months~~ ended ~~September 30, 2004,~~March 31, 2005, to ~~$95.4 million and $280.7~~$97.0 million for the corresponding periods in ~~2005.~~2006. The increase in general and administrative expenses is principally due to Sovereign’s continued investment in people and processes to support its expanding franchise, including the full quarter effect of the Waypoint acquisition.

The New England Banking Division’s net interest income increased ~~$32.3 million and $142.7~~$6.4 million to ~~$170.9 million and $494.1~~$163.7 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to the corresponding ~~periods~~period in the preceding year. The increase in net interest income was principally due to an increase in net interest margin of 10 basis points, as interest earning asset ~~growth.~~yields have increased at a faster rate than interest bearing liabilities. The average balance of loans was ~~$5.4~~$5.3 billion with an average yield of ~~5.84%~~6.69% for the ~~nine-months~~three-months ended ~~September 30, 2005~~March 31, 2006 compared to an average balance of ~~$4.1~~$5.2 billion with an average yield of ~~4.88%~~5.62% for the corresponding period in the preceding year. The average balance of deposits was ~~$17.6~~$17.5 billion at a cost of ~~1.32%~~1.92% for the ~~nine-months~~three-months ended ~~September 30, 2005,~~March 31, 2006, compared to ~~$15.3~~$17.4 billion at a cost of ~~0.94%~~1.18% for the same period a year ago. The reason for the increase in the loan and deposit average balances is due to ~~the Seacoast acquisition and to a lesser extent the First Essex acquisition as well as~~ organic growth. The increase in rates is primarily driven by the increase in market interest rates between these two time periods. The increase in fees and other income of ~~$2.4 million and $13.3~~$2.5 million was due primarily from fees generated from higher loan and deposit balances. The provision for loan losses ~~declined $0.3 million and $6.3~~increased $1.6 million to ~~$5.1 million and $17.2~~$3.4 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 due to ~~improvements in the credit quality of our loan portfolio due to improved risk management practices and improving economic conditions.~~increased charge-offs. General and administrative expenses (including allocated corporate and direct support costs) increased from ~~$98.8 million and $270.5~~$100.7 million for the three-months ~~and nine-months~~ ended ~~September 30, 2004,~~March 31, 2005, to ~~$106.6 million and $315.6~~$109.2 million for the three-months ~~and nine-months~~ ended ~~September 30, 2005.~~March 31, 2006. The increase in general and administrative expenses is principally due to Sovereign’s continued investment in people and processes to support its expanding ~~franchise, including~~franchise.

The Shared Services Consumer segment net interest income decreased $2.7 million to $87.9 million for the ~~effect~~three-month period ended March 31, 2006 compared to the corresponding period in the preceding year. The reason for the decline in net interest income for the three-month period ended March 31, 2006 was due to the margin compression experienced on our consumer loans compared with margins from a year earlier. The average balance and yield earned on loans by this segment for the three-month period ended March 31, 2006 was $23.4 billion and 5.67%, respectively, compared with $19.6 billion and 5.28% for the corresponding period in the prior year. The increase in loan balances was driven by strong residential loan originations and increased purchases of wholesale home equity loans. The provision for loan losses increased $6.4 million to $19.2 million at March 31, 2006 due primarily to higher charge-offs on our correspondent home equity loan business. Sovereign deemphasized these loan purchases in the ~~Seacoast~~latter half of 2005 and ~~First Essex acquisitions.~~in the first quarter of 2006 decided to cease purchasing loans from this channel for the foreseeable future. As a result, Sovereign terminated certain employees that had previously supported this group and incurred a $1.4 million severance charge which was recorded in compensation and benefits within general and administrative expenses. General and administrative expenses (including allocated corporate and direct support costs) decreased slightly from $38.5 million for the three-months ended March 31, 2005, to $37.7 million for the three-months ended March 31, 2006.

3637

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

The Shared Services Consumer segment net interest income decreased $3.3 million and increased $28.2 million to $75.3 million and $231.7 million for the three-month and nine-month periods ended September 30, 2005 compared to the corresponding periods in the preceding year. The increase in net interest income for the nine-month period ended September 30, 2005 was principally due to loan growth. The reason for the decline in net interest income for the three-month period ended September 30, 2005 was due to increased funds transfer pricing allocations which reflects the flattening yields experienced on our consumer loans secured by residential real estate. The average balance and yield earned on loans by this segment for the three-month and nine-month periods ended September 30, 2005 was $21.2 billion and $20.6 billion and 5.27% and 5.24%, respectively, compared with $16.1 billion and $14.0 billion and 5.20% and 5.27% for the corresponding periods in the prior year. The increase in loan balances was driven by strong residential loan originations and increased purchases of wholesale home equity loans. The increase in fees and other income of $39.6 million and $69.5 million was due to increased mortgage banking revenues from increased loan sale activity and higher loan fees which grew due to the increased loan balances. The provision for loan losses increased $2.5 million and $4.6 million to $12.1 million and $33.3 million at September 30, 2005 due to loan growth. General and administrative expenses (including allocated corporate and direct support costs) increased from $25.1 million and $74.6 million for the three-months and nine-months ended September 30, 2004, to $34.9 million and $107.6 million for the three-months and nine-months ended September 30, 2005. The increase in general and administrative expenses is principally to Sovereign’s continued investment in people and processes to support its expanding franchise, including the effect of the Seacoast, First Essex and Waypoint acquisitions.

~~The Shared Services~~ Commercial segment net interest income increased ~~$17.9 million and $47.5~~$0.3 million to ~~$60.4 million and $169.8~~$54.3 million for the three-month ~~and nine-month periods~~period ended ~~September 30, 2005~~March 31, 2006 compared to the corresponding ~~periods~~period in the preceding year. The increase in net interest income was principally due to loan ~~growth.~~growth, partially offset by margin compression of 15 basis points. The average balance and yield earned on loans by this segment for the ~~nine-months~~three-months ended ~~September 30, 2005~~March 31, 2006 was ~~$8.6~~$9.5 billion and ~~5.88%~~6.86%, respectively, compared with ~~$6.8~~$8.0 billion and ~~4.59%~~5.43% for the corresponding period in the prior year. The increase in fees and other income of ~~$12.2 million and $17.9~~$7.7 million was due to the increased level of ~~loans and also included the previously mentioned gain on the dealer floor plan securitization of $3.9 million recorded in the third quarter of 2005.~~loans. The provision for loan losses ~~decreased $2.9 million and $20.1~~increased $1.7 million to ~~$1.2 million and $3.6~~$3.1 million for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 due to ~~improved risk management practices and improving economic conditions.~~increased charge-offs. General and administrative expenses (including allocated corporate and direct support costs) were ~~$29.4 million and $81.4~~$27.0 million for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 compared with ~~$28.9 million and $84.0~~$24.4 million for the corresponding ~~periods~~period in the prior year.

The net loss before income taxes for Other ~~decreased $32.8 million and~~ increased ~~$70.1~~$4.2 million to ~~$84.7 million and $212.8~~$78.2 million for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 compared to the corresponding ~~periods~~period in the preceding year. Net interest income decreased ~~$50.7 million and $150.2~~$9.5 million to a net expense of ~~$60.3 million and $134.5~~$42.8 million for the three-months ~~and nine-months~~ ended ~~September 30, 2005~~March 31, 2006 compared to the corresponding periods in the preceding year due primarily to a ~~$2.0~~$2.1 billion increase in average ~~borrowings and a $2.6 billion decline in average investments.~~borrowings. Average borrowings for the ~~nine-month~~three-month period ended ~~September 30,~~March 31, 2006 and 2005 ~~and 2004~~ was ~~$17.3~~$18.6 billion and ~~$15.3~~$16.5 billion, respectively, with an average cost of ~~3.85%~~4.43% and ~~3.20%~~3.64%. Average investments for the three-month period ended March 31, 2006 and 2005 was $12.7 billion and $12.1 billion respectively, at an average yield of 5.29% and 5.06%. The increase in cost is due to the rise in market interest rates between periods.

The Other segment includes ~~net gains on securities~~merger and integration reversals of ~~$1.7 million and $13.0~~$2.8 million for the ~~three-month~~three-months ended March 31, 2006 and ~~nine-month periods ending September 30, 2005, as compared to $20.2 million and $39.0 million recorded in 2004. The 2005 and 2004 results include merger and integration~~ charges of ~~$27.9~~$23.2 million ~~and $51.5 million, respectively.~~for the three-months ended March 31, 2005. The 2005 results also include ~~the previously mentioned call option premium gains of $3.9 million,~~ a ~~gain of $1.9 million on a sale of a marketing trademark to a third party and the~~ lease and contract termination charge of ~~$4.0~~$5.2 million. ~~The three-month and nine-month periods ended September 30, 2004 included losses on debt extinguishments of $65.5 million and $63.3 million, respectively.~~

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the December 31, ~~2004~~2005 consolidated financial statements filed on Form 10-K. The preparation of financial statements in accordance with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. We have identified accounting for the allowance for loan losses, securitizations, derivatives and goodwill as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require management’s most difficult, subjective or complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management’s Discussion and Analysis and the December 31, ~~2004~~2005 Management’s Discussion and Analysis filed on Form 10-K.

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

3738

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

FINANCIAL CONDITION

Loan Portfolio

At ~~September 30, 2005,~~March 31, 2006, commercial loans totaled ~~$16.2~~$17.3 billion representing ~~38%~~38.2% of Sovereign’s loan portfolio, compared to ~~$13.9~~$16.6 billion or ~~38%~~38.0% of the loan portfolio at December 31, ~~2004~~2005 and ~~$13.4~~$15.4 billion or ~~38%~~38.1% of the loan portfolio at ~~September 30, 2004.~~March 31, 2005. At ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, only 8% ~~and 7% respectively,~~ of our total commercial portfolio was unsecured. The increase in commercial loans since December 31, ~~2004~~2005 has primarily been driven by ~~the Waypoint acquisition and~~ organic loan growth. See Note 13 for the related loan balances Sovereign acquired from Waypoint. The commercial loan balances at September 30, 2005 were impacted by the securitization of the $832.5 million of dealer floor plan loans. See Note 14 for additional details.

The consumer loan portfolio secured by real estate ~~(includes~~(consisting of home equity loans and lines of credit of ~~$10.3~~$9.9 billion and residential loans of ~~$11.2~~$13.2 billion) totaled ~~$21.5~~$23.1 billion at ~~September 30, 2005,~~March 31, 2006, representing ~~50%~~51.0% of Sovereign’s loan portfolio, compared to ~~$18.3~~$22.3 billion, or ~~49%~~50.8%, of the loan portfolio at December 31, ~~2004~~2005 and ~~$16.9~~$20.1 billion or ~~48%~~49.8% of the loan portfolio at ~~September 30, 2004.~~March 31, 2005. The increase ~~is primarily related to loan purchases and loans acquired~~ in ~~connection with business acquisitions. The~~the consumer loan portfolio secured by real estate ~~at September 30, 2005~~ was ~~impacted~~driven by continued growth in our residential mortgage loan portfolio as a result of a decrease in the ~~sale~~amount of ~~$503 million~~residential mortgage loans sold in the secondary market in the first quarter of ~~home equity lines~~2006 as a result of ~~credit loans that occurred on September 30, 2005.~~margin compression.

The consumer loan portfolio not secured by real estate ~~(representing~~(consisting of automobile loans of ~~$4.5~~$4.4 billion and other consumer loans of ~~$505~~$459 million) totaled ~~$5.0~~$4.9 billion at ~~September 30, 2005,~~March 31, 2006, representing ~~12%~~10.8% of Sovereign’s loan portfolio, compared to ~~$4.7~~$4.9 billion, or ~~13%~~11.2%, of the loan portfolio at December 31, ~~2004~~2005 and ~~$4.7~~$4.9 billion or ~~13%~~12.1% of the loan portfolio at ~~September 30, 2004. The increase is primarily related to increased auto loan originations that has been driven by attractive manufacturer pricing on newer models in 2005 compared to 2004.~~March 31, 2005.

Non-Performing Assets

At ~~September 30, 2005,~~March 31, 2006, Sovereign’s non-performing assets ~~increased~~decreased by ~~$21~~$5.1 million to ~~$181.1~~$200.5 million compared to ~~$160.1~~$205.6 million at December 31, ~~2004.~~2005. This ~~increase~~decrease is due to increased first quarter 2006 charge-offs and stable asset quality in our loan ~~growth, since non-performing~~portfolios. Non-performing assets as a percentage of total loans, real estate owned and repossessed assets improved to ~~0.42%~~0.44% at ~~September 30, 2005~~March 31, 2006 from ~~0.44%~~0.47% at December 31, ~~2004.~~2005. Sovereign generally places all commercial loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer and residential loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved for. Loans secured by residential real estate with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved for or charged off.

3839

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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


	September 30,			December 31,			March 31,			December 31,
	2005			2004			2006			2005
Non-accrual loans:
Consumer:
Residential mortgages	$	33,427		$	33,656		$	31,874		$	30,393
Home equity loans and lines of credit		37,051			26,801			61,078			55,543
Auto loans and other consumer loans		3,335			1,220			2,283			2,389

Total consumer loans		73,813			61,677			95,235			88,325
Commercial		62,340			54,042			56,035			68,572
Commercial real estate		32,963			26,757			31,531			31,800


Total non-accrual loans		169,116			142,476			182,801			188,697
Restructured loans		822			1,097			692			777


Total non-performing loans		169,938			143,573			183,493			189,474

Other real estate owned		6,107			12,276			13,622			11,411
Other repossessed assets		5,083			4,247			3,352			4,678


Total other real estate owned and other repossessed assets								16,974			16,089


Total non-performing assets	$	181,128		$	160,096		$	200,467		$	205,563


Past due 90 days or more as to interest or principal and accruing interest	$	39,278		$	38,914		$	34,027		$	54,794
Annualized net loan charge-offs to average loans								0.26	%		0.20	%
Non-performing assets as a percentage of total assets		0.29	%		0.29	%		0.31	%		0.32	%
Non-performing loans as a percentage of total loans		0.40	%		0.39	%		0.41	%		0.43	%
Non-performing assets as a percentage of total loans and real estate owned		0.42	%		0.44	%		0.44	%		0.47	%
Allowance for loan losses as a percentage of total non-performing assets		241.2	%		255.3	%
Allowance for loan losses as a percentage of total non-performing loans		257.1	%		284.7	%
Allowance for credit losses as a percentage of total non-performing assets⁽¹⁾								218.7	%		213.0	%
Allowance for credit losses as a percentage of total non-performing loans⁽¹⁾								239.0	%		231.1	%

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

A comprehensive analysis of the allowance for loan losses and reserve for unfunded lending commitments is performed by ~~management~~the Company on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on ~~a periodic~~at least an annual basis. ~~Although management determines~~

In addition to the ~~amount~~Allowance for Loan Losses, we also estimate probable losses related to unfunded lending commitments. Unfunded lending commitments are subject to individual reviews, and are analyzed and segregated by risk according to the Corporation’s internal risk rating scale. These risk classifications, in conjunction with an analysis of ~~each element~~historical loss experience, current economic conditions and performance trends within specific portfolio segments, and any other pertinent information result in the estimation of the reserve for unfunded lending commitments. In the fourth quarter of 2005, the Company reclassified the reserve for unfunded lending commitments from the allowance ~~separately~~for loan losses to other liabilities for all periods presented. Additions to the reserve for unfunded lending commitments are made by charges to the provision for credit losses.

The factors supporting the allowance for loan losses and ~~this process is an important credit management tool,~~the reserve for unfunded lending commitments do not diminish the fact that the entire allowance for ~~credit~~loan losses isand the reserve for unfunded lending commitments are available ~~for~~to absorb losses in the ~~entire~~ loan ~~portfolio.~~portfolio and related commitment portfolio, respectively. The actual amount of losses incurred can vary significantly from the estimated amounts. Management’s methodology includes several factors intended to minimize the differences between estimated and actual losses. These factors allow management to adjust its estimate of losses basedCompany’s principal focus, therefore, is on the ~~most recent information available.~~adequacy of the total allowance for loan losses and reserve for unfunded lending commitments.

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

Commercial Portfolio. The portion of the allowance for loan losses related to the commercial portfolio has increased from ~~$209.6~~$220.3 million at December 31, ~~2004~~2005 to ~~$236.6~~$226.5 million at ~~September 30,~~March 31, 2006. As a percentage of commercial loans the allowance decreased from 1.32% to 1.31% at March 31, 2006 despite a 4% increase in commercial loans at December 31, 2005. This iswas a result of ~~loan growth, increases~~a decrease in non-accrual and criticized and classified assets ~~and allowances acquired from the Waypoint acquisition.~~as of March 31, 2006 compared to December 31, 2005.

Consumer Secured by Real Estate Portfolio. The allowance for the consumer loans secured by real estate portfolio ~~increased~~decreased from ~~$119.3~~$142.7 million at December 31, ~~2004,~~2005, to ~~$128.4~~$136.4 million at ~~September 30, 2005~~March 31, 2006 due primarily to ~~increases~~continued favorable credit quality and an increase in the proportion of residential mortgages in the consumer secured by real estate portfolio which carry lower reserve requirements than our home equity loan ~~balances, classified loans rated substandard and allowances acquired from the Waypoint acquisition.~~portfolios.

Consumer Not Secured by Real Estate Portfolio. The allowance for the consumer not secured by real estate portfolio remained relatively consistent, decreasing from ~~$52.2~~$50.6 million at December 31, ~~2004~~2005 to ~~$51.4~~$49.3 million at ~~September 30, 2005,~~March 31, 2006, due to ~~portfolio mix changes to assets with a lower~~slightly improved credit ~~risk profile.~~quality measures.

Unallocated Allowance. The unallocated allowance for loan losses ~~decreased~~increased to ~~$20.4~~$9.6 million at ~~September 30, 2005~~March 31, 2006 from ~~$27.7~~$6.0 million at December 31, ~~2004 due to improvements in the credit quality of our loan portfolio.~~2005. Management continuously evaluates current economic conditions and loan portfolio trends. However, this balance is subject to changes each reporting period due to certain inherent but undetected losses which exist within the loan portfolios.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Investment Securities

Investment securities consist primarily of mortgage-backed securities, tax-free municipal securities, U.S. Treasury and government agency securities, corporate debt securities and stock in the Federal Home Loan Bank of Pittsburgh (“FHLB”), Freddie Mac and Fannie Mae. Mortgage-backed securities consist of pass-throughs and collateralized mortgage obligations issued by federal agencies or private label issuers. Sovereign’s mortgage-backed securities are generally either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by Standard and Poor’s and Moody’s at the date of issuance. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. The effective duration of the ~~total~~available for sale investment portfolio at ~~September 30, 2005~~March 31, 2006 was ~~4.48~~3.96 years and the effective duration of the held to maturity portfolio was 6.68 years.

Total investment securities available-for-sale were ~~$8.2~~$7.1 billion at ~~September 30, 2005~~March 31, 2006 and ~~$7.6~~$7.3 billion at December 31, ~~2004.~~2005. Investment securities held-to-maturity was ~~$4.5~~$4.9 billion at ~~September 30, 2005~~March 31, 2006 compared to ~~$3.9~~$4.6 billion at December 31, ~~2004.~~2005. For additional information with respect to Sovereign’s investment securities, see ~~Notes~~Note 3 ~~and 4~~ in the Notes to Consolidated Financial Statements.

Goodwill and Core Deposit Intangible Assets

Goodwill ~~increased by $589 million since December 31, 2004 due primarily to the Waypoint acquisition~~remained constant at $2.7 billion and core deposit intangibles decreased by ~~$25~~$17.2 million since December 31, ~~2004~~2005 due to year-to-date amortization ~~expense of $56.1 million, offset by a core deposit intangible asset of $31.1 million recorded in connection with the Waypoint acquisition.~~expense. See Note 10 for the anticipated amortization expense for each of the five succeeding calendar years ending December 31^st. There were no ~~indicators of impairment~~goodwill or core deposit intangible asset impairment charges recorded in ~~2004~~2005 and through ~~September 30, 2005.~~March 31, 2006.

Deposits and Other Customer Accounts

Sovereign attracts deposits within its primary market area with an offering of deposit instruments including demand accounts, NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits and other customer accounts at ~~September 30, 2005~~March 31, 2006 were ~~$37.3~~$38.8 billion ~~which includes deposit balances of $2.9 billion acquired from the Waypoint acquisition,~~ compared to ~~$32.6~~$38.0 billion at December 31, ~~2004.~~2005.

Borrowings and Other Debt Obligations

Sovereign utilizes borrowings and other debt obligations as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the FHLB provided certain standards related to creditworthiness have been met. Sovereign also utilizes reverse repurchase agreements, which are short-term obligations collateralized by securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof, and federal funds lines with other financial

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

institutions. Total borrowings at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004~~2005 were ~~$18.9~~$19.2 billion and ~~$16.1~~$18.7 billion, respectively. ~~During the third quarter of 2005, Sovereign issued $500 million of Senior notes, see Note 7 in the Notes to Consolidated Financial Statement for additional details on these obligations.~~

Off Balance Sheet Arrangements

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

In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has retained interests in the QSPEs. Off-balance sheet QSPEs had ~~$1.2~~$1.3 billion of assets that Sovereign sold to the QSPEs which are not included in Sovereign’s Consolidated Balance Sheet at ~~September 30, 2005.~~March 31, 2006. Sovereign’s retained interests and servicing assets in such QSPEs was ~~$119~~$107.9 million at ~~September 30, 2005~~March 31, 2006 and this amount represents Sovereign’s maximum exposure to credit losses related to these unconsolidated securitizations. Sovereign does not provide contractual legal recourse to third party investors that purchase debt or equity securities issued by the QSPEs beyond the credit enhancement inherent in Sovereign’s subordinated interests in the QSPEs. At ~~September 30, 2005,~~March 31, 2006, there are no known events or uncertainties that would result in or are reasonably likely to result in the termination or material reduction in availability to Sovereign’s access to off-balance sheet markets. See Note 14 for a description of Sovereign’s retained interests in its off-balance sheet asset securitizations.

~~As described in our 2004 annual report filed on Form 10-K, in connection with the Fleet Boston transaction, Sovereign entered into operating leases, which were financed through the use~~

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of ~~variable interest entities, for commercial properties which had an initial term~~Financial Condition and Results of approximately 20 years. This structured real estate transaction included 104 commercial properties that were transferred by Fleet Boston to the special purpose entities and 23 commercial properties that were transferred by Sovereign. A gain on the transfer of the 23 Sovereign properties was deferred and is being amortized over the lease term of the properties sold and subsequently leased back. The certificates which were issued through the variable interest entities are payable from the rental payments under the lease, the proceeds of the sale or refinancing of the mortgage properties or payments under insurance policies on the real estate properties. The aggregate principal balance of the certificates at September 30, 2005 and December 31, 2004, was $106.4 million and $219.9 million, respectively. A scheduled principal payment of $113.4 million was made at June 30, 2005 and the remaining balance is due on June 30, 2020. Sovereign does not consolidate this variable interest entity since we are not the primary beneficiary as defined under FIN 46. Sovereign has no off balance sheet contingencies or any other potential loss exposure related to this transaction. However, in the event that Sovereign terminates a lease and does not substitute a similar property to replace it, a penalty would be incurred. This penalty would be calculated based on the excess of the present value of the remaining installments of principal and interest on such related notes underlying the terminated property, through maturity, discounted semi-annually against the remaining principal amount of such secured note, plus accrued interest.Operations (Continued)

Bank Regulatory Capital

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

The FDICIA established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution’s capital tier depends upon its capital levels in relation to various relevant capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, Sovereign Bank had met all quantitative thresholds necessary to be classified as well-capitalized under regulatory guidelines.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Federal banking laws, regulations and policies also limit Sovereign Bank’s ability to pay dividends and make other distributions to Sovereign Bancorp. Sovereign Bank is required to give prior notice to the OTS before paying any dividend. In addition Sovereign Bank must obtain prior OTS approval to declare a dividend or make any other capital distribution if, after such dividend or distribution, Sovereign Bank’s total distributions to Sovereign within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, or if Sovereign Bank is not adequately capitalized at the time. In addition, OTS prior approval would be required if Sovereign Bank’s examination or CRA ratings fall below certain levels or Sovereign Bank is notified by the OTS that it is a problem association or an association in troubled condition. The following schedule summarizes the actual capital balances of Sovereign Bank at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004~~2005 (in thousands):


							TIER 1			TOTAL									TIER 1			TOTAL
				TIER 1			RISK-BASED			RISK-BASED						TIER 1			RISK-BASED			RISK-BASED
	TANGIBLE			LEVERAGE			CAPITAL TO			CAPITAL TO			TANGIBLE			LEVERAGE			CAPITAL TO			CAPITAL TO
	CAPITAL TO			CAPITAL TO			RISK			RISK			CAPITAL TO			CAPITAL TO			RISK			RISK
	TANGIBLE			TANGIBLE			ADJUSTED			ADJUSTED			TANGIBLE			TANGIBLE			ADJUSTED			ADJUSTED
REGULATORY CAPITAL	ASSETS			ASSETS			ASSETS			ASSETS			ASSETS			ASSETS			ASSETS			ASSETS
Sovereign Bank at September 30, 2005:
Sovereign Bank at March 31, 2006:
Regulatory capital	$	3,960,762		$	3,960,762		$	3,867,128		$	5,090,303		$	4,345,470		$	4,345,470		$	4,267,229		$	5,492,984
Minimum capital requirement (1)		1,203,523			2,407,046			1,954,337			3,908,673			1,247,744			2,495,487			2,002,652			4,005,304

Excess													$	3,097,726		$	1,849,983		$	2,264,577		$	1,487,680

Sovereign Bank capital ratio														6.97	%		6.97	%		8.52	%		10.97	%

Sovereign Bank at December 31, 2005:
Regulatory capital													$	4,167,306		$	4,167,306		$	4,090,381		$	5,313,535
Minimum capital requirement (1)														1,219,112			2,438,224			1,993,145			3,986,289

Excess	$	2,757,239		$	1,553,716		$	1,912,791		$	1,181,630		$	2,948,194		$	1,729,082		$	2,097,236		$	1,327,246


Sovereign Bank capital ratio		6.58	%		6.58	%		7.91	%		10.42	%		6.84	%		6.84	%		8.21	%		10.66	%

Sovereign Bank at December 31, 2004:
Regulatory capital	$	3,761,163		$	3,761,163		$	3,710,119		$	4,911,264
Minimum capital requirement (1)		1,043,438			2,086,876			1,687,852			3,375,704


Excess	$	2,717,725		$	1,674,287		$	2,022,267		$	1,535,560


Sovereign Bank capital ratio		7.21	%		7.21	%		8.79	%		11.64	%

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

managed. This process includes reviewing all available wholesale liquidity sources. As of ~~September 30, 2005,~~March 31, 2006, Sovereign had ~~$8.0~~$6.9 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investments to be pledged as collateral for additional borrowings. Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times.

Sovereign Bancorp has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, a revolving credit agreement and access to the capital markets. Sovereign Bank may pay dividends to its parent subject to approval of the OTS, as discussed above. ~~Year-to-date Sovereign Bank has paid $750 million dividends to Sovereign Bancorp.~~ Sovereign also has approximately ~~$226 million~~$2.5 billion of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets.

Cash and cash equivalents ~~increased $277.3~~decreased $134.5 million from December 31, ~~2004.~~2005. Net cash ~~provided~~used by operating activities was ~~$826.9~~$35.0 million for ~~2005.~~2006. Net cash used by investing activities for ~~2005~~2006 was ~~$4.0~~$1.4 billion and consisted primarily of the purchase of loans of ~~$5.0 billion, purchases of investments of $4.7~~$2.7 billion and net increase in loans of ~~$3.9~~$0.8 billion, offset by proceeds from loan sales of ~~$5.5 billion and sales, repayments and maturities of investments of $1.6~~$2.3 billion. Net cash provided by financing activities for ~~2005~~2006 was ~~$3.4 million,~~$1.3 billion, which was primarily due to an increase in net deposits of ~~$1.9~~$843.1 million and an increase in net borrowings of ~~$1.5 billion and proceeds net of repayments, from borrowings of $450 million, offset by treasury stock repurchases of $458~~$494.6 million.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Contractual Obligations and Commercial Commitments

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

Contractual Obligations
(in thousands of dollars)


	Payments Due by Period										Payments Due by Period
			Less than		Over 1 yr		Over 3 yrs		Over				Less than		Over 1 yr		Over 3 yrs		Over
	Total		1 year		to 3 yrs		to 5 yrs		5 yrs		Total		1 year		to 3 yrs		to 5 yrs		5 yrs
FHLB advances (1)	$	15,310,000	$	8,305,797	$	1,931,912	$	1,829,321	$	3,242,970	$	16,264,385	$	7,851,184	$	1,720,197	$	1,999,123	$	4,693,881
Securities sold under repurchase agreements (1)		192,475		157,475		35,000		—		—		35,000		—		35,000		—		—
Fed Funds (1)		655,745		655,745		—		—		—		335,145		335,145		—		—		—
Other debt obligations (1)		4,265,554		409,116		539,873		1,820,984		1,495,581		4,314,978		413,824		1,602,259		494,662		1,804,233
Junior subordinated debentures due to Capital Trust entities (1)(2)		3,000,101		58,547		134,796		135,172		2,671,586		2,987,382		63,441		139,899		136,296		2,647,746
Certificates of deposit (1)		10,547,250		7,312,777		2,441,169		545,262		248,042		12,383,532		8,357,173		2,789,985		648,862		587,512
Investment partnership commitments (3)		45,004		22,479		21,200		1,246		79		59,649		34,285		21,500		3,643		221
Business Acquisitions (4)												3,585,371		3,585,371		—		—		—
Operating leases		572,131		76,647		130,479		89,883		275,122		565,410		78,941		129,130		89,276		268,063


Total contractual cash obligations	$	34,588,260	$	16,998,583	$	5,234,429	$	4,421,868	$	7,933,380	$	40,530,852	$	20,719,364	$	6,437,970	$	3,371,862	$	10,001,656

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

agreed to provide nonvoting equity and debt financing in an aggregate amount not to exceed $1.2 billion at prevailing market rates if requested by Sovereign in order to assist with the acquisition of Independence. The acquisition of Independence and the transaction with Santander are anticipated to close in the third quarter of 2006. For additional details see Note 16.

Sovereign’s senior credit facility requires Sovereign to maintain certain financial ratios and to maintain a “well capitalized” regulatory status. Sovereign has complied with these covenants as of ~~September 30, 2005~~March 31, 2006 and expects to be in compliance with these covenants for the foreseeable future. However, if in the future Sovereign is not in compliance with these ratios or is deemed to be other than well capitalized by the OTS, and is unable to obtain a waiver from its lenders, Sovereign would be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any outstanding borrowings thereunder. Due to cross-default provisions in such senior credit facility, if more than $5 million of Sovereign’s debt is in default, Sovereign will be in default under this credit facility and the lenders could terminate the facility and accelerate the maturity of any borrowings thereunder.

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

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

Amount of Commitment Expiration Per Period


	Total										Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs				Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs		Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs
(in thousands of dollars)
Commitments to extend credit	$	15,540,770	$	7,887,969	$	2,635,547	$	1,819,922	$	3,197,332	$	14,901,970	$	7,227,534	$	2,897,183	$	2,353,782	$	2,423,471
Standby letters of credit		2,462,916		749,921		832,118		808,700		72,177		2,835,153		733,832		839,050		1,159,471		102,800
Loans sold with recourse		7,792		—		—		—		7,792		76,744		—		—		—		76,744
Forward buy commitments		509,445		509,445		—		—		—		478,195		478,195		—		—		—


Total commercial commitments	$	18,520,923	$	9,147,335	$	3,467,665	$	2,628,622	$	3,277,301	$	18,292,062	$	8,439,561	$	3,736,233	$	3,513,253	$	2,603,015

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

income and net interest margin. To achieve these objectives, the treasury group works closely with each business line in the Company and guides new business. The treasury group also uses various other tools to manage interest rate risk including wholesale funding maturity targeting, investment portfolio purchase strategies, asset securitization/sale, and financial derivatives.

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

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

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


	The following estimated
	percentage
	increase/(decrease) to
If interest rates changed in parallel by the	~~increase/(decrease) to~~ net interest
amounts below at ~~September 30, 2005~~March 31, 2006	income would result
Up 100 basis points		~~0.65~~(0.60	)%
Up 200 basis points		(~~0.22~~2.69	)%
Down 100 basis points		(~~2.08~~0.60	)%

Sovereign also monitors the relative repricing sensitivities of its assets versus its liabilities. Management attempts to keep assets and liabilities in balance so that when interest rates do change, the net interest income of Sovereign will not experience any significant short-term volatility as a result of assets repricing more quickly than liabilities or vice versa. As of ~~September 30, 2005,~~March 31, 2006, the one year cumulative gap was ~~1.93%~~(6.96)%, compared to ~~1.65%~~(3.87)% at December 31, ~~2004 indicating Sovereign could benefit~~2005. As we approach the end of the Federal Reserve interest rate tightening cycle, management has adjusted its target for managing its interest rate position from ~~rising rates.~~asset sensitive to slightly liability sensitive.

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


If interest rates changed in parallel by the	Estimated NPV Ratio						Estimated NPV Ratio
amounts below at September 30, 2005	September 30, 2005			December 31, 2004
amounts below at March 31, 2006							March 31, 2006			December 31, 2005
Base		11.9	%		11.3	%		12.25	%		12.38	%
Up 200 basis points		11.4	%		10.3	%		11.40	%		11.82	%
Up 100 basis points								11.86	%		12.16	%
Down 100 basis points		11.7	%		10.9	%		12.27	%		12.37	%
Down 200 basis points								11.83	%		12.00	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

~~The market value profile (long-term interest rate risk) has improved due to the following factors: reduction in the investment portfolio mix, sale~~Item 2. Management’s Discussion and Analysis of ~~longer duration residential mortgage loans in the second quarter, restructuring~~Financial Condition and Results of ~~FHLB borrowings which increased the duration of the borrowings portfolio, and an increase in the mix of variable rate commercial loans.~~Operations (Continued)

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

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

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

~~Items~~

Item 1 – Legal Proceedings

As previously reported, in December 2005, Sovereign commenced litigation in the United States District Court for the Southern District of New York against Relational Investors, LLC (“Relational”), seeking a declaratory judgment that, under Sovereign’s articles of incorporation and the Pennsylvania Business Corporation Law, directors of Sovereign may only be removed from office by shareholders for cause. In January 2006, this action was combined with certain outstanding claims by Relational, including, among others, claims seeking a declaratory judgment that shareholders can remove members of Sovereign’s classified board of directors without cause. On March 2, 2006, the judge in the District Court action in the Southern District of New York issued ruling in favor of Relational. Sovereign disagrees with the District Court’s ruling and is ~~not applicable.~~seeking review of the ruling by the United States Court of Appeals for the Second Circuit. Sovereign cannot predict with reasonable certainty the eventual outcome of such appeal or, if the ruling is upheld, the extent of the adverse impact of the ruling, if any, on Sovereign. As reported in a Current Report on Form 8-K filed by Sovereign on March 24, 2006, Sovereign and Relational entered in to a Settlement Agreement, dated March 22, 2006, which among other things, provided for the termination of then existing litigation between them, but reserved to Sovereign the right to appeal the New York District Court ruling.

Item 1A – Risk Factors

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

	•		An economic downturn may lead to a deterioration in our asset quality and adversely affect our earnings and cash flow.

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

	•		The preparation of Sovereign’s financial statements requires the use of estimates that may vary from actual results.

			The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make significant estimates that affect the financial statements. One example of a significant critical estimate is the level of allowance for credit losses. Due to the 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.

	•		Changing interest rates may adversely affect our profits.

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

	•		We experience intense competition for loans and deposits.

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

	•		We are subject to substantial regulation which could adversely affect our business and operations.

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

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

			Existing federal regulations limit our ability to increase our commercial loans. We are required to maintain 65% of our assets in residential mortgage loans and certain other loans, including small business loans. We also cannot have more than 10% of

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

	•		Changes in accounting standards could impact reported earnings.

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

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

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

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

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended ~~September 30, 2005:~~March 31, 2006:

Maximum Number
Average Total Number of of Shares
Total Price Shares Purchased that may be
Number of Paid as Part of Publicly Purchased Under to
Shares Per Announced Plans the Plans or
Period Purchased Share or Programs (1) Programs (1)
7/1/05 through 7/31/05 4,001,121 $ 23.90 4,000,000 24,500,000
8/1/05 through 8/31/05 4,009,237 23.67 4,000,000 20,500,000
9/1/05 through 9/30/05 1,024 22.87 NA 20,500,000

Maximum Number

Average

Total Number of

of Shares

Total

Price

Shares Purchased

that may be

Number of

Paid

as Part of Publicly

Purchased Under

Per

Announced Plans

the Plans or

Period

Purchased

or Programs (1)

Programs (1)

1/1/06 through 1/31/06

60,787

$21.81

N/A

19,500,000

2/1/06 through 2/28/06

118,029

20.85

N/A

19,500,000

3/1/06 through 3/31/06

57,486

21.56

N/A

19,500,000

(1) Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40.5 million shares of common stock as of March 31, 2006. Twenty one million shares have been purchased under these repurchase programs as of March 31, 2006. All of Sovereign’s stock repurchase programs have no prescribed time limit in which to fill the authorized repurchase amount.

Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 236,302 shares outside of publicly announced repurchase programs during the first quarter of 2006.

Items 3 – 54 are not applicable or the response is negative.

Item 5 – Other information

As disclosed in Sovereign’s Form 10-K/A filed on May 1, 2006, Sovereign’s 2006 Annual Meeting of Shareholders (the “2006 Annual Meeting”) is currently scheduled to be held on September 20, 2006, subject to the right of Sovereign’s Board of Directors (the “Board”) to change such date based on changed circumstances. In accordance with SEC Rule 14a-5(f) under the Securities Exchange Act of 1934 (the “Exchange Act”), the Company has determined that proposals to be considered for inclusion in the Company’s proxy statement for the 2006 Annual Meeting under SEC Rule 14a-8 under the Exchange Act must be received by the Company at its principal executive offices on or before May 22, 2006. In addition, in order for a shareholder proposal made outside of SEC Rule 14a-8 to be considered timely for purposes of SEC Rule 14a-4(c) under the Exchange Act and under Section 3.10(b) of the Company’s bylaws, such proposal must be received by the Company at its principal executive offices on or before June 22, 2006.

Item 6 – Exhibits

(a) Exhibits


(3.1)		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign’s Registration on Form S-8, SEC File No. 333-117621 filed July 23, 2004.)

(3.2)		ByLaws of Sovereign Bancorp, Inc., as amended and restated as of June 24, 2004 (Incorporated by reference to Exhibit 3.2 to Sovereign’s Registration on Form S-8, SEC File No. ~~333-117621,~~333-133514, filed July 23, 2004.)

(4.1)		Senior Trust Indenture dated as of ~~February~~November 1, ~~1994,~~2005, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company (as successor to Harris Trust and Savings Bank), as Trustee. (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Registration Statement No. ~~33-75472 on Form S-3)~~

~~(4.2)~~		Sixth Indenture Supplement, dated September 1, 2005, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as trustee under an indenture, dated as of February 1, 1994, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as successor to Harris Trust and Savings Bank (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

~~(4.3)~~		~~Form of Senior Floating Rate Notes due 2009 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.3 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)~~

~~(4.4)~~		~~Form of 4.80% Senior Notes due 2010 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.4 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)~~

~~(4.5)~~		Exchange and Registration Rights Agreement, dated September 1, 2005, between Sovereign Bancorp, Inc. and Goldman, Sachs & Co., as representative of the several purchasers (Incorporated by reference to Exhibit 4.5 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~EXHIBITS INDEX~~


~~(3.1)~~		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign’s Registration on Form S-8, SEC File No. 333-117621 filed July 23, 2004.)

~~(3.2)~~		ByLaws of Sovereign Bancorp, Inc., as amended and restated as of June 24, 2004 (Incorporated by reference to Exhibit 3.2 to Sovereign’s Registration on Form S-8, SEC File No. 333-117621, filed July 23, 2004.)

~~(4.1)~~		Senior Trust Indenture dated as of February 1, 1994, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company (as successor to Harris Trust and Savings Bank), as Trustee. (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Registration Statement No. 33-75472333-133514 on Form S-3)

(4.2)		Sixth Indenture Supplement, dated September 1, 2005, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as trustee under an indenture, dated as of February 1, 1994, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as successor to Harris Trust and Savings Bank (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.3)		Form of Senior Floating Rate Notes due 2009 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.3 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.4)		Form of 4.80% Senior Notes due 2010 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.4 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.5)		Exchange and Registration Rights Agreement, dated September 1, 2005, between Sovereign Bancorp, Inc. and Goldman, Sachs & Co., as representative of the several purchasers (Incorporated by reference to Exhibit 4.5 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.6)		Statement with Respect to Shares with respect to Series C Non-Cumulative Perpetual Preferred Stock of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.1 to Sovereign Bancorp’s Current Report on Form 8-K filed on May 1, 2006).

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

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

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

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

EXHIBITS INDEX


(3.1)		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign’s Registration on Form S-8, SEC File No. 333-117621 filed July 23, 2004.)

(3.2)		ByLaws of Sovereign Bancorp, Inc., as amended and restated as of June 24, 2004 (Incorporated by reference to Exhibit 3.2 to Sovereign’s Registration on Form S-8, SEC File No. 333-133514, filed July 23, 2004.)

(4.1)		Senior Trust Indenture dated as of November 1, 2005, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company (as successor to Harris Trust and Savings Bank), as Trustee. (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Registration Statement No. 333-133514 on Form S-3)

(4.2)		Sixth Indenture Supplement, dated September 1, 2005, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as trustee under an indenture, dated as of February 1, 1994, between Sovereign Bancorp, Inc. and BNY Midwest Trust Company, as successor to Harris Trust and Savings Bank (Incorporated by reference to Exhibit 4.2 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.3)		Form of Senior Floating Rate Notes due 2009 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.3 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.4)		Form of 4.80% Senior Notes due 2010 of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.4 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.5)		Exchange and Registration Rights Agreement, dated September 1, 2005, between Sovereign Bancorp, Inc. and Goldman, Sachs & Co., as representative of the several purchasers (Incorporated by reference to Exhibit 4.5 to Sovereign Bancorp’s Current Report on Form 8-K filed on September 1, 2005)

(4.6)		Statement with Respect to Shares with respect to Series C Non-Cumulative Perpetual Preferred Stock of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 4.1 to Sovereign Bancorp’s Current Report on Form 8-K filed on May 1, 2006).

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

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

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

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


	Three-Month Period					Nine-Month Period
	Ended September 30,					Ended September 30,				Three-Month Period
	2005			2004		2005		2004		Ended March 31,
	(in thousands, except									2006			2005
	per share data)									(in thousands, except, per share data)
OTHER EXPENSES:
Amortization of core deposit intangibles	$	18,284		$	19,836	$	56,055	$	54,965	$	17,219		$	18,956
Other minority interest expense		5,837			5,502		17,257		16,376		5,992			5,668
Merger-related and integration charges (reversal)		(2,000	)		27,941		12,744		51,528		(2,798	)		23,191
Equity method investments		11,656			10,257		33,392		19,596		10,042			10,770
Lease and contract termination charge (reversal)		(1,222	)		—		3,982		—
Loss on debt extinguishment		—			65,546		—		63,261
Proxy and related professional fees											14,337			—
Lease and contract termination charge											—			5,204


TOTAL OTHER EXPENSES		32,555			129,082		123,430		205,726		44,792			63,789


INCOME BEFORE INCOME TAXES		238,792			99,712		678,085		407,203		184,528			196,689
Income tax provision		57,749			17,170		167,420		91,080		43,130			50,538


NET INCOME	$	181,043		$	82,542	$	510,665	$	316,123	$	141,398		$	146,151


EARNING PER SHARE:
EARNINGS PER SHARE:
Basic	$	0.50		$	0.25	$	1.40	$	1.01	$	0.39		$	0.40


Diluted	$	0.48		$	0.24	$	1.33	$	0.97	$	0.38		$	0.38


DIVIDENDS DECLARED PER COMMON SHARE	$	0.040		$	.030	$	0.11	$	.085	$	.060		$	.030


	September 30, 2005								March 31, 2006
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value		Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	361,880	$	3	$	720	$	361,163	$	44,769	$	—	$	682	$	44,087
Debentures of FHLB, FNMA, and FHLMC		180,909		33		2,778		178,164		182,404		1,373		3,268		180,509
Corporate debt and asset-backed securities		142,148		2,307		—		144,455		102,690		21		—		102,711
Equity securities (1)		2,103,888		1,032		29,845		2,075,075		962,512		1,454		37,296		926,670
State and municipal securities		4,816		18		308		4,526		4,333		9		5		4,337
Mortgage-backed securities:
U.S. government agencies		1,210,490		937		30,555		1,180,872		1,106,000		495		39,560		1,066,935
FHLMC and FNMA debt securities		2,200,975		2,605		50,606		2,152,974		2,021,734		1,259		86,415		1,936,578
Non-agencies		2,190,745		167		44,112		2,146,800
Non-agency securities										2,892,640		58		91,033		2,801,665


Total investment securities available-for- sale	$	8,395,851	$	7,102	$	158,924	$	8,244,029
Total investment securities available-for-sale									$	7,317,082	$	4,669	$	258,259	$	7,063,492


	December 31, 2004								December 31, 2005
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value		Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	54,273	$	—	$	352	$	53,921	$	48,507	$	—	$	764	$	47,743
Debentures of FHLB, FNMA and FHLMC		58,397		243		152		58,488		182,809		2,098		2,970		181,937
Corporate debt and asset-backed securities		207,129		8,928		—		216,057		105,810		36		—		105,846
Equity securities (1)		1,554,464		5,308		1,605		1,558,167		967,515		1,231		13,595		955,151
State and municipal securities		5,277		22		7		5,292		4,758		11		301		4,468
Mortgage-backed securities:
U.S. government agencies		954,467		5,721		3,923		956,265		1,153,497		705		31,332		1,122,870
FHLMC and FNMA debt securities		2,355,521		6,621		16,528		2,345,614		2,094,665		1,751		59,626		2,036,790
Non-agencies		2,460,567		3,300		15,113		2,448,754
Non-agency securities										2,860,278		1,396		58,077		2,803,597


Total investment securities available-for- sale	$	7,650,095	$	30,143	$	37,680	$	7,642,558
Total investment securities available-for-sale									$	7,417,839	$	7,228	$	166,665	$	7,258,402

													��
	September 30, 2005								March 31, 2006
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized			Unrealized		Fair
	Cost		Appreciation		Depreciation		Value		Cost		Appreciation			Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	9,279	$	—	$	134	$	9,145	$	7,208	$	—		$	169	$	7,039
Corporate debt and asset-backed securities		104,233		6		462		103,777		103,675		6			2,912		100,769
State and municipal securities		1,754,086		23,223		19,835		1,757,474		2,132,262		18,114			35,640		2,114,736
Mortgage-backed securities:
U.S. government agencies		104,131		—		2,595		101,536		95,424		—			4,610		90,814
FHLMC and FNMA debt securities		1,744,061		5,039		51,075		1,698,025		2,019,891		2,125			106,940		1,915,076
Non-agencies		785,091		677		13,602		772,166
Non-agency securities										577,606		232			22,915		554,923


Total investment securities held-to-maturity	$	4,500,881	$	28,945	$	87,703	$	4,442,123	$	4,936,066	$	20,477		$	173,186	$	4,783,357


	December 31, 2004								December 31, 2005
	Amortized		Unrealized		Unrealized		Fair		Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value		Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	11,432	$	44	$	32	$	11,444	$	7,241	$	—	$	147	$	7,094
Debentures of FHLB, FNMA, and FHLMC		561		10		—		571
Corporate debt and asset-backed securities		36,566		—		—		36,566		103,954		6		895		103,065
State and municipal securities		824,331		11,232		8,652		826,911		1,752,739		23,515		17,167		1,759,087
Mortgage-backed securities:
U.S. government agencies		115,222		3,017		7		118,232		99,640		—		2,864		96,776
FHLMC and FNMA debt securities		1,951,449		10,234		28,758		1,932,925		1,940,582		3,505		74,988		1,869,099
Non-agencies		964,758		3,119		5,524		962,353
Non-agency securities										743,471		29		17,224		726,276


Total investment securities held-to-maturity	$	3,904,319	$	27,656	$	42,973	$	3,889,002	$	4,647,627	$	27,055	$	113,285	$	4,561,397


~~(1)~~		(1) Equity ~~securities consist principally of FHLB, FHLMC, and FNMA common and preferred stock.~~


	At December 31, 2005
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	25,937	$	(368	)	$	28,899	$	(543	)	$	54,836	$	(911	)
Debentures of FHLB, FNMA and FHLMC		150,671		(2,799	)		9,835		(171	)		160,506		(2,970	)
Corporate debt and asset-backed securities		63,748		(895	)		4		—			63,752		(895	)
Equity securities		858,985		(13,595	)		—		—			858,985		(13,595	)
State and municipal securities		1,141,155		(17,468	)		—		—			1,141,155		(17,468	)
Mortgage-backed Securities:
U.S. government agencies		796,850		(22,276	)		384,197		(11,920	)		1,181,047		(34,196	)
FHLMC and FNMA securities		1,180,024		(35,160	)		2,490,404		(99,454	)		3,670,428		(134,614	)
Non-agency securities		1,462,615		(32,091	)		1,359,094		(43,210	)		2,821,709		(75,301	)


Total investment securities available for sale and held to maturity	$	5,679,985	$	(124,652	)	$	4,272,433	$	(155,298	)	$	9,952,418	$	(279,950	)


(1)		Loan totals include deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts. These items resulted in a net increase in loans of ~~$335.6~~$267.3 million and ~~$296.8~~$312.8 million at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, respectively. Loans pledged as collateral totaled ~~$17.0~~$17.5 billion and ~~$13.3~~$15.8 billion at ~~September 30, 2005~~March 31, 2006 and December 31, ~~2004,~~2005, respectively.


Related party loans at December 31, 2004	$	59,348
Related party loans at December 31, 2005				$	58,014
Loan fundings		46,608			21,874
Loan repayments		(54,900	)		(217	)
Related party loan balance at September 30, 2005		51,056


Related party loan balance at March 31, 2006					79,671


	Calendar				Remaining		Calendar				Remaining
	Year		Recorded		Amount		Year		Recorded		Amount
Year	Amount		To Date		To Record		Amount		To Date		To Record
2005	$	73,821	$	56,055	$	17,766
2006		65,765		—		65,765	$	65,765	$	17,219	$	48,546
2007		57,313		—		57,313		57,313		—		57,313
2008		42,204		—		42,204		42,204		—		42,204
2009		20,399		—		20,399		20,399		—		20,399
2010								12,995		—		12,995


Assets
Investments	$	379.2
Loans		2,604.1
Less allowance for loan losses		(26.5	)


Total loans, net		2,577.6
Cash acquired, net of cash paid		324.2
Premises and equipment, net		34.2
Bank Owned Life Insurance		97.0
Prepaid expenses and other assets		263.9
Core deposit intangible		31.1
Goodwill		598.5


Total assets	$	4,305.7


Liabilities
Deposits:
Core	$	1,503.7
Time		1,384.6


Total deposits		2,888.3
Borrowings and other debt obligations		668.2
Other liabilities (1)		67.6


Total liabilities	$	3,624.1


Branch and office consolidations	$	2,396
System conversions		5,831
Retail banking conversion costs and other		8,511


Total	$	16,738


~~(1)~~		During the second quarter, Sovereign determined that certain accruals established for contract termination costs and severance on the Seacoast opening balance sheet were no longer required. These accruals were reversed which resulted in a decrease to the goodwill recorded in connection with the Seacoast acquisition.

~~(2)~~		In the first quarter of 2005, Sovereign updated various sublease market rate assumptions related to previous acquisition related accruals for First Essex and Seacoast which were recorded in merger-related and integration expense. Additionally, during the first quarter we determined that certain reserves established in connection with the First Essex acquisition were no longer required and reduced merger-related and integration expense. These items reduced merger related expense by $1.5 million in the first quarter of 2005.

		During the second quarter of 2005, Sovereign reversed $8.2 million as a result of conversion costs and other merger-related items being lower than the amounts initially estimated on the Waypoint and Seacoast acquisitions. This adjustment reduced merger-related and integration expense on Sovereign’s consolidated financial statements. Sovereign also recorded a reversal of $0.2 million related to the Main Street Bancorp acquisition during the three-month period ended June 30, 2005.

		During the third quarter of 2005, Sovereign reversed $2.0 million of Waypoint related accruals for items that were determined to be no longer required, which resulted in a reduction to merger-related and integration expense.


~~(1)~~		The dealer floor plan securitization that was entered into by Sovereign in 2000 was paid off in October 2005 and as such the sensitivity analysis at September 30, 2005 was not disclosed since it is not meaningful.


(1)		In accordance with banking regulatory reporting guidance issued in the ~~third~~first quarter of ~~2005,~~2006, Sovereign reclassified ~~its~~prepayment fees and late fees on loans from non-interest ~~earning deposits~~income to ~~be shown as a separate component of other liabilities~~interest income. Prior periods were reclassified to ~~be consistent with industry practice. This change had no impact~~conform to ~~Sovereign’s historically reported net interest margin.~~the current period presentation.

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

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


	September 30, 2005					December 31, 2004					March 31, 2006					December 31, 2005
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Commercial real estate loans	$	7,151,189		16.8	%	$	5,824,133		15.9	%	$	7,128,116		15.8	%	$	7,209,180		16.5	%
Commercial and industrial loans		9,071,731		21.2			8,040,107		21.9			10,122,781		22.4			9,426,466		21.5


Total Commercial Loans		16,222,920		38.0			13,864,240		37.8			17,250,897		38.2			16,635,646		38.0


Residential mortgages		11,198,366		26.2			8,497,496		23.2			13,161,773		29.1			12,462,802		28.4
Home equity loans and lines of credit		10,301,161		24.1			9,577,656		26.1			9,892,235		21.9			9,793,124		22.4


Total consumer loans secured by real estate		21,499,527		50.3			18,075,152		49.3			23,054,008		51.0			22,255,926		50.8

Auto loans		4,463,931		10.5			4,205,547		11.5			4,400,980		9.8			4,434,021		10.1
Other		505,261		1.2			486,140		1.3			458,528		1.0			478,254		1.1


Total Consumer Loans		26,468,719		62.0			22,766,839		62.2			27,913,516		61.8			27,168,201		62.0


Total Loans (1)	$	42,691,639		100.0	%	$	36,631,079		100.0	%	$	45,164,413		100.0	%	$	43,803,847		100.0	%


Total Loans with:
Fixed rate	$	24,895,678		58.3	%	$	21,145,915		57.7	%	$	26,924,714		59.6	%	$	26,141,411		59.7	%
Variable rate		17,795,961		41.7			15,485,164		42.3			18,239,699		40.4			17,662,436		40.3


Total Loans (1)	$	42,691,639		100.0	%	$	36,631,079		100.0	%	$	45,164,413		100.0	%	$	43,803,847		100.0	%


	September 30, 2005								December 31, 2004								March 31, 2006								December 31, 2005
						Weighted								Weighted								Weighted								Weighted
						Average								Average								Average								Average
Account Type	Amount		Percent			Rate			Amount		Percent			Rate			Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	5,414,212		14.5	%		—	%	$	5,087,531		15.6	%		—	%	$	5,165,140		13	%		—	%	$	5,331,659		14	%		—	%
NOW accounts		9,170,052		24.5			1.82			7,838,584		24.1			0.98			9,110,005		23			2.30			8,844,875		23			2.07
Customer repurchase agreements		959,024		2.6			3.21			837,643		2.6			1.44			1,086,010		3			4.19			1,012,574		3			3.71
Savings accounts		3,684,423		9.9			0.70			3,807,099		11.7			0.61			3,397,183		9			0.78			3,460,292		9			0.79
Money market accounts		8,167,546		21.9			1.83			7,870,288		24.2			1.24			8,384,317		22			2.68			7,989,846		21			2.21
Certificates of deposit		9,937,334		26.6			3.33			7,114,373		21.8			2.32			11,677,492		30			4.12			11,338,460		30			3.79


Total Deposits	$	37,332,591		100	%		1.89	%	$	32,555,518		100	%		1.15	%	$	38,820,147		100	%		2.55	%	$	37,977,706		100	%		2.25	%


	September 30, 2005			December 31, 2004			September 30, 2004			December 31, 2003
CPR speed		15.80	%		16.53	%		17.30	%		19.51	%
Escrow credit spread		4.01	%		3.92	%		3.75	%		4.00	%


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


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


(1)		Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon interest rates in effect at ~~September 30, 2005.~~March 31, 2006. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.

(2)		Excludes unamortized premiums or discounts.

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

(4)		Amount represents estimated purchase price to acquire all of the outstanding common stock of Independence. Part of the funding for this acquisition will be received from the proceeds we anticipate receiving from Santander in which they will be acquiring approximately 88 million shares of Sovereign’s common stock for $2.4 billion. Santander has also agreed to provide nonvoting equity and debt financing in an aggregate amount not to exceed $1.2 billion at prevailing market rates if requested by Sovereign in order to assist with the acquisition of Independence. The acquisition of Independence and the transaction with Santander is scheduled to close on or before June 1, 2006. For additional details see Note 16.


~~(1)~~		Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40.5 million shares of common stock as of September 30, 2005. Twenty million shares have been purchased under these repurchase programs as of September 30, 2005. All of Sovereign’s stock repurchase programs have no prescribed time limit in which to fill the authorized repurchase amount.

		Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 11,382 shares outside of publicly announced repurchase programs during the third quarter of 2005.


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

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

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

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


				~~SOVEREIGN BANCORP, INC.~~
				~~(Registrant)~~

~~Date: November 7, 2005~~				~~/s/ Jay S. Sidhu~~


				~~Jay S. Sidhu, Chairman,~~
				~~Chief Executive Officer and President~~
				~~(Authorized Officer)~~

~~Date: November 7, 2005~~				~~/s/ Mark R. McCollom~~

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


		SOVEREIGN BANCORP, INC.
		(Registrant)

Date: May 9, 2006		/s/ Jay S. Sidhu

		Jay S. Sidhu, Chairman, Chief Executive Officer and President (Authorized Officer)

Date: May 9, 2006		/s/ Mark R. McCollom

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