UNITED STATES
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 quarterly period ended ~~June 30, 2008~~March 31, 2009


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

For the transition period from to .

Commission File Number: 001-16581

SOVEREIGN BANCORP, INC.

(Exact name of registrant as specified in its charter)


~~Pennsylvania~~Virginia		23-2453088

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

~~1500 Market~~75 State Street, ~~Philadelphia, Pennsylvania~~Boston, Massachusetts (Address of principal executive offices)		~~19102~~02109 (Zip Code)

~~(267) 256-8601~~(617) 346-7200
Registrant’s telephone number including area code

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 has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation ST (Section 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yeso. Noo.*

*Registrant is not subject to the requirements of Rule 405 of Regulation S-T at this time.

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act) 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 ~~July 21, 2008~~April 30, 2009

Common Stock (no par value)		~~662,741,960~~503,907,043 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” or the “Company”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (the “SEC” or the “Commission”) (including this Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to shareholders (including its ~~2007~~ Annual ~~Report)~~Report on Form 10-K for the fiscal year ended December 31, 2008) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the statements made by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “hope,” ~~“anticipate,~~anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

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

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 and are not historical facts. Although Sovereign believes that the expectations reflected in these forward-looking statements are reasonable, these statements are not guarantees of future performance and involve risks and uncertainties which are subject to change based on various important factors (some of which are beyond Sovereign’s control). Among the factors, which could cause Sovereign’s financial performance to differ materially from that expressed in the forward-looking statements are:

	•		the strength of the United States economy in general and the strength of the regional and local economies in which Sovereign conducts ~~operations;~~operations, which may affect, among other things, the level of non-performing assets, charge-offs, and provision for credit losses;

	•		the effects of, or policies determined by the Federal Deposit Insurance Corporation, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Board of Governors of the Federal Reserve System;

	•		inflation, interest rate, market and monetary ~~fluctuations;~~fluctuations, which may, among other things reduce interest margins, impact funding sources and affect the ability to originate and distribute financial products in the primary and secondary markets;

	•		adverse movements and volatility in debt and equity capital markets;

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

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

	•		changing market conditions may force us to alter the implementation or continuation of cost savings or revenue enhancement strategies;

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

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

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

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

	•		~~technological changes;~~additional legislation and regulations may be enacted or promulgated in the future, and we are unable to predict the form such legislation or regulation may take or to the degree which we need to modify our businesses or operations to comply with such legislation or regulation (for example, proposed legislation has been introduced in Congress that would amend the Bankruptcy Code to permit modifications of certain mortgages that are secured by a Chapter 13 debtor’s principal residence);

	•		technological changes;

~~FORWARD LOOKING STATEMENTS~~
~~(continued)~~


	•		changes in consumer spending and savings habits;

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

	•		regulatory or judicial proceedings;

	•		changes in asset quality;

	•		the outcome of ongoing tax audits by federal, state and local income tax authorities may require additional taxes be paid by Sovereign as compared to what has been accrued or paid as of period end; ~~and~~

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

	•		the integration of Sovereign into the existing businesses of Santander or the integration may be more difficult, time consuming or costly than expected;

	•		the combined company may not realize, to the extent or at the time we expect, revenue synergies and cost savings from the transaction;

	•		deposit attrition, operating costs, customer losses and business disruptions following the acquisition of Sovereign by Santander, including difficulties in maintaining relationships with employees, could be greater than expected.

If one or more of the factors affecting Sovereign’s forward-looking information and statements proves incorrect, then ~~Sovereign’s~~its actual results, performance or achievements could differ materially from those expressed in, or implied by, forward-looking information and statements. Therefore, Sovereign cautions you not to place undue reliance on any forward-looking information and statements. The effect of these factors is difficult to predict. Factors other than these also could adversely affect our results, and the reader should not consider these factors to be a complete set of all potential risks or uncertainties. 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.~~document and Sovereign ~~does not intend~~undertakes no obligation to update any forward-looking information and statements, whether written or oral, to reflect any change. All forward-looking statements attributable to Sovereign are expressly qualified by these cautionary statements.

PART 1-1 — FINANCIAL INFORMATION

Item 1. Condensed Financial Information

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	June 30,			December 31,			March 31,			December 31,
	2008			2007			2009			2008
	(in thousands, except share data)						(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	1,140,965		$	3,130,770		$	6,153,885		$	3,754,523
Investment securities:
Available-for-sale		11,118,184			13,941,847			8,688,238			9,301,339
Other investments		944,606			1,200,545			705,690			718,771
Loans held for investment		56,936,597			57,232,019			53,723,663			55,541,899
Allowance for loan losses		(808,748	)		(709,444	)		(1,344,480	)		(1,102,753	)


Net loans held for investment		56,127,849			56,522,575			52,379,183			54,439,146


Loans held for sale		469,189			547,760			1,221,216			327,332
Premises and equipment		559,986			562,332
Premises and equipment, net								529,993			550,150
Accrued interest receivable		298,741			350,534			225,490			251,612
Goodwill		3,430,653			3,426,246			3,431,481			3,431,481
Core deposit intangibles and other intangibles, net of accumulated amortization of $812,163 and $754,935 at June 30, 2008 and December 31, 2007, respectively		314,888			372,116
Core deposit intangibles and other intangibles, net of accumulated amortization of $878,595 and $858,578 at March 31, 2009 and December 31, 2008, respectively								248,455			268,472
Bank owned life insurance		1,820,403			1,794,099			1,861,059			1,847,688
Other assets		2,971,985			2,897,572			2,746,173			2,203,154


TOTAL ASSETS	$	79,197,449		$	84,746,396		$	78,190,863		$	77,093,668


LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	47,294,108		$	49,915,905		$	50,546,927		$	48,438,573
Borrowings and other debt obligations		22,050,359			26,126,082			18,626,698			20,964,185
Advance payments by borrowers for taxes and insurance		101,555			83,091			126,874			93,225
Other liabilities		1,370,339			1,482,563			2,101,235			2,000,971


TOTAL LIABILITIES		70,816,361			77,607,641			71,401,734			71,496,954


Minority interests		147,139			146,430


STOCKHOLDERS’ EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 8,000 shares outstanding at June 30, 2008 and December 31, 2007		195,445			195,445
Common stock; no par value; 800,000,000 shares authorized; 663,702,053 shares issued at June 30, 2008 and 482,773,610 shares issued at December 31, 2007		7,701,024			6,295,572
Preferred stock; no par value; $25,000 liquidation preference; 7,500,000 shares authorized; 80,000 shares outstanding at March 31, 2009 and 8,000 shares outstanding at December 31, 2008								1,995,445			195,445
Common stock; no par value; 800,000,000 shares authorized; 503,907,043 shares issued at March 31, 2009 and 666,161,708 shares issued at December 31, 2008								7,821,712			7,718,771
Warrants and employee stock options issued		348,844			348,365			285,435			350,572
Treasury stock at cost; 1,060,605 shares at June 30, 2008 and 1,369,453 shares at December 31, 2007		(10,531	)		(19,853	)
Treasury stock at cost; 0 shares at March 31, 2009 and 2,217,811 shares at December 31, 2008								—			(9,379	)
Accumulated other comprehensive loss		(720,036	)		(326,133	)		(865,725	)		(785,814	)
Retained earnings		719,203			498,929
Retained deficit								(2,447,738	)		(1,872,881	)


TOTAL STOCKHOLDERS’ EQUITY		8,233,949			6,992,325			6,789,129			5,596,714


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	79,197,449		$	84,746,396		$	78,190,863		$	77,093,668

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three-Month Period				Six-Month Period					Three-Month Period
	Ended June 30,				Ended June 30,					Ended March 31,
	2008		2007		2008		2007			2009			2008
	(in thousands, except per share data)									(in thousands, except per share data)
INTEREST INCOME:
Interest-earning deposits	$	997	$	4,144	$	3,961	$	10,380		$	1,785		$	2,964
Investment securities:
Available-for-sale		156,164		180,252		324,273		370,087			87,547			168,109
Other investments		6,671		11,179		16,491		25,480			234			9,820
Interest on loans		837,988		943,860		1,733,264		1,960,827			675,696			895,276


TOTAL INTEREST INCOME		1,001,820		1,139,435		2,077,989		2,366,774			765,262			1,076,169


INTEREST EXPENSE:
Deposits and customer accounts		228,546		409,616		543,649		822,867			216,398			315,103
Borrowings and other debt obligations		267,144		276,435		546,030		602,670			239,796			284,096


TOTAL INTEREST EXPENSE		495,690		686,051		1,089,679		1,425,537			456,194			599,199


NET INTEREST INCOME		506,130		453,384		988,310		941,237			309,068			476,970
Provision for credit losses		132,000		51,000		267,000		97,000			505,000			135,000


NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		374,130		402,384		721,310		844,237
NET INTEREST (EXPENSE)/INCOME AFTER PROVISION FOR CREDIT LOSSES											(195,932	)		341,970


NON-INTEREST INCOME:
Consumer banking fees		80,969		77,268		154,160		145,282			73,752			73,219
Commercial banking fees		53,747		52,046		108,200		101,454			46,093			54,425
Mortgage banking income/(loss)		37,897		26,500		32,764		(80,705	)
Capital markets revenue		7,209		5,982		17,602		11,671
Mortgage banking (losses)/income											(44,843	)		(5,133	)
Capital markets (expense)/revenue											(3,290	)		10,393
Bank owned life insurance		19,065		20,274		38,489		40,783			14,927			19,424
Miscellaneous income		6,322		8,227		11,619		17,694			3,963			5,297


TOTAL FEES AND OTHER INCOME		205,209		190,297		362,834		236,179			90,602			157,625
Net gain on investment securities		1,908		—		16,043		970

Total other-than-temporary impairment losses											(181,024	)		—
Portion of loss recognized in other comprehensive income (before taxes)											101,358			—
Gains on the sale of investment securities											1,969			14,135

Net (loss)/gain on investment securities recognized in earnings											(77,697	)		14,135


TOTAL NON-INTEREST INCOME		207,117		190,297		378,877		237,149			12,905			171,760


GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		192,760		171,557		377,872		345,353			184,038			184,592
Occupancy and equipment expenses		74,868		75,637		152,881		156,156			78,041			78,013
Technology expense		25,728		23,812		50,226		47,148			24,496			24,498
Outside services		15,542		16,969		31,172		32,247			14,928			15,630
Marketing expense		19,699		17,092		35,945		25,924			12,892			16,246
Other administrative expenses		53,266		31,525		93,031		59,760			35,783			30,592


TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		381,863		336,592		741,127		666,588			350,178			349,571

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

Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
2008 2007 2008 2007
(in thousands, except per share data)
OTHER EXPENSES:
Amortization of intangibles $ 28,106 $ 32,257 $ 57,228 $ 65,510
Minority interest expense 5,211 4,989 10,421 10,355
Merger-related and integration charges — 166 — 2,242
Equity method investments 9,508 9,498 12,637 22,547
Restructuring, other employee severance and debt extinguishment charges — 35,938 — 55,970
ESOP expense related to freezing of plan — (3,266 ) — 40,119
Recoveries of proxy and related professional fees — (125 ) — (516 )

TOTAL OTHER EXPENSES 42,825 79,457 80,286 196,227

INCOME/ BEFORE INCOME TAXES 156,559 176,632 278,774 218,571
Income tax provision 29,120 29,180 51,200 23,060

NET INCOME $ 127,439 $ 147,452 $ 227,574 $ 195,511

EARNINGS/ PER SHARE:
Basic $ 0.22 $ 0.30 $ 0.42 $ 0.39

Diluted $ 0.22 $ 0.29 $ 0.42 $ 0.39

DIVIDENDS DECLARED PER COMMON SHARE $ 0.00 $ 0.08 $ 0.00 $ 0.16


	Three-Month Period
	Ended March 31,
	2009			2008
	(in thousands, except per share data)
OTHER EXPENSES:
Amortization of intangibles	$	20,017		$	29,122
Deposit insurance premiums		21,642			9,173
Equity method investments		9,861			3,129
Merger, restructuring and other charges		233,308			520


TOTAL OTHER EXPENSES		284,828			41,944


(LOSS)/INCOME BEFORE INCOME TAXES		(818,033	)		122,215
Income tax (benefit)/provision		(742	)		22,080


NET (LOSS)/INCOME	$	(817,291	)	$	100,135

See accompanying notes to consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE ~~SIX-MONTH~~THREE-MONTH PERIOD ENDED ~~JUNE 30, 2008~~
MARCH 31, 2009

(Unaudited)

(in thousands)


	Common													Accumulated						Total																Accumulated						Total
	Shares							Warrants						Other						Stock-			Common							Warrants						Other			Retained			Stock-
	Out-			Preferred		Common		& Stock			Treasury			Comprehensive			Retained			Holders’			Shares			Preferred		Common		& Stock			Treasury			Comprehensive			Earnings			Holders’
	Standing			Stock		Stock		Options			Stock			Income/(Loss)			Earnings			Equity			Outstanding			Stock		Stock		Options			Stock			Loss			(Deficit)			Equity
Balance, December 31, 2007		481,404		$	195,445	$	6,295,572	$	348,365		$	(19,853	)	$	(326,133	)	$	498,929		$	6,992,325
Balance, December 31, 2008																								663,946		$	195,445	$	7,718,771	$	350,572		$	(9,379	)	$	(785,814	)	$	(1,872,881	)	$	5,596,714
Cumulative effect of adopting FSP FAS 115-2 and FAS 124-2																								—			—		—		—			—			(157,894	)		246,084			88,190

Balance at January 1, 2009																								663,946			195,445		7,718,771		350,572			(9,379	)		(943,708	)		(1,626,797	)		5,684,904
Comprehensive income:
Net income		—			—		—		—			—			—			227,574			227,574
Net loss																								—			—		—		—			—			—			(817,291	)		(817,291	)
Change in unrealized gain/loss, net of tax:
Investment securities available for sale		—			—		—		—			—			(399,254	)		—			(399,254	)		—			—		—		—			—			40,912			—			40,912
Pension liabilities		—			—		—		—			—			249			—			249			—			—		—		—			—			796			—			796
Cash flow hedges		—			—		—		—			—			5,102			—			5,102			—			—		—		—			—			36,275			—			36,275

Total comprehensive income																					(166,329	)
Total comprehensive loss																																											(651,118	)

Issuance of preferred stock to Santander																								—			1,800,000		—		—			—			—			—			1,800,000
Stock issued in connection with employee benefit and incentive compensation plans		1,188			—		5,113		(1,471	)		12,439			—			—			16,081			4			—		46,800		346			47			—			—			47,193
Employee stock options earned		—			—		—		1,950			—			—			—			1,950
Vesting of employee share based awards																								—			—		56,141		(65,483	)		9,342			—			—			—
Dividends paid on preferred stock		—			—		—		—			—			—			(7,300	)		(7,300	)		—			—		—		—			—			—			(3,650	)		(3,650	)
Issuance of common stock		180,309			—		1,400,339		—			—			—			—			1,400,339
Stock repurchased		(260	)		—		—		—			(3,117	)		—			—			(3,117	)		(5	)		—		—		—			(10	)		—			—			(10	)
Shares cancelled by Santander																								(160,038	)		—		—		—			—			—			—			—


Balance, June 30, 2008		662,641		$	195,445	$	7,701,024	$	348,844		$	(10,531	)	$	(720,036	)	$	719,203		$	8,233,949
Balance, March 31, 2009																								503,907		$	1,995,445	$	7,821,712	$	285,435		$	—		$	(865,725	)	$	(2,447,738	)	$	6,789,129

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Six-Month Period						Three-Month Period
	Ended June 30,						Ended March 31,
	2008			2007			2009			2008
	(in thousands)						(in thousands)
CASH FLOWS FROM OPERATING ACTIVITES:
Net income	$	227,574		$	195,511
Adjustments to reconcile net income to net cash provided by operating activities:
Net (loss)/income							$	(817,291	)	$	100,135
Adjustments to reconcile net income to net cash used in operating activities:
Provision for credit losses		267,000			97,000			505,000			135,000
Depreciation and amortization		119,531			133,782			60,323			58,853
Net amortization/accretion of investment securities and loan premiums and discounts		18,286			25,712			(16,056	)		9,132
Net (gain)/loss on sale of loans		(26,766	)		47,497			(9,551	)		(13,227	)
Net gain on investment securities		(16,043	)		(970	)
Net (gain)/loss on investment securities								77,697			(14,135	)
Loss on debt extinguishments								68,733			—
Net loss on real estate owned and premises and equipment		6,165			393			2,655			2,739
Loss on debt extinguishments		—			13,782
Stock-based compensation		12,330			14,043			47,181			6,682
Allocation of Employee Stock Ownership Plan		—			40,119
Origination and purchases of loans held for sale, net of repayments		(3,793,753	)		(2,201,980	)		(2,193,843	)		(2,094,315	)
Proceeds from sales of loans held for sale		3,933,343			2,021,862			1,308,184			1,917,030
Net change in:
Accrued interest receivable		51,793			54,052			26,122			27,774
Other assets and bank owned life insurance		72,023			46,972			(317,651	)		(406,454	)
Other liabilities		(121,408	)		(106,619	)		(861,559	)		158,492

Net cash provided by operating activities		750,075			381,156
Net cash used by operating activities								(2,120,056	)		(112,294	)


CASH FLOWS FROM INVESTING ACTIVITIES:
Adjustments to reconcile net cash used in investing activities:
Proceeds from sales of investment securities:
Available-for-sale		110,657			124,506			2,557,208			103,893
Proceeds from repayments and maturities of investment securities:
Available-for-sale		3,164,698			3,721,591			1,332,691			2,649,818
Net change in other investments		255,939			353,490			13,081			65,740
Purchases of available-for-sale investment securities		(266,860	)		(3,635,412	)		(3,319,786	)		(215,927	)
Proceeds from sales of loans held for investment		118,117			8,971,331			15,882			20,281
Purchase of loans		(210,287	)		(96,306	)		(54,064	)		(112,475	)
Net change in loans other than purchases and sales		(593,436	)		(2,765,442	)		2,432,618			(885,892	)
Proceeds from sales of premises and equipment		3,565			19,365			1,934			285
Purchases of premises and equipment		(42,355	)		(27,761	)		(1,156	)		(15,210	)
Proceeds from sales of real estate owned		18,763			7,166			12,202			10,445

Net cash provided by investing activities		2,558,801			6,672,528			2,990,610			1,620,958

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

Six-Month Period
Ended June 30,
2008 2007
(in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Adjustments to reconcile net cash provided by financing activities:
Net decrease in deposits and other customer accounts (2,623,680 ) (2,546,013 )
Net decrease in borrowings (4,397,955 ) (3,857,878 )
Net proceeds from senior notes, subordinated notes and credit facility 495,320 580,000
Repayments of borrowings and other debt obligations (180,000 ) (1,124,590 )
Net increase in advance payments by borrowers for taxes and insurance 18,464 6,306
Repurchase of minority interests — (11,822 )
Cash dividends paid to preferred stockholders (7,300 ) (7,300 )
Cash dividends paid to common stockholders — (76,332 )
Proceeds from issuance of common stock, net of transaction costs 1,398,933 14,689
Sale of unallocated ESOP shares — 26,574
Treasury stock repurchases, net of proceeds (2,463 ) 5,859

Net cash used in financing activities (5,298,681 ) (6,990,507 )

Net change in cash and cash equivalents (1,989,805 ) 63,177
Cash and cash equivalents at beginning of period 3,130,770 1,804,117

Cash and cash equivalents at end of period $ 1,140,965 $ 1,867,294


						Three-Month Period
						Ended March 31,
						2009			2008
						(in thousands)
CASH FLOWS FROM FINANCING ACTIVITIES:
Adjustments to reconcile net cash provided by financing activities:
Net increase/(decrease) in deposits and other customer accounts						$	2,108,354		$	(920,463	)
Net increase/(decrease) in borrowings							(2,209,545	)		(1,780,677	)
Repayments of borrowings and other debt obligations							(200,000	)		—
Net increase/(decrease) in advance payments by borrowers for taxes and insurance							33,649			22,045
Cash dividends paid to preferred stockholders							(3,650	)		(3,650	)
Cash dividends paid to common stockholders							—			3,110
Proceeds from issuance of preferred stock							1,800,000			—
Treasury stock repurchases, net of proceeds							—			(2,396	)

Net cash provided by / (used in) financing activities							1,528,808			(2,682,031	)


Net change in cash and cash equivalents							2,399,362			(1,173,367	)
Cash and cash equivalents at beginning of period							3,754,523			3,130,770

Cash and cash equivalents at end of period						$	6,153,885		$	1,957,403


	Six-Month Period					Three-Month Period
	Ended June 30,					Ended March 31,
	2008			2007		2009			2008
	(in thousands)					(in thousands)
Supplemental Disclosures:
Net income taxes (refunded)/paid	$	(5,964	)	$	28,613
Net income taxes paid / (refunded)						$	1,769		$	(35,325	)
Interest paid	$	1,147,262		$	1,577,702	$	440,049		$	631,833

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect 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 (the “Bank”), Independence Community Bank Corp. (“Independence”), and Sovereign Delaware Investment Corporation. Sovereign Bancorp is a wholly owned subsidiary of Banco Santander, SA (“Santander”). All intercompany balances and transactions have been eliminated in consolidation.

These financial statements have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in conformity with U.S. generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. However, in the opinion of management, the accompanying consolidated financial statements reflect all adjustments of a normal and recurring nature necessary to present fairly the consolidated balance sheet, statements of operations, stockholders’ equity and cash flows for the periods indicated, and contain adequate disclosure to make the information presented not misleading. These consolidated financial statements should 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. Certain amounts in the financials statements of prior periods have been reclassified to conform with the presentation used in the current period financial statements. These reclassifications have no effect on net income.

(2) ~~EARNINGS PER SHARE~~ACQUISITION OF SOVEREIGN BY SANTANDER

~~Basic earnings per~~On October 13, 2008, Sovereign and Santander entered into a transaction agreement pursuant to which Santander agreed to acquire all of Sovereign’s common stock that it did not already own (the “Transaction”). Prior to entering into the transaction agreement, Santander owned approximately 24.35% of Sovereign’s voting common stock. Both the Board of Directors of Sovereign and the Executive Committee of Santander unanimously approved the Transaction, and both companies’ shareholders voted in favor of the Transaction in January 2009. The Transaction closed on January 30, 2009. Upon adoption of the transaction agreement and the Transaction becoming effective, each share of Sovereign’s common stock was exchanged into the right to receive 0.3206 Santander American Depository Shares (“ADSs”), or at the election of the holders of Sovereign’s common stock, 0.3206 ordinary shares of Santander (subject to Santander’s discretion).

Sovereign will continue to apply its historical basis of accounting in its stand-alone financial statements after the Transaction. This is ~~calculated by dividing net income by~~based on our determination under SFAS 141 (R), Business Combinations, that Santander is the ~~weighted average common~~acquiring entity and our determination under SEC Staff Accounting Bulletin (SAB) No. 54, codified as Topic 5J, Push Down Basis of Accounting Required In Certain Limited Circumstances, that while the push down of Santander’s basis in Sovereign is permissible, it was not required due to the existence at Sovereign of significant outstanding public debt securities.

SFAS 141 (R) provides that for each business combination, one of the combining entities shall be identified as the acquirer with the acquirer defined as the entity that obtains control. We determined that the Transaction resulted in Santander obtaining control of Sovereign as Santander acquired all the voting shares of Sovereign. In reaching our determination that our outstanding ~~excluding options~~public debt securities are significant, we considered both the face amount and ~~warrants. The dilutive~~fair value of our outstanding public debt securities as well as a number of provisions contained within those securities which we believe might impact Santander’s ability to control their form of ownership of Sovereign. If push down accounting had been applied to the separate stand-alone financial statements of Sovereign, the measurement amounts for assets and liabilities as of January 30, 2009 would be based on the guidance in SFAS 141 (R), and would have approximated the purchase price of approximately $1.9 billion, as compared to Sovereign’s equity as of December 31, 2008 of approximately $5.6 billion. Such adjustments to fair value, if recorded, would have the effect of significantly reducing our ~~options is calculated using the treasury stock method~~regulatory capital and ~~the dilutive effect of our warrants that were issued~~would require a capital infusion in ~~connection with our contingently convertible debt issuance is calculated under the if-converted method.~~order to ensure Sovereign Bank would remain well-capitalized.

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

Three-Month Period Six-Month Period
Ended June 30, Ended June 30,
2008 2007 2008 2007
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income as reported and for basic EPS $ 127,439 $ 147,452 $ 227,574 $ 195,511
Less preferred dividend (3,650 ) (3,650 ) (7,300 ) (7,300 )

Net income available to common stockholders 123,789 143,802 220,274 188,211
Contingently convertible trust preferred interest expense, net of tax (1) — 6,413 — 12,825

Net income for diluted EPS available to common stockholders $ 123,789 $ 150,215 $ 220,274 $ 201,036

WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares (3) 570,056 478,278 527,164 476,722
Dilutive effect of:
Warrants (1) — 27,435 — 27,435
Stock options (2) 1,302 6,928 1,654 6,923

Weighted average diluted shares (3) 571,358 512,641 528,818 511,080

EARNINGS PER SHARE:
Basic $ 0.22 $ 0.30 $ 0.42 $ 0.39
Diluted $ 0.22 $ 0.29 $ 0.42 $ 0.39


~~(1)~~		~~This item was excluded from diluted earnings per share for the three-month and six-month periods ended June 30, 2008 since the result would have been anti-dilutive.~~

~~(2)~~		~~Based on Sovereign’s closing stock price on June 30, 2008 of $7.36, Sovereign had 9.8 million of outstanding stock options that were out-of-the-money (exercise price of award exceeded $7.36).~~

~~(3)~~		On May 16th, 2008, Sovereign issued 179.7 million shares of common stock which raised net proceeds of $1.39 billion to enhance its capital and liquidity positions. As a result, this increased our weighted average shares outstanding during the second quarter by 90.8 million. Therefore, our weighted average share count in the third quarter will increase due to the full quarter impact of this transaction by approximately 88.9 million shares.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(3) INVESTMENT SECURITIES (continued)

The following table discloses the aggregate amount of unrealized losses as of ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007~~2008 on securities in Sovereign’s investment portfolio classified according to the amount of time that those securities have been in a continuous loss position (in thousands):


	At June 30, 2008															At March 31, 2009
	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	$	59,206	$	(266	)	$	—	$	—		$	59,206	$	(266	)
Debentures of FHLB, FNMA and FHLMC																$	598,403	$	(348	)	$	—	$	—		$	598,403	$	(348	)
Corporate debt and asset-backed securities		4,794		(64	)		399,492		(411,855	)		404,286		(411,919	)		3,060		(2	)		40,180		(22,246	)		43,240		(22,248	)
Equity securities		597,484		(34,468	)		253		(1	)		597,737		(34,469	)		—		—			253		(1	)		253		(1	)
State and municipal securities		489,064		(13,597	)		1,382,644		(83,275	)		1,871,708		(96,872	)		120,760		(4,455	)		1,490,102		(145,845	)		1,610,862		(150,300	)
Mortgage-backed Securities:
U.S. government agencies		—		—			1,130		(34	)		1,130		(34	)		357		(9	)		826		(50	)		1,183		(59	)
FHLMC and FNMA debt securities		1,144,757		(23,804	)		25,221		(782	)		1,169,978		(24,586	)		184,680		(313	)		25,539		(580	)		210,219		(893	)
Non-agency securities		896,266		(77,107	)		1,852,184		(240,401	)		2,748,450		(317,508	)		120,815		(39,719	)		1,865,090		(771,146	)		1,985,905		(810,865	)


Total investment securities available-for-sale	$	3,191,571	$	(149,306	)	$	3,660,924	$	(736,348	)	$	6,852,495	$	(885,654	)	$	1,028,075	$	(44,846	)	$	3,421,990	$	(939,868	)	$	4,450,065	$	(984,714	)

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(3) INVESTMENT SECURITIES (continued)

~~At June 30, 2008,~~ Sovereign had 8 securities totaling $622.6 million of perpetual preferred stock of FHLMC and FNMA which had an unrealized loss of $34.4 million. These losses are related to liquidity spreads due to negative events on the issuers of these securities. These securities have experienced significant changes in prices month-to-month based on movements in credit spreads and as recently as Maydetermined at March 31, 2008, the securities were in a net unrealized gain position of $11.3 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 June 30, 2008, each of the individual securities was investment grade. Given the short duration of the losses and the fact2009 that ~~the losses were not severe, we concluded that the above unrealized losses are temporary in nature at June 30, 2008.~~

~~Recent news stories in July and concerns in the marketplace have resulted in significant decreases in the share prices of Fannie Mae and Freddie Mac. Since June 30, 2008, the common stock prices for~~our Fannie Mae and Freddie Mac ~~have been very volatile~~preferred stock unrealized loss of $36.9 million was other-than-temporary in accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and ~~have declined significantly. It is widely believed that~~Equity Securities” and the ~~U.S. government will support these two government sponsored entities if needed~~SEC’s Staff Accounting Bulletin No. 59, “Accounting for Non-Current Marketable Equity Securities”. The Company’s assessment considered the duration and has publicly stated so, but it is unclear whether the support would extend to their common and preferred shareholders. Their primary regulator has also stated that both institutions are adequately capitalized. In July, a housing and economic recovery bill was signed into law by the Presidentseverity of the ~~United States which allows~~unrealized loss, the U.S. Treasury Department the authority to purchase equity in both Fannie Mae and Freddie Mac. The housing and recovery bill also permits the Treasury Department to provide a temporary increase in a long standing line of credit for the two companies. The Fed’s Board also granted the New York Fed authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Finally, the housing and recovery bill also includes an increase in the federal debt limit to $10.6 trillion and a $300 billion program to refinance loans for struggling borrowers in an effort to help stabilize the U.S. housing market.

~~The concerns around capital adequacy~~financial condition and the likely dilution on existing shareholders when capital is raised for these two companies has caused the market valuations of the Company’s Fannie Mae and Freddie Mac perpetual preferred stock to decrease significantly in July. It is unclear whether the values of Sovereign’s investment in Fannie Mae and Freddie Mac perpetual preferred stock will change once additional facts and circumstances become known which may not be until Fannie Mae and Freddie Mac release second quarter earnings and the U.S. Government determines the final form of any changes to support Fannie Mae and Freddie Mac. To the extent the market conditions do not improve and the values for these securities do not stabilize, it is possible that Sovereign could have an additional other than temporary impairment charge in future periods.

The unrealized losses on corporate debt and asset backed securities include $390.5 million of unrealized losses on $750 million of highly rated investments in collateralized debt obligations (“CDOs”) at June 30, 2008. These CDOs consist of interests in credit default swaps on investment grade corporate credits. These credits are primarily to companies based in North America and Europe. Additionally, the credits are to various industries with no specific industries exceeding 8.5% of the total investment pool. In all of the CDOs, Sovereign’s investment is senior to one or more subordinated tranche(s) which have first loss exposure. The Company believes that these losses are primarily related to market interest rates and credit spreads and not underlying credit issues associated with the issuers of the debt obligations. The CDOs were purchased in the second and third quarters of 2006 and have not experienced any losses to date. Sovereign does not believe it should have any loss of principal on these investments given its senior position and the protection that the subordinated classes provide. The weighted average contractual life of this portfolio is 8.4 years. The Company has concluded these unrealized losses are temporary in nature since they are not related to the underlying credit qualitynear-term prospects of the issuers and the ~~Company has~~likelihood of the ~~intent and ability~~market value of these instruments increasing to ~~hold these investments for~~our initial cost basis within a ~~time necessary to recover its cost and will ultimately recover its cost~~reasonable period of time. The remaining value of our shares at ~~maturity (i.e. these investments have contractual maturities that, absent credit default, ensure Sovereign will ultimately recover its cost).~~March 31, 2009 is $10.4 million.

The unrealized losses on the Company’s state and municipal bond portfolio ~~increased~~decreased to ~~$96.9~~$150.3 million at ~~June 30,~~March 31, 2009 from $211.0 million at December 31, 2008. This portfolio consists of 100% general obligation bonds of states, cities, counties and school districts. The portfolio has a weighted average underlying credit risk rating of AA-. These bonds are insured with various companies and as such, carry additional credit protection. The Company has determined that the unrealized losses on the portfolio are due to an increase in credit spreads and liquidity issues in the marketplace and concerns with respect to the financial strength of third party insurers. However, even if it was assumed that the insurers could not honor their obligation, our underlying portfolio is still investment grade and the Company believes that we will collect all scheduled principal and interest. The Company has concluded these unrealized losses 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~~does not intend to ~~hold~~sell these investments, ~~for a time necessary~~and it is not more likely than not that the Company will be required to ~~recover its cost.~~

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

~~(3) INVESTMENT SECURITIES (continued)~~sell the investments before recovery of their amortized cost basis, which may be maturity.

The unrealized losses on the non-agency securities portfolio increased to ~~$317.5~~$810.9 million at ~~June 30, 2008. This~~March 31, 2009 from $552.4 million at year-end. Other than what is described in the following two paragraphs, this portfolio consists primarily of ~~AAA~~highly rated non-agency mortgage-backed securities from a diverse group of issuers in the private-label market. The Company has determined that the unrealized losses on the portfolio are due to an increase in credit spreads and liquidity issues in the marketplace. The Company has concluded these unrealized losses are temporary in nature on the majority of this portfolio since they are not related to the underlying credit quality of the issuers, and the Company ~~has the intent and ability~~does not intend to ~~hold~~sell these investments, and it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost basis, which may be maturity. Additionally, our investments are in subordinated positions that are in excess of current and expected cumulative loss positions.

For the three-month period ended December 31, 2008, it was concluded that the Company would not recover the full outstanding principal on five bonds in our non-agency mortgage backed portfolio with a book value of $654.3 million whose fair value was $346.4 million. Under SFAS No. 115 (prior to the issuance by the Financial Accounting Standards Board (FASB) of the final staff position (FSP) FAS 115-2 and FAS 124-2), in the event that it is concluded that all of the investment securities principal cash flows will not be collected, a charge to earnings was required to write-down the investment to its fair market value even if the entity expected to collect principal cash flows in excess of this amount. As a result, Sovereign recorded a $307.9 million OTTI charge.

In April 2009, the FASB issued three FSP’s intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 115-2 and FAS 124-2 changes existing impairment guidance under FASB Statement No. 115,Accounting for Certain Investments in Debt and Equity Securities(FAS 115) in the following significant ways:

•

For debt securities, the “ability and intent to hold” provision was eliminated, and impairment is now considered to be other than temporary if an entity (i)intends to sell the security, (ii) more likely than notwill be required to sellthe security before recovering its cost, or (iii) does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). This new frameworkdoes not apply to equity securities(i.e., impaired equity securities will continue to be evaluated under previously existing guidance).

The “probability” standard relating to the collectibility of cash flows is eliminated, and impairment is now considered to be other than temporary if the present value of cash flowsexpected to be collectedfrom the debt security is less than the amortized cost basis of the security (any such shortfall is referred to in FSP 115-2 as a ~~time necessary~~“credit loss”).

If an entity intends to ~~recover~~sell an impaired debt security or more likely than not will be required to sell the security before recovery of its amortized cost basis less any current-period credit loss, the impairment is other than temporary and should be recognized currently in earnings in an amount equal to the entire difference between fair value and amortized cost.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(3) INVESTMENT SECURITIES (continued)

If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other than temporary and should be separated into (i) the estimated amount relating to credit loss, and (ii) the amount relating to all other factors. Only the estimated credit loss amount is recognized currently in earnings, with the remainder of the loss amount recognized in other comprehensive income.

Upon adoption of FSP FAS 115-2, an adjustment to reclassify the non-credit portion of any other-than-temporary impairments previously recorded through earnings to accumulated other comprehensive income for investments held as of the beginning of the interim period of adoption should be identified as a cumulative effect (e.g., a calendar-year entity adopting in its second quarter 2009 would calculate its cumulative-effect adjustment as of April 1, 2009). This adjustment should only be made if the entity does not intend to sell and more-likely-than-not will ~~ultimately recover~~not be required to sell the security before recovery of its amortized cost basis (i.e., the impairment does not meet the new definition of other-than-temporary). The cumulative effect adjustment should be determined based on the difference between the present value of the cash flows expected to be collected and the amortized cost basis of the debt security as of the beginning of the interim period in which the FSP is adopted. The cumulative effect adjustment should include the related tax effects.

FSP FAS 115-2 and FAS 124-2 were adopted by the Company for the quarter ended March 31, 2009. Upon adoption, a cumulative effect adjustment was recorded in the amount of $246 million to increase retained earnings, with an increase to unrealized losses in other comprehensive income of $158 million and a reduction to our deferred tax valuation allowance of $88 million. The increase to retained earnings represented the non-credit related impairment charge related to the non-agency mortgage backed securities discussed above.

For the quarter ended March 31, 2009, Sovereign updated its assessment of the unrealized losses in its non-agency mortgage backed security portfolio and whether the losses were temporary in nature. Upon completion of this review, it was concluded that additional credit losses are expected on the five bonds which Sovereign recorded an OTTI charge at ~~maturity (i.e.~~December 31, 2008 in the amount of $22.3 million. Finally, it was also determined in the first quarter of 2009 that the present value of the expected cash flows on three additional non-agency mortgage backed securities was less than their carrying value which resulted in an additional impairment of $20.5 million.

Below is a rollforward of the anticipated credit losses on securities which Sovereign has recorded other than temporary impairment charges on through earnings and other comprehensive income. (in thousands).


December 31, 2008	$	62,834
Additions for amount related to credit loss for which an OTTI was not previously recognized		20,504
Reductions for securities sold during the period		—
Reductions for increases in cash flows expected to be collected and recognized over the remaining life of security		—
Additional increases to credit losses for previously recognized OTTI charges when the entity does not intend to sell the security		22,287

Ending balance as March 31, 2009	$	105,625

Sovereign estimated the expected cash flows of its non-agency security portfolio with the assistance of a third party. Upon completion of this review at March 31, 2009, the Company concluded that the present value of the cash flows expected to be received on eight non-agency mortgage backed securities was less than its amortized cost basis.

The eight bonds that have been determined to be other-than-temporarily impaired have a weighted average S&P credit rating of B+ at March 31, 2009. Each of these ~~investments~~securities that Sovereign holds contains various levels of credit subordination. The underlying mortgage loans that comprise these investment securities were primarily originated in the years 2006 and 2007 and consist of 65.9% of jumbo mortgage loans and 71.8% of limited documentation loans. A summary of the key assumptions utilized to forecast future expected cash flows on the securities determined to have ~~contractual maturities that, absent credit default, ensure Sovereign will ultimately recover its cost).~~OTTI were as follows at March 31, 2009.


	March 31, 2009
Loss severity		45	%
Expected cumulative loss percentage		32.30	%
Cumulative loss percentage to date		1.66	%
Weighted average FICO		705
Weighted average LTV		72.1	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(4) LOANS

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


	June 30, 2008					December 31, 2007					March 31, 2009					December 31, 2008
	Amount		Percent			Amount		Percent			Amount		Percent			Amount		Percent
Commercial real estate loans (1)	$	13,271,241		23.3	%	$	12,306,914		21.5	%	$	13,122,159		24.4	%	$	13,181,624		23.7	%
Commercial and industrial loans		12,700,012		22.3			12,594,652		22.0			11,759,754		21.9			12,428,069		22.4
Multi-family loans		4,559,809		8.0			4,088,992		7.1			4,547,556		8.5			4,512,608		8.1
Other		1,748,246		3.1			1,765,036		3.1			1,547,670		2.9			1,650,824		3.0


Total commercial loans held for investment		32,279,308		56.7			30,755,594		53.7			30,977,139		57.7			31,773,125		57.2


Residential mortgages		11,543,270		20.3			12,950,811		22.7			10,666,460		19.9			11,103,279		20.0
Home equity loans and lines of credit		6,504,738		11.4			6,197,148		10.8			6,900,687		12.8			6,891,918		12.4


Total consumer loans secured by real estate		18,048,008		31.7			19,147,959		33.5			17,567,147		32.7			17,995,197		32.4

Auto loans		6,306,484		11.1			7,028,894		12.3			4,895,646		9.1			5,482,852		9.9
Other		302,797		0.5			299,572		0.5			283,731		0.5			290,725		0.5


Total consumer loans held for investment		24,657,289		43.3			26,476,425		46.3			22,746,524		42.3			23,768,774		42.8


Total loans held for investment (2)	$	56,936,597		100.0	%	$	57,232,019		100.0	%	$	53,723,663		100.0	%	$	55,541,899		100.0	%


Total loans held for investment with:
Fixed rate	$	31,302,053		55.0	%	$	32,903,007		57.5	%	$	28,258,527		52.6	%	$	29,559,229		53.2	%
Variable rate		25,634,544		45.0			24,329,012		42.5			25,465,136		47.4			25,982,670		46.8


Total loans held for investment (2)	$	56,936,597		100.0	%	$	57,232,019		100.0	%	$	53,723,663		100.0	%	$	55,541,899		100.0	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(5) DEPOSIT PORTFOLIO COMPOSITION

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


	March 31, 2009								December 31, 2008
						Weighted								Weighted
						Average								Average
	Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	6,705,028		13.3	%		—	%	$	6,684,232		13.8	%		—	%
NOW accounts		5,220,650		10.3			0.44			5,031,748		10.4			0.56
Money market accounts		11,696,088		23.2			1.54			10,483,151		21.6			2.39
Savings accounts		3,602,086		7.1			0.23			3,582,150		7.4			0.46
Certificates of deposit		13,809,369		27.3			3.23			13,559,146		28.0			3.37

Total retail and commercial deposits		41,033,221		81.2			1.60			39,340,427		81.2			1.91
Wholesale NOW accounts		10,969		0.0			1.00			67,213		0.2			2.27
Wholesale money market accounts		1,451,226		2.9			0.42			1,701,734		3.5			0.46
Wholesale certificates of deposit		3,685,594		7.3			3.19			3,004,958		6.2			3.54

Total wholesale deposits		5,147,789		10.2			2.41			4,773,905		9.9			2.43
Government deposits		2,743,493		5.4			0.84			2,633,859		5.4			1.01
Customer repurchase agreements		1,622,424		3.2			0.30			1,690,382		3.5			0.41


Total deposits	$	50,546,927		100.0	%		1.60	%	$	48,438,573		100.0	%		1.86	%

(6) BORROWINGS AND OTHER DEBT OBLIGATIONS

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


	June 30, 2008					December 31, 2007					March 31, 2009					December 31, 2008
			Effective					Effective					Effective					Effective
	Balance		Rate			Balance		Rate			Balance		Rate			Balance		Rate
Sovereign Bank borrowings and other debt obligations:
Securities sold under repurchase agreements	$	77,000		4.12	%	$	76,526		4.12	%
Fed funds purchased		1,202,000		2.16			2,720,000		4.22		$	2,000,000		0.25	%	$	2,000,000		0.60	%
FHLB advances		16,824,146		4.53			19,705,438		4.64			11,125,677		5.14			13,267,834		4.71
Reit preferred												148,100		9.39			147,961		14.10
Senior notes												1,345,113		3.92			1,344,702		3.92
Subordinated notes		1,648,847		5.89			1,148,813		4.65			1,656,104		5.86			1,653,684		5.87
Holding company borrowings and other debt obligations:
Senior notes		1,043,956		3.95			1,042,527		5.14			1,094,665		3.68			1,293,859		3.56
Senior credit facility		—		—			180,000		5.55
Junior subordinated debentures due to Capital Trust Entities		1,254,410		6.88			1,252,778		7.30			1,257,039		6.59			1,256,145		7.23


Total borrowings and other debt obligations	$	22,050,359		4.61	%	$	26,126,082		4.75	%	$	18,626,698		4.64	%	$	20,964,185		4.51	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

~~Additionally,~~NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in May 2008, Sovereign Bancorp issued 179.7 million shares of common stock which raised net proceeds of $1.39 billion. Sovereign utilized the proceeds of this offering and the subordinated debt to pay down $1.7 billion of FHLB advances and $180 million outstanding under the senior credit facility.thousands, expect per share amounts)

Sovereign currently has a series of callable advances totaling $2.6 billion with the FHLB. These advances provide variable funding (currently at 4.84%) during the non-call period which ranges from 6 to 18 months. The majority of these advances are past their non-call periods. After the non-call period, the interest rates on these advances reset to a fixed rate of interest with certain caps (ranging from 4.95% to 5.50%) and floors of 0%. If these advances are not called by the FHLB, they will mature on various dates ranging from August 2012 to September 2016.(Unaudited)

~~(6)~~(7) DERIVATIVES

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

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

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

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

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

Fair Value Hedges. Sovereign has entered into pay-variable, receive-fixed interest rate swaps to hedge changes in fair values of certain brokered certificates of deposits and certain debt obligations. For the ~~six-month period~~three-month periods ended ~~June 30,~~March 31, 2009 and 2008, ~~and 2007, charges~~income of ~~$3.2~~$2.0 million and ~~$1.7~~expense of $2.0 million, respectively, were recorded in earnings associated with hedge ineffectiveness.

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. The last of the hedges is scheduled to expire in January 2016. For the ~~six~~three months ended ~~June 30,~~March 31, 2009 and 2008, ~~and 2007,~~ no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. ~~No gains or~~During the three months ended March 31, 2009 and 2008, $8.7 million and $3.1 million of losses deferred in accumulated other comprehensive income were ~~reclassified into earnings during the six months ended June 30, 2008 or 2007~~recorded as interest expense as a result of discontinuance of cash flow hedges for which the forecasted transaction was ~~not~~ probable of occurring. As of ~~June 30, 2008,~~March 31, 2009, Sovereign expects approximately ~~$124.1~~$119.7 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.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

~~(6)~~(7) DERIVATIVES (continued)

The following financial statement line items were impacted by Sovereign’s derivative activity as of and for the ~~six~~three months ended ~~June 30, 2008:~~March 31, 2009:


	Balance Sheet Effect at	Income Statement Effect For The ~~Six~~Three Months Ended
Derivative Activity	~~June 30, 2008~~March 31, 2009	~~June 30, 2008~~March 31, 2009
Fair value hedges:
Receive fixed-pay variable interest rate swaps	~~Decrease~~Increase to CDs of ~~$0.2~~$0.6 million and increases to other assets and other liabilities of ~~$0.7~~$1.0 million and ~~$0.5~~$6.2 million, respectively.	Increase in net interest income of ~~$6.7~~$0.6 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other liabilities and deferred taxes of ~~$213.5~~$320.3 million and ~~$74.7~~$116.9 million, respectively, and a decrease to stockholders’ equity of ~~$138.8~~$203.4 million.	Decrease in net interest income of ~~$60.3 million.~~

~~Other hedges:~~
~~Forward commitments to sell loans~~	~~Increase to other assets of $2.3 million.~~	~~Increase in mortgage banking revenues of $7.1 million.~~

~~Interest rate lock commitments~~	~~Increase to mortgage loans of $1.1 million.~~	~~Decrease in mortgage banking revenues of $1.0 million.~~

~~Net customer related hedges~~	~~Increase to other assets of $38.9 million.~~	~~Increase in capital markets revenue of $4.1 million.~~

~~Forward commitments to sell precious metals inventory, net~~	~~Increase to other liabilities of $63 thousand.~~	~~Increase in commercial banking fees of $1.0 million.~~

~~Foreign exchange~~	~~Increase to other assets of $5.3 million.~~	~~Increase in commercial banking fees of $3.4 million.~~

~~The following financial statement line items were impacted by Sovereign’s derivative activity as of December 31, 2007 and for the six months ended June 30, 2007:~~


	~~Balance Sheet Effect at~~	~~Income Statement Effect For The Six Months~~
~~Derivative Activity~~	~~December 31, 2007~~	~~Ended June 30, 2007~~
~~Fair value hedges:~~
~~Receive fixed-pay variable~~ ~~interest rate swaps~~	~~Decrease to CDs of $1.8 million and increases to other assets and other liabilities of $0.4 million and $2.2 million, respectively.~~	~~Decrease in net interest income of $6.9 million.~~

~~Cash flow hedges:~~
~~Pay fixed-receive floating~~ ~~interest rate swaps~~	~~Increase to other liabilities and deferred taxes of $214.5 million and $75.1 million, respectively, and a decrease to stockholders’ equity of $139.5 million.~~	~~Increase in net interest income of $8.5~~$53.8 million.

Other hedges:
Forward commitments to sell loans	Increase to other liabilities of ~~$4.7~~$22.0 million.	~~Increase~~Decrease in mortgage banking revenues of ~~$31.2~~$12.4 million.

Interest rate lock commitments	Increase to mortgage loans of ~~$2.1~~$12.0 million.	~~Decrease~~Increase in mortgage banking revenues of ~~$0.2~~$3.4 million.

Net customer related hedges	Increase to other assets of ~~$34.8~~$31.1million.	Decrease in capital markets revenue of $2.0 million.

Foreign exchange	Increase to other assets of $5.8 million.	Decrease in commercial banking fees of $2.0 million.

The following financial statement line items were impacted by Sovereign’s derivative activity as of December 31, 2008 and for the three months ended March 31, 2008:


	Balance Sheet Effect at	Income Statement Effect For The Three Months Ended
Derivative Activity	December 31, 2008	March 31, 2008
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Increases to borrowings, CDs, other assets, and other liabilities of $6.1 million, $1.4 million, $6.3 million and $0.4 million, respectively.	Increase in net interest income of $4.0 million.

Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increases to other assets, other liabilities, and deferred taxes of $4.2 million, $358.0 million, and $129.1 million, respectively and a net decrease to stockholders’ equity of $224.7 million.	Decrease in net interest income of $15.8 million.

Other hedges:
Forward commitments to sell loans	Increase to other liabilities of $9.6 million.	Increase in mortgage banking revenues of $0.4 million.

Interest rate lock commitments	Increase to mortgage loans of $8.6 million.	Increase in mortgage banking revenues of $1.4 million.

Net customer related hedges	Increase to other assets of $33.0 million.	Increase in capital markets revenue of ~~$5.4~~$3.4 million.

Forward commitments and forward settlement arrangements on precious metals	Increase to other liabilities of ~~$1.0~~$0 million.	Increase in commercial banking fees of ~~$1.5~~$1.2 million.

Foreign exchange	Increase to other assets of ~~$1.9~~$7.7 million.	Decrease in commercial banking ~~fees~~revenues of ~~$0.2~~$0.7 million.

1719

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

~~(8)~~(9) MORTGAGE SERVICING RIGHTS (continued)

A valuation allowance is established for the excess of the cost of each residential mortgage servicing asset stratum over its estimated fair value. Activity in the valuation allowance for mortgage servicing rights for the ~~six~~three months ended ~~June 30, 2008~~March 31, 2009 consisted of the following (in thousands):

Balance as of December 31, 2007 $ 1,473
Decrease in valuation allowance for mortgage servicing rights (1,134 )

Balance as June 30, 2008 $ 339

In the first quarter of 2008, Sovereign recorded a residential mortgage servicing right impairment charge of $18.7 million for the three-month period ended March 31, 2008, which was driven by lower interest rates and higher market prepayment speed assumptions. In the second quarter of 2008, Sovereign recovered $19.8 million of its total impairment reserve as a result of normalization in market prepayment speed assumptions as CPR speeds declined to 12.19% at June 30, 2008 compared to 20.64% at March 31, 2008.

Sovereign had gains/(losses) on the sale of mortgage loans, multi-family loans and home equity loans of $14.7 million and $27.9 million for the three-month and six-month periods ended June 30, 2008, compared with $9.1 million and $(94.7) million for the corresponding periods ended June 30, 2007. The loss in 2007 is a result of $119.9 million of losses recorded on the Company’s correspondent home equity loan portfolio.


Balance as of December 31, 2008	$	48,815
Increase in valuation allowance for mortgage servicing rights		14,114

Balance as March 31, 2009	$	62,929

Sovereign also originates and sells multi-family loans in the secondary market to Fannie Mae while retaining servicing. At ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, Sovereign serviced ~~$12.2~~$13.1 billion and ~~$10.9~~$13.0 billion ~~respectively,~~ of loans for Fannie Mae and as a result has recorded servicing assets of ~~$18.6~~$9.5 million and ~~$20.4~~$14.7 million, respectively. Sovereign recorded servicing asset amortization of ~~$1.9~~$2.2 million and ~~$3.5~~$1.7 million related to the multi-family loans sold to Fannie Mae for the ~~three-month~~three-months ended March 31, 2009 and ~~six-month periods ended June 30, 2008 and~~March 31, 2008. Sovereign recognized servicing assets of ~~$5.9~~$0.5 million during the first ~~six~~three months of ~~2008.~~2009. Additionally, due to lower escrow credit rate assumptions and increased prepayment speed assumptions since year-end, Sovereign has recorded a multi-family servicing right net impairment charge of ~~$4.2~~$3.5 million for the ~~six-month~~three-month period ended ~~June 30, 2008.~~

~~(9) BUSINESS SEGMENT INFORMATION~~

~~During the first quarter of 2008, as previously discussed in Sovereign’s 2008 first quarter Form 10-Q, certain changes~~March 31, 2009 compared to ~~our executive management were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, Sovereign centralized the responsibility~~$4.9 million for the ~~major businesses within~~corresponding period in the ~~Company naming~~prior year.

Sovereign had (losses)/gains on the sale of mortgage loans, multi-family loans and home equity loans of $(38.5) million for the three-month period ended March 31, 2009, compared with $13.2 million for the corresponding period ended March 31, 2008. The three-month period ended March 31, 2009 included a ~~new head~~$48.1 million charge to increase our recourse reserves associated with the sales of ~~Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly~~multifamily loans to Fannie Mae. This increase was due to higher loss rate assumptions due to the ~~Chief Executive Officer~~deteriorating economic environment and along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group. These events changed how our executive management team measures and assesses business performance. During the second quarter we finalized the process of updating our business unit profitability system to reflect our new organizational structure.

Asas a result, ~~of the changes discussed above,~~ Sovereign now has ~~four reportable segments. The Company’s segments are focused principally around the customers Sovereign serves. The Retail Banking Division is comprised~~recourse reserves of ~~our branch locations. Our branches offer a wide range of products and services~~$80.0 million associated with multi-family loans sold to customers and each attracts deposits by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposits and retirement savings plans. Our branches also offer certain consumer loans such as home equity loans and other consumer loan products. The Corporate Specialties Group segment is primarily comprised of our mortgage banking group, our New York multi-family and national commercial real estate lending group, our automobile dealer floor plan lending group and our indirect automobile lending group. It also provides capital market services and cash management services. The Commercial Lending segment provides the majority of Sovereign’s commercial lending platforms such as commercial real estate loans, commercial industrial loans, leases to commercial customers and small business loans. The Other segment includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and other debt obligations, minority interest expense, amortization of intangible assets and certain unallocated corporate income and expenses.

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

~~(9)~~(10) BUSINESS SEGMENT INFORMATION ~~(continued)~~

The following tables present certain information regarding the Company’s segments (in thousands). Prior periods have been reclassified to conform to the current presentation.


	Retail		Corporate											Retail			Corporate
For the three-month period ended	Banking		Specialty			Commercial								Banking			Specialty			Commercial
June 30, 2008	Division		Group			Lending			Other			Total
Net interest income (expense)	$	264,891	$	106,304		$	128,818		$	6,117		$	506,130
Fees and other income⁽¹⁾		101,441		52,240			30,614			20,914			205,209
March 31, 2009														Division			Group			Lending			Other (3)			Total

Net interest income/(expense)														$	192,303		$	90,527		$	111,175		$	(84,937	)	$	309,068
Fees and other income															93,198			(40,452	)		20,796			17,060			90,602
Provision for credit losses		13,745		69,693			48,562			—			132,000		69,691			191,415			243,894			—			505,000
General and administrative expenses		266,616		44,241			56,347			14,659			381,863		248,854			42,004			48,623			10,697			350,178
Depreciation/amortization		10,754		12,176			696			37,052			60,678		10,385			17,717			434			31,787			60,323
Income (loss) before income taxes		85,971		39,942			55,061			(24,415	)		156,559
Intersegment revenues (expense)⁽²⁾		377,213		(323,675	)		(182,117	)		128,579			—
Income/(loss) before income taxes^{(1) (3)}															(55,620	)		(183,525	)		(160,678	)		(418,210	)		(818,033	)
Intersegment revenue/(expense)⁽²⁾															296,511			(286,928	)		(103,895	)		94,312			—
Total average assets	$	6,815,730	$	30,196,374		$	22,494,819		$	20,294,827		$	79,801,750	$	7,312,001		$	28,750,759		$	20,400,967		$	19,714,572		$	76,178,299

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

~~(10) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS~~(11) INCOME TAXES

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

Items considered in ~~its annual report filed~~this evaluation include historical financial performance, expectation of future earnings, the ability to carry back losses to recoup taxes previously paid, length of statutory carry forward periods, experience with operating loss and tax credit carry forwards not expiring unused, tax planning strategies and timing of reversals of temporary differences. Significant judgment is required in assessing future earning trends and the timing of reversals of temporary differences. The evaluation is based on ~~Form 10-K, Sovereign has securitized certain financial~~current tax laws as well as expectations of future performance.

SFAS No. 109 suggests that additional scrutiny should be given to deferred tax assets of an entity with cumulative pre-tax losses during the three most recent years and is widely considered significant negative evidence that is objective and verifiable and therefore, difficult to ~~qualified special purpose entities which were deconsolidated~~overcome. During the three years ended December 31, 2008, we had cumulative pre-tax losses and considered this factor in our analysis of deferred tax assets at year-end. Additionally, based the continued economic uncertainty that existed at that time, it was determined that it was probable that the Company would not generate significant pre-tax income in the near term on a stand-alone basis. (i.e. Management did not consider the potential economic benefits associated with our transaction with Santander in accordance with ~~FAS 140.~~U.S. generally accepted accounting principles). As a result of these facts, Sovereign recorded a $1.43 billion valuation allowance against its deferred tax assets for the year-ended December 31, 2008.

During the three-month period ended March 31, 2009, Sovereign reported a pretax loss of $818 million, due to an elevated provision for credit losses, as well as significant restructuring and transaction costs associated with the acquisition of Sovereign by Santander which closed on January 30, 2009. Sovereign did not benefit its pretax loss that was incurred in the first quarter (which resulted in an increase to the valuation allowance for deferred taxes of ~~2008, Sovereign exercised its cleanup call option on its securitized mortgage loan portfolio. This did not have a~~$258.6 million) given the significant ~~impact on our consolidated statement of operations or financial condition.~~

Shown below are the types of assets underlying the securitizations for which Sovereign owns and continues to own an interest in and the related balances and delinquencies at June 30, 2008 and December 31, 2007, and the net credit lossesloss incurred for the ~~six-month period ended June 30, 2008 and~~current quarter, as well as in prior years. The Company will continue to evaluate the ~~year ended December 31, 2007 (in thousands):~~

June 30, 2008 December 31, 2007
Principal Net Principal Net
Total 90 Days Credit Total 90 Days Credit
Principal Past Due Losses Principal Past Due Losses
Mortgage Loans $ 11,856,434 $ 180,085 $ 9,482 $ 13,397,822 $ 130,101 $ 7,498
Home Equity Loans and Lines of Credit 6,598,027 97,708 11,666 6,300,558 88,848 11,063
Commercial Real Estate and Multi-family Loans 17,943,548 144,265 43,095 17,526,885 57,623 15,540
Automotive Floor Plan Loans 1,176,478 8,998 2,039 1,255,729 — 335

Total Owned and Securitized $ 37,574,487 $ 431,056 $ 66,282 $ 38,480,994 $ 276,572 $ 34,436

Less:
Securitized Mortgage Loans $ — $ — $ — $ 56,629 $ 638 $ 30
Securitized Home Equity Loans 93,289 14,973 1,916 103,410 15,764 2,915
Securitized Commercial Real Estate and Multi-family Loans 958,964 — — 973,601 — —
Securitized Automotive Floor Plan Loans 855,000 — 2,039 855,000 — 335

Total Securitized Loans $ 1,907,253 $ 14,973 $ 3,955 $ 1,988,640 $ 16,402 $ 3,280

Net Loans $ 35,667,234 $ 416,083 $ 62,327 $ 36,492,354 $ 260,170 $ 31,156

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~
~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS~~
~~(dollars~~need for its valuation allowance against deferred taxes in ~~thousands, expect per share amounts)~~
~~(Unaudited)~~

~~(10) INTERESTS THAT CONTINUE TO BE HELD BY SOVEREIGN IN ASSET SECURITIZATIONS (continued)~~

At June 30, 2008 and December 31, 2007, key economic assumptions and the sensitivity of the fair value of the retained interests to immediate 10 percent and 20 percent adverse changes in those assumptions are as follows (dollars in thousands):

Home
Equity Commercial
Loans & Auto Loans
Lines of Floor Secured by
Credit Plan Loans Real Estate Total
Interests that continue to be held by Sovereign:
Accrued interest receivable $ — $ 3,448 $ — $ 3,448
Subordinated interest retained — 43,996 6,867 50,863
Interest only strips 2,223 1,010 — 3,233
Cash reserve — 4,381 — 4,381

Total Interests that continue to be held by Sovereign $ 2,223 $ 52,835 $ 6,867 $ 61,925

Weighted-average life (in yrs) 3.42 0.41 8.07
Prepayment speed assumption (annual rate)

As of the date of the securitization 22 % 50 % 10 %
As of December 31, 2007 17 % 49 % 10 %
As of June 30, 2008 13 % 43 % 10 %
Impact on fair value of 10% adverse change $ (148 ) $ (42 ) $ —
Impact on fair value of 20% adverse change $ (299 ) $ (92 ) $ —
Expected credit losses (annual rate)

As of the date of the securitization 0.75 % .25 % .50 %
As of December 31, 2007 5.25 % .25 % .50 %
As of June 30, 2008 3.74 % .25 % .60 %
Impact on fair value of 10% adverse change $ (382 ) $ (42 ) $ (60 )
Impact on fair value of 20% adverse change $ (740 ) $ (84 ) $ (119 )
Residual cash flows discount rate (annual)

As of the date of the securitization 12 % 8 % 12 %
As of December 31, 2007 12 % 8 % 17 %
As of June 30, 2008 12 % 8 % 28 %
Impact on fair value of 10% adverse change $ (90 ) $ (95 ) $ (91 )
Impact on fair value of 20% adverse change $ (174 ) $ (191 ) $ (178 )

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

Sovereign enters into partnerships, which are variable interest entities under FIN 46, with real estate developers for the construction and development of low-income housing. The partnerships are structured with the real estate developer as the general partner and Sovereign as the limited partner. Sovereign is not the primary beneficiary of these variable interest entities. The Company’s risk of loss is limited to its investment in the partnerships, which totaled $158.6 million at June 30, 2008 and any future cash obligations that Sovereign has committed to the partnerships. Future cash obligations related to these partnerships totaled $21.3 million at June 30, 2008. Sovereign investments in these partnerships are accounted for under the equity method.

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

~~(11) UNRECOGNIZED TAX BENEFITS~~periods.

At ~~June 30, 2008,~~March 31, 2009, Sovereign had net unrecognized tax benefit reserves related to uncertain tax positions of ~~$92.1 million. Of this amount, approximately $13.7~~$85.3 million, related to reserves established for uncertain tax positions from the acquisition of Independence. Any adjustments to these reserves in future periods will be adjusted through goodwill prior to the effective date of SFAS 141(R). After SFAS 141(R) becomes effective, (which for Sovereign will be January 1, 2009) any adjustments to reserves associated with the Independence acquisition or other acquisitions will be required to be recorded through earnings as an adjustment to Sovereign’s income tax provision. The remaining balance of $78.4 millionwhich represents the total amount of unrecognized tax benefits that, if recognized, would affect the effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows:

(in thousands)
Gross unrecognized tax benefits at December 31, 2007 $ 87,461
Additions based on tax positions related to the current year 10,861
Additions based on tax positions related to prior years (1) 16,847
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations (1,142 )

Gross unrecognized tax benefits at June 30, 2008 114,027
Less: Federal, state and local income tax benefits 21,884

Net unrecognized tax benefits at June 30, 2008 92,143
Less: Unrecognized tax benefits included above that relate to acquired entities that would impact goodwill if recognized 13,708

Total unrecognized tax benefits that, if recognized, would impact the effective income tax rate as of June 30, 2008 $ 78,435


	(in thousands)
Gross unrecognized tax benefits at December 31, 2008	$	105,705
Additions based on tax positions related to the current year		748
Additions based on tax positions related to prior years		377
Settlements		(900	)
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations		(2,477	)

Gross unrecognized tax benefits at March 31, 2009		103,453
Less: Federal, state and local income tax benefits		18,183

Total unrecognized tax benefits that, if recognized, would impact the effective income tax rate as of March 31, 2009	$	85,270


~~(1)~~		Includes additional reserves of $16.0 million ($10.4 million, net of tax) recorded in the second quarter of 2008 to increase reserves for uncertain tax positions based on recent rulings in certain states.

Sovereign recognizes penalties and interest accrued related to unrecognized tax benefits within income tax expense on the Consolidated Statement of Operations. During the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, Sovereign recognized a decrease of approximately ~~$4.6~~$0.9 million ~~and $5.9 million, respectively,~~ in interest and penalties compared to ~~$2.1~~a $1.3 million ~~and $4.0 million, respectively,~~increase for the corresponding ~~periods~~period in the prior year. Included in gross unrecognized tax benefits at ~~June 30, 2008~~March 31, 2009 was approximately ~~$14.7~~$14.0 million for the potential payment of interest and penalties.

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(11) INCOME TAXES (continued)

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. The Internal Revenue Service (the “IRS”) ~~is currently examining~~recently examined the Company’s federal income tax returns for the years 2002 through 2005. The ~~Company anticipates that the~~ IRS ~~will complete~~completed this review in ~~the second half of~~ 2008. Included in this examination cycle are two separate financing transactions with an international bank totaling $1.2 ~~billion, which are discussed in Note 12 in the Company’s Form 10-K.~~billion. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign was subject to an additional $87.6 million and $22.5 million, respectively, of foreign taxes related to these financing transactions and claimed a corresponding foreign tax credit. ~~While the~~The IRS ~~audit is not complete, recent developments in our IRS audit leads us to expect that the IRS will propose to disallow~~issued a notification of adjustment disallowing the foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these ~~transactions~~transactions; disallowing deductions for issuance costs and interest expense related to ~~assess~~the transaction which would result in an additional tax liability of $24.9 million and assessed interest and potential penalties, the combined amount of which totaled approximately ~~$73.4 million~~$71.0 million. Sovereign has paid the additional tax due resulting from the IRS’ adjustments, as well as the assessed interest and penalties and is now going through the IRS administrative process to challenge the adjustments and to obtain a refund of ~~June 30, 2008.~~the amounts paid. In addition, ~~while~~ the IRS has ~~not yet initiated an~~commenced its audit for the years 2006 and ~~2007, we~~2007. We expect that in the future the IRS will propose to disallow the foreign tax credits and deductions taken in 2006 and 2007 of $87.6 million and $22.5 million, ~~respectively,~~respectively; disallow deductions for issuance costs and interest expense which would result in an additional tax liability of $37.1 million; and to assess interest and ~~potential penalties, the combined amount of which totals approximately $16.9 million as of June 30, 2008.~~penalties. Sovereign ~~may~~expects that it will need to litigate this matter with the IRS. Sovereign ~~believes~~continues to believe that it is entitled to claim these foreign tax credits taken with respect to the transactions and also continues to believe it is entitled to tax deductions for the related issuance costs and interest deductions. Sovereign also believes that its recorded tax reserves for ~~this~~its position of ~~$58.7~~$57.6 million adequately provides for any potential exposure to the IRS related to ~~foreign tax credits and other tax assessments.~~these items. However, as the Company continues to go through the IRS administrative process, and if necessary litigation, we will continue to evaluate the appropriate tax reserve levels for this position and any changes made to the tax reserves may materially affect Sovereign’s income tax provision, net income and regulatory capital in future periods.

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

(12) RELATED PARTY TRANSACTIONS

Loans to related parties include loans made to certain officers, directors and their affiliated interests. These loans were made on terms similar to non-related parties. The following table discloses the changes in Sovereign’s related party loan balances since December 31, 2007.

Related party loans at December 31, 2007 $ 13,963
Loan fundings 4,785
Loan repayments (672 )
Reduction of executive officers (1,637 )

Related party loan balance at June 30, 2008 $ 16,439

Related party loans at June 30, 2008 included commercial loans to affiliated businesses of directors of Sovereign Bancorp and the Bank totaling $15.0 million compared with $10.6 million at December 31, 2007. Related party loans at June 30, 2008 and December 31, 2007 also included consumer loans secured by residential real estate of $1.4 million and $3.4 million, respectively, to executive officers and directors of Sovereign Bancorp. Related party loans do not include undrawn commercial and consumer lines of credit that totaled $1.2 million and $1.3 million at June 30, 2008 and December 31, 2007, respectively.

The Company is engaged in certain activities with ~~Meridian Capital~~a mortgage broker due to its acquisition of Independence. ~~Meridian Capital~~This broker is deemed to be a “related party” of the Company as such term is defined in SFAS No. 57 since Sovereign has a 35% minority equity investment in ~~Meridian Capital, which is 65% owned by Meridian Funding, a New York-based~~it. This mortgage ~~firm. Meridian Capital~~broker refers and receives fees from borrowers seeking financing of their multi-family and/or commercial real estate loans to Sovereign as well as to numerous other financial institutions. Sovereign recognized $2.5 million and $4.9 million, respectively, of income due to its investment in Meridian Capital for the three-month and six-month periods ended June 30, 2008 compared to $2.4 million and $3.9 million, respectively, for the three-month and six-month periods ended June 30, 2007. Additionally, substantially all of Sovereign’s multi-family loan originations are obtained via our relationship with ~~Meridian Capital.~~this broker. Sovereign recognized ~~gains~~a loss on the ~~sale~~sales of multi-family loans of ~~$9.7~~$50.1 million ~~and $18.9 million, respectively,~~ for the three-month ~~and six-month periods~~period ended ~~June 30, 2008 and $5.7~~March 31, 2009 due to the previously mentioned increases to recourse reserves on loans sold to Fannie Mae, compared to a gain of $9.2 million ~~and $16.3 million, respectively,~~in for the three-month ~~and six-month periods~~period ended ~~June 30, 2007.~~March 31, 2008.

~~As discussed~~In March 2009, Sovereign Bancorp, parent company of Sovereign Bank, issued to Santander, parent company of Sovereign Bancorp, 72,000 shares of Sovereign’s Series D Non-Cumulative Perpetual Convertible Preferred Stock, without par value (the “Series D Preferred Stock”), having a liquidation amount per share equal to $25,000, for a total price of $1.8 billion. The Series D Preferred Stock pays non-cumulative dividends at a rate of 10% per year. Sovereign may not redeem the Series D Preferred Stock during the first five years. The Series D Preferred Stock is generally non-voting. Each share of Series D Preferred Stock is convertible into 100 shares of common stock, without par value, of Sovereign. Sovereign contributed the proceeds from this offering to Sovereign Bank in ~~Note 3 in Sovereign’s 2007 Form 10-K,~~order to increase the Bank’s regulatory capital ratios.

Sovereign ~~raised $2.4~~has $2.03 billion of ~~equity by issuing 88.7 million shares to Banco~~public securities that consists of various senior note obligations, trust preferred security obligations and preferred stock issuances. Santander ~~Central Hispano (“Santander”), which makes Santander~~has purchased approximately 26% of these securities in the ~~largest shareholder and a related party. Per the terms~~open market as of Sovereign’s investment agreement with Santander, Sovereign is permitted to have at least three Santander employees on its payroll, and Santander is permitted to have at least three Sovereign employees on its payroll.March 31, 2009.

In 2006, Santander extended a total of $425 million in unsecured lines of credit to ~~the~~Sovereign Bank for federal funds and Eurodollar borrowings and for the confirmation of standby letters of credit issued by ~~the~~Sovereign Bank. ~~These lines are~~This line is at a market rate and in the ordinary course of business and can be cancelled by either ~~the Bank~~Sovereign or Santander at any time and can be replaced by ~~the Bank~~Sovereign at any time. In the first quarter of 2009, this line was increased to $2.5 billion. During the ~~second quarter of~~three months ended March 31, 2009 and 2008, respectively, the average balance outstanding under these commitments was ~~$203.4~~$100.2 million ~~which consisted entirely of standby letters of credit.~~and $98.7 million. As of ~~June 30, 2008,~~March 31, 2009, there was no outstanding balance on the unsecured lines of credit for federal funds and Eurodollar borrowings. ~~The~~Sovereign Bank paid approximately ~~$0.6~~$1.3 million in fees to Santander ~~for~~in the ~~six-month~~three month period ended ~~June 30, 2008~~March 31, 2009 in connection with these ~~commitments.~~

In February 2007, Sovereign entered into an agreement with Isban U.K., Ltd. (“Isban”), an information technology subsidiary of Santander, under which Isban performed a review of, and recommended enhancementscommitments compared to ~~Sovereign’s banking information systems. Sovereign has paid Isban $0.5~~$0.3 million excluding expenses, for this review. In June 2007, Sovereign and Isban entered into an agreement whereby Isban will provide Sovereign certain consulting services through December 31, 2008. Sovereign has agreed to pay Isban $2.2 million, excluding expenses for these services.

~~As discussed~~ in ~~Note 12 of our 2007 Form 10-K, Sovereign issued $300 million of senior notes during~~fees in the ~~first quarter of 2007 and Santander was a co-issuer of this issuance. Santander received underwriting fees of $37,500~~corresponding period in ~~connection with this transaction.~~the prior year.

2423

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(13) FAIR VALUE

As discussed in Note 15, “Recent Accounting Pronouncements”, to the Consolidated Financial Statements Sovereign adopted SFAS No. 159 on its residential mortgage loans classified as held for sale that were originated subsequent to January 1, 2008 which allows us to record our mortgage loan held for sale portfolio at fair market value versus the lower of cost or market. Sovereign hedges its residential held for sale portfolio with forward sale agreements which are reported at fair value under SFAS No. 133. We historically did not apply hedge accounting to this loan portfolio because of the complexity of these accounting provisions. Under our historical lower of cost or market accounting treatment, we were unable to record the excess of our fair market value over book value but were required to record the corresponding reduction in value on our hedges. Under SFAS No. 159, both the loans and related hedges are carried at fair value which reduces earnings volatility as the amounts more closely offset, particularly in environments when interest rates are declining.

Sovereign’s residential loan held for sale portfolio had an aggregate fair value of $313.2 million at June 30, 2008. The contractual principal amount of these loans totaled $316.1 million. The difference in fair value compared to principal balance of $2.9 million was recorded in mortgage banking revenues during the six-month period ended June 30, 2008. Substantially all of these loans are current and none are in non-accrual status. Interest income on these loans is credited to interest income as earned. The fair value of these loans is estimated based upon the anticipated exit price for these loans in the secondary market to agency buyers such as Fannie Mae and Freddie Mac. Practically our entire residential loan held for sale portfolio is sold to these two agencies.

The most significant instruments that the Company fair values include investment securities, derivative instruments and loans held for sale. The majority of the securities in the Company’s available for sale portfolios are priced via independent providers, whether those are pricing services or quotations from market-makers in the specific instruments. In obtaining such valuation information from third parties, the Company has evaluated the valuation methodologies used to develop the fair values in order to determine whether such valuations are representative of an exit price in the Company’s principal markets. The Company’s principal markets for its investment securities are the secondary institutional markets with an exit price that is predominantly reflective of bid level pricing in these markets.

Currently, the Company uses derivative instruments to manage its interest rate risk. The valuation of these instruments is determined using widely accepted valuation techniques including discounted cash flow analysis on the expected cash flows of each derivative. This analysis reflects the contractual terms of the derivatives, including the period to maturity, and uses observable market-based inputs.

To comply with the provisions of SFAS No. 157, the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurement of its derivatives. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of June 30, 2008, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the Company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy. The Company does not have any fair value measurements for derivatives using significant unobservable input (Level 3) as of June 30, 2008.

When estimating the fair value of its loans held for sale portfolio, interest rates and general conditions in the principal markets for the loans are the most significant underlying variables that will drive changes in the fair values of the loans, not borrower-specific credit risk since substantially all of the loans are current.

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

~~(13) FAIR VALUE (continued)~~

The following table presents the assets that are measured at fair value on a recurring basis by level within the fair value hierarchy (see Note 15 for further information on the fair value hierarchy) as reported on the consolidated balance sheet at June 30, 2008. As required by SFAS No. 157, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands).

Fair Value Measurements at Reporting Date Using:
Quoted Prices in
Active Markets for Significant Other Significant Balance at
Identical Assets Observable Inputs Unobservable June 30,
(Level 1) (Level 2) Inputs (Level 3) 2008
Assets:

US Treasury and government agency securities $ — $ 66,296 $ — $ 66,296
Debentures of FHLB, FNMA and FHLMC — 22,331 — 22,331
Corporate debt and asset-backed securities — 53,370 458,040 511,410
Equity securities — 16,586 588,171 604,757
State and municipal securities — 2,417,826 — 2,417,826
Mortgage backed securities — 6,338,223 1,157,341 7,495,564

Total investment securities available for sale — 8,914,632 2,203,552 11,118,184
Loans held for sale — 469,189 — 469,189
Derivatives — (165,711 ) — (165,711 )
Mortgage servicing rights — — 181,129 181,129
Other assets — 44,417 3,448 47,865

Total $ — $ 9,262,527 $ 2,388,129 $ 11,650,656

Sovereign’s Level 3 assets are primarily comprised of CDO’s, FNMA/FHLMC preferred stock and certain non-agency mortgage backed securities. These investments are thinly traded and, in certain instances, Sovereign is the sole investor in these securities. Sovereign receives third party broker quotes for these securities to determine their estimated fair value. These quotes are benchmarked against similar securities that are more actively traded in order to assess the reasonableness of the estimated fair values. The fair market value estimates we assign to these securities assume liquidation in an orderly fashion and not under distressed circumstances. Due to the continued illiquidity and credit risk of certain securities, the market value of these securities is highly sensitive to assumption changes and market volatility.

~~The table below presents the changes in our Level 3 balances since year-end (in thousands).~~

Investments Mortgage
Available Servicing Other
for Sale Rights Assets Total
Balance at December 31, 2007 $ 2,700,513 $ 162,623 $ 7,104 $ 2,870,240
Gains/(losses) in other comprehensive income (382,813 ) — — (382,813 )
Gains/(losses) in earnings (4,381 ) (3,086 ) — (7,467 )
Purchases/Additions 104 42,449 — 42,553
Repayments (109,871 ) — (735 ) (110,606 )
Sales/Amortization — (20,857 ) (2,921 ) (23,778 )

Balance at June 30, 2008 $ 2,203,552 $ 181,129 $ 3,448 $ 2,388,129

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

~~(14) LEGAL CONTINGENCIES~~

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

In January 2008, the Company received a letter from a purported shareholder demanding an investigation into the Board of Director’s oversight of several public disclosures made by the Company from June 2006 through January 2008, contending primarily that the Company inadequately disclosed its exposure to changes in the consumer credit market. The Board, with the assistance of independent counsel, is in the process of analyzing the issues raised in the demand letter.

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

In the first quarter of 2008 a voluntary mediation was held in connection with a claim made against Sovereign related to an investment advisor in Massachusetts who defrauded numerous victims over a long period of time. The fraud reportedly amounted to tens of millions of dollars. The investment advisor’s companies had accounts at Sovereign. The court appointed an ancillary receiver to pursue claims against Sovereign and another bank, and the ancillary receiver filed a complaint against Sovereign. Some of the victims joined in the action as plaintiffs, and some of the claims are putative class action claims. The ancillary receiver recently filed a motion seeking class certification. Little progress was made towards a settlement at the voluntary mediation that was held in the first quarter of 2008 and the trial is currently scheduled to begin in September 2008. The Company believes the claims are without merit and intends to vigorously defend the claims.

~~(15) RECENT ACCOUNTING PRONOUNCEMENTS~~

On January 1, 2008, the Company adopted Statement of Financial Accounting Standards No. 157,~~Fair~~ “Fair Value ~~Measurements~~(“Measurements” (“SFAS No. 157”). SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. SFAS No. 157 applies to reported balances that are required or permitted to be measured at fair value under existing accounting pronouncements; accordingly, the standard does not require any new fair value measurements of reported balances.

SFAS No. 157 emphasizes that fair value is a market-based measurement, not an entity-specific measurement. Therefore, a fair value measurement should be determined based on the assumptions that market participants would use in pricing the asset or liability. As a basis for considering market participant assumptions in fair value measurements, SFAS No. 157 establishes a fair value hierarchy that distinguishes between market participant assumptions based on market data obtained from sources independent of the reporting entity (observable inputs that are classified within Levels 1 and 2 of the hierarchy) and the reporting entity’s own assumptions about market participant assumptions (unobservable inputs classified within Level 3 of the hierarchy).

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

~~(15) RECENT ACCOUNTING PRONOUNCEMENTS (continued)~~

Level 1 inputs utilize quoted prices (unadjusted) in active markets for identical assets or liabilities that the Company has the ability to access. Level 2 inputs are inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. Level 2 inputs may include quoted prices for similar assets and liabilities in active markets, as well as inputs that are observable for the asset or liability (other than quoted prices), such as interest rates, foreign exchange rates, and yield curves that are observable at commonly quoted intervals. Level 3 inputs are unobservable inputs for the asset or liability, which are typically based on an entity’s own assumptions, as there is little, if any, related market activity. In instances where the determination of the fair value measurement is based on inputs from different levels of the fair value hierarchy, the level in the fair value hierarchy within which the entire fair value measurement falls is based on the lowest level input that is significant to the fair value measurement in its entirety. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment and considers factors specific to the asset or liability.

Sovereign’s ~~adoption~~residential loan held for sale portfolio had an aggregate fair value of $1.2 billion at March 31, 2009. The contractual principal amount of these loans totaled $1.2 billion. The difference in fair value compared to the principal balance was $27.7 million which was recorded in mortgage banking revenues during the three-month period ended March 31, 2009. Substantially all of these loans are current and none are in non-accrual status. Interest income on these loans is credited to interest income as earned. The fair value of these loans is estimated based upon the anticipated exit price for these loans in the secondary market to agency buyers such as Fannie Mae and Freddie Mac. Practically our entire residential loans held for sale portfolio is sold to these two agencies.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(13) FAIR VALUE (continued)

To comply with the provisions of SFAS No. 157, ~~did~~the Company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurement of its derivatives. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the Company has considered the impact of netting and any applicable credit enhancements, such as collateral postings and guarantees.

Although the Company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the fair value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2009, the Company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not ~~have~~significant to the overall valuation of its derivatives. As a result, the Company has determined that the majority of its derivative valuations are classified in Level 2 of the fair value hierarchy.

When estimating the fair value of its loans held for sale portfolio, interest rates and general conditions in the principal markets for the loans are the most significant ~~impact~~underlying variables that will drive changes in the fair values of the loans, not borrower-specific credit risk since substantially all of the loans are current.

The following table presents the assets that are measured at fair value on ~~its financial condition or results of operations. See further discussion and analysis of Sovereign’s adoption of~~a recurring basis by level within the fair value hierarchy as reported on the consolidated balance sheet at March 31, 2009. As required by SFAS No. 157, financial assets and liabilities are classified in ~~Note 13.~~their entirety based on the lowest level of input that is significant to the fair value measurement (in thousands).


	Fair Value Measurements at Reporting Date Using:
	Quoted Prices in Active		Significant Other			Significant
	Markets for Identical		Observable Inputs			Unobservable Inputs		Balance at
	Assets (Level 1)		(Level 2)			(Level 3)		March 31, 2009
Assets:
US Treasury and government agency securities	$	—	$	242,681		$	—	$	242,681
Debentures of FHLB, FNMA and FHLMC		—		4,271,230			—		4,271,230
Corporate debt and asset-backed securities		—		52,242			40,206		92,448
Equity securities		—		16,840			10,401		27,241
State and municipal securities		—		1,689,181			—		1,689,181
Mortgage backed securities		—		760,721			1,604,736		2,365,457

Total investment securities available for sale		—		7,032,895			1,655,343		8,688,238
Loans held for sale		—		1,221,216			—		1,221,216
Derivatives		—		(310,632	)		11,969		(298,663	)
Mortgage servicing rights		—		—			111,877		111,877
Other assets		—		26,212			—		26,212

Total	$	—	$	7,969,692		$	1,779,189	$	9,748,881

Sovereign’s Level 3 assets are primarily comprised of FNMA/FHLMC preferred stock and certain non-agency mortgage backed securities. These investments are thinly traded and, in certain instances, Sovereign is the sole investor in these securities. Sovereign evaluates prices from a third party pricing service, third party broker quotes for certain securities and from another independent third party valuation source to determine their estimated fair value. These quotes are benchmarked against similar securities that are more actively traded in order to assess the reasonableness of the estimated fair values. The fair market value estimates we assign to these securities assume liquidation in an orderly fashion and not under distressed circumstances. Due to the continued illiquidity and credit risk of certain securities, the market value of these securities is highly sensitive to assumption changes and market volatility.

The table below presents the changes in our Level 3 balances since year-end (in thousands).


	Investments			Mortgage					Other
	Available for Sale			Servicing Rights			Derivatives		Assets			Total
Balance at December 31, 2008	$	1,190,868		$	127,811		$	8,573		3,474		$	1,330,726
Gains/(losses) in other comprehensive income		10,103			—			—		—			10,103
Gains/(losses) in earnings		(77,211	)		(17,646	)		3,396		—			(91,461	)
Reclassification from Level 2		662,526			—			—		—			662,526
Additions		25			67,448			—		—			67,473
Repayments		(130,968	)		—			—		(3,474	)		(134,442	)
Sales/Amortization		—			(65,736	)		—		—			(65,736	)

Balance at March 31, 2009	$	1,655,343		$	111,877		$	11,969		—		$	1,779,189

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(14) FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents disclosures about the fair value of financial instruments as defined by SFAS No. 107, “Fair Value of Financial Instruments.” These fair values for certain instruments are presented based upon subjective estimates of relevant market conditions at a specific point in time and information about each financial instrument. In ~~February 2007,~~cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. These techniques involve uncertainties resulting in variability in estimates affected by changes in assumptions and risks of the FASB issued Statement No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities — Including an Amendment of FASB Statement No. 115” (“SFAS 159”), which allows entities, at specified election dates, to choose to measure certain financial instruments at a certain point in time. Therefore, the derived fair value estimates presented below for certain instruments cannot be substantiated by comparison to independent markets. In addition, the fair values do not reflect any premium or discount that could result from offering for sale at one time an entity’s entire holdings of a particular financial instrument nor does it reflect potential taxes and the expenses that would be incurred in an actual sale or settlement.

Accordingly, the aggregate fair value amounts presented below do not represent the underlying value to Sovereign (in thousands):


	March 31, 2009						December 31, 2008
	Carrying						Carrying
	Value			Fair Value			Value			Fair Value

Financial Assets:
Cash and amounts due from depository institutions	$	6,153,885		$	6,153,885		$	3,754,523		$	3,754,523
Investment securities:
Available for sale		8,688,238			8,688,238			9,301,339			9,301,339
Other investments		705,690			705,690			718,711			718,711
Loans held for investment, net		52,379,183			49,972,717			54,439,146			51,832,061
Loans held for sale		1,221,216			1,221,216			327,332			327,332
Mortgage servicing rights		111,877			113,310			127,811			128,558
Mortgage banking forward commitments		(22,002	)		(22,002	)		(9,598	)		(9,598	)
Mortgage interest rate lock commitments		11,969			11,969			8,573			8,573
Financial Liabilities:
Deposits		50,546,927			50,605,988			48,438,573			48,906,511
Borrowings and other debt obligations		18,626,698			18,707,725			20,816,224			21,005,248
Interest rate derivative instruments		288,630			288,630			307,137			307,137
Precious metal forward sale agreements		(2,595	)		(2,595	)		(1,227	)		(1,227	)
Precious metal forward settlement arrangements		2,595			2,595			1,227			1,227
Unrecognized Financial Instruments:⁽¹⁾
Commitments to extend credit		105,106			105,022			113,175			113,085


(1)		The amounts shown under “carrying value” represent accruals or deferred income arising from those unrecognized financial instruments.

The following methods and assumptions were used to estimate the fair value of each class of financial instruments:

Cash and amounts due from depository institutions and interest-earning deposits. For these short-term instruments, the carrying amount equals the fair value.

Investment securities available for sale. Generally, the fair value of investment securities available for sale are based on a third party pricing service which utilizes matrix pricing on securities that actively trade in the marketplace. For investment securities that do not actively trade in the marketplace, (primarily our preferred stock in FNMA and FHLMC) fair value is obtained from third party broker quotes. For certain non-agency mortgage backed securities, Sovereign evaluates prices from a third party pricing service, third party broker quotes for certain securities and from another independent third party valuation source to determine their estimated fair value. These quotes are benchmarked against similar securities that are more actively traded in order to assess the reasonableness of the estimated fair values. The fair market value estimates we assign to these securities assume liquidation in an orderly fashion and not ~~currently required~~under distressed circumstances. In accordance with SFAS No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” changes in fair value are reflected in the carrying value of the asset and are shown as a separate component of stockholders’ equity.

Loans. Fair value is estimated by discounting cash flows using estimated market discount rates at which similar loans would be made to ~~be measured at fair value.~~borrowers and reflect similar credit ratings and interest rate risk for the same remaining maturities.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(14) FAIR VALUE OF FINANCIAL INSTRUMENTS (continued)

Mortgage servicing rights. The fair value ~~option~~of mortgage servicing rights is ~~applied~~estimated using internal cash flow models. For additional discussion see Note 9.

Mortgage interest rate lock commitments. Fair value is estimated based on ~~an instrument-by-instrument basis, is irrevocable and can only be applied to an entire instrument and not to specified risks, specific~~a net present value analysis of the anticipated cash flows ~~or portions of that instrument. Unrealized gains and losses on items for which~~associated with the rate lock commitments.

Deposits. The fair value ~~option has been elected will be reported in earnings at each subsequent reporting date~~of deposits with no stated maturity, such as non-interest bearing demand deposits, NOW accounts, savings accounts and ~~upfront~~certain money market accounts, is equal to the amount payable on demand as of the balance sheet date. The fair value of fixed-maturity certificates of deposit is estimated by discounting cash flows using currently offered rates for deposits of similar remaining maturities.

Borrowings and other debt obligations. Fair value is estimated by discounting cash flows using rates currently available to Sovereign for other borrowings with similar terms and remaining maturities. Certain other debt obligations instruments are valued using available market quotes.

Commitments to extend credit. The fair value of commitments to extend credit is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and ~~costs related~~the present creditworthiness of the counter parties. For fixed rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

Precious metals customer forward settlement arrangements and precious metals forward sale agreements. The fair value of these contracts is based on the price of the metals based on published sources, taking into account when appropriate, the current credit worthiness of the counterparties.

Interest rate derivative instruments. The fair value of interest rate swaps, caps and floors that represent the estimated amount Sovereign would receive or pay to ~~those items will be recognized in earnings as incurred~~terminate the contracts or agreements, taking into account current interest rates and not deferred. SFAS No. 159 is effective in fiscal years beginning after November 15, 2007 and may not be applied retrospectively. Effective January 1, 2008, Sovereign adopted SFAS No. 159 on residential mortgage loans classified as held for sale that were originated subsequent to January 1, 2008. See further discussion and analysiswhen appropriate, the current creditworthiness of ~~Sovereign’s adoption of this standard at Note 13.~~the counterparties are obtained from dealer quotes.

(15) RECENT ACCOUNTING PRONOUNCEMENTS

In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations” (“SFAS 141R”). The new pronouncement requires the acquiring entity in a business combination to recognize only the assets acquired and liabilities assumed in a transaction (for example, acquisition costs must be expensed when incurred), establishes the fair value at the date of acquisition as the initial measurement for all assets acquired and liabilities assumed, including contingent consideration, and requires expanded ~~disclosures,~~disclosures. SFAS 141(R) ~~will be~~is effective for fiscal years beginning after December 15, 2008. Early adoption iswas prohibited. As discussed in Note 2, Sovereign ~~does not expect the adoption~~has continued to apply its historical basis of accounting in these stand-alone financial statements after being acquired by Santander. Therefore this pronouncement ~~to have a material impact to its financial statements.~~

In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements and Amendment of ARB No. 51” (“SFAS No. 160”). The new pronouncement requires all entities to report noncontrolling (minority) interests in subsidiaries as a component of shareholders’ equity. SFAS No. 160 will be effective for fiscal years beginning after December 15, 2008. Early adoption is prohibited. Management does not anticipate that this statement will have a materialhad no impact on Sovereign’s financial ~~condition and results of operations.~~statements.

In March 2008, the FASB issued SFAS No. 161,~~“Disclosures~~ “Disclosures about Derivative Instruments and Hedging ~~Activities-an~~Activities—an amendment of FASB Statement No. ~~133~~(“133” (“SFAS 161”), which requires enhanced disclosures about an entity’s derivative and hedging activities intended to improve the transparency of financial reporting. Under SFAS 161, entities will be required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations and (c) how derivative instruments and related hedged items affect an entity’s financial ~~position, financial performance and cash flows.~~statements. SFAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008, with early application encouraged. Sovereign ~~will adopt~~adopted SFAS 161 effective January 1, ~~2009.~~2009, and the disclosures required by this pronouncement are included in Note 7.

In April 2009, the FASB issued three final Staff Positions (FSPs) intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” (FSP FAS 115-2 and FAS 124-2), FSP FAS 107-1 and ABP 28-1, “Interim Disclosures about Fair Value of Financial Instruments” (FSP FAS 107-1 and ABP 28-1), and FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions that are not Orderly” (FSP FAS 157-4).

2827

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED ~~FINANCIAL~~FINIANCIAL STATEMENTS

(dollars in thousands, expect per share amounts)

(Unaudited)

(15) RECENT ACCOUNTING PRONOUNCEMENTS (continued)

FSP FAS 115-2 and FAS 124-2, is intended to bring greater consistency to the timing of impairment recognition, and provide greater clarity to investors about the credit and noncredit components of impaired debt securities that are not expected to be sold. The measure of impairment in comprehensive income remains at fair value. The FSP also requires increased and more timely disclosures sought by investors regarding expected cash flows, credit losses, and an aging of securities with unrealized losses. Sovereign elected to early adopt this FSP and the impact of its adoption and the disclosures required by the FSP are contained in Note 3.

FSP FAS 107-1 and ABP 28-1, relates to fair value disclosures for any financial instruments that are not currently reflected on the balance sheet of companies at fair value. Prior to issuing this FSP, fair values for these assets and liabilities were only disclosed once a year. The FSP now requires these disclosures on a quarterly basis, providing qualitative and quantative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value. The disclosures required by this statement are contained in Note 14.

Finally FSP FAS 157-4, relates to determining fair values when there is no active market or where the price inputs being used represent distressed sales. It reaffirms what Statement 157 states is the objective of fair value measurement which is to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) at the date of the financial statements under current market conditions. Specifically, it reaffirms the need to use judgment to ascertain if a formerly active market has become inactive and in determining fair values when markets have become inactive. The adoption of this statement had no impact on Sovereign’s financial position or results from operations.

(16) MERGER, RESTRUCTURING AND OTHER CHARGES, NET

In connection with the Santander transaction, Sovereign recorded charges against its earnings for the three-month period ending March 31, 2009 for merger, restructuring and other expenses of $233.3 million pre-tax, which were comprised of the following (in thousands):


Severance	$	72,694
Debt extinguishment		68,733
Restricted stock acceleration charges		45,037
Miscellaneous deal costs and other		46,844

Transaction related and integration charges	$	233,308

The status of the reserves related to merger, restructuring and other expenses is summarized as follows:


	Severance			Other			Total
Reserve balance at December 31, 2008	$	17,416		$	23,229		$	40,645
Charge recorded in earnings		72,694			42,693			115,387
Payments		(63,960	)		(38,281	)		(102,241	)

Reserve balance at March 31, 2009	$	26,150		$	27,641		$	53,791

(17) SUBSEQUENT EVENT

In late ~~July 2008,~~April, Sovereign announced a ~~syndicated loan~~reduction in force that will result in the ~~commercial loan portfolio declared bankruptcy. It appears~~elimination of approximately 830 full time positions in order to streamline operations and improve the ~~entity may have engaged~~Company’s profitability. As a result of this action, Sovereign expects to record a severance charge of approximately $57.2 million in ~~some high-risk business practices which caused a sudden liquidity crisis and ultimately led to~~its statement of operations for the bankruptcy. Sovereign’s total exposure to this entity is approximately $73 million. Sovereign’s exposure is collateralized by accounts receivable, inventory, and fixed assets. The Company is in the process of gathering more facts about this situation and is working with the lead bank and our consultants to determine the appropriate course of action to mitigate any potential losses. Accordingly, at this point the loss severity, if any, on this loan cannot be determined. However, to the extent that this matter is not resolved favorably, Sovereign’s third quarter results could include a significant charge-off related to this one loan.three-month period ended June 30, 2009.

2928

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 $78 billion financial institution as of March 31, 2009, 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.~~Maryland. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources ~~including:~~including deposit and loan services, sales of ~~residential, home equity, and multi-family~~ loans and investment securities, capital markets products ~~cash management products,~~ and ~~bank owned~~bank-owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and ~~facility related~~facility-related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by ~~various factors including~~ the economic environment, ~~and its affect on~~including interest rates, consumer and business confidence and spending, as well as the competitive conditions within our geographic footprint. On January 30, 2009, Sovereign was acquired by Banco Santander, N.A. (“Santander”). We believe that the acquisition of the Company by Santander will further strengthen our financial position and enable us to continue to execute our strategy of focusing on our core retail and commercial customers in our geographic footprint.

Our customers select Sovereign for banking and other financial services based on our ability to assist customers by understanding and anticipating their individual financial needs and providing customized solutions. Our major strengths include a strong franchise value in terms of market share and demographics and diversified loan portfolio and products. Our weaknesses have included operating returns and capital ratios that are lower than certain of our peers. We have also not achieved our growth targets with respect to low cost core deposits.

~~We took proactive steps during~~Following the ~~second quarter of 2008~~acquisition by Santander, Sovereign is focused on four objectives:

	1)		stabilizing our financial condition with respect to liquidity and capital;

	2)		improving risk management and collections;

	3)		improving our margins and efficiency; and

	4)		reorganizing to align to Santander business models with a strong commercial focus.

In order to ~~improve our~~enhance the Company’s capital position, on March 25, 2009, Sovereign issued 72,000 shares of preferred stock to Santander to raise proceeds of $1.8 billion. The preferred stock pays non-cumulative dividends of 10% per year. Each share of preferred stock is convertible into 100 shares of Sovereign common stock. Sovereign contributed the proceeds from this issuance to Sovereign Bank in order to strengthen the Bank’s regulatory capital ratios.

As discussed in Note 3 and 15, on April 9, 2009, the Financial Accounting Standards Board (FASB) issued three final staff positions (“FSPs”) intended to provide additional application guidance and enhance disclosures regarding fair value measurements and impairments of securities. FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments” were adopted by ~~raising $1.4 billion~~the Company for the quarter ended March 31, 2009. Upon adoption, a cumulative effect adjustment was recorded in the amount of ~~common~~$246.1 million to increase retained earnings. The adjustment also increased other comprehensive losses by $157.9 million with the remaining difference reducing our valuation allowance on deferred taxes. The increase to retained earnings represented the non-credit related impairment charge related to the non-agency mortgage backed securities discussed above. Since losses within other comprehensive income on debt securities are added back to equity ~~and $500 million of subordinated debt at~~for regulatory capital calculations, this rule had a positive impact on Sovereign ~~Bank.~~Bank’s capital ratios. As a result of the ~~capital raise, net income~~preferred stock issuance and the impact of ~~$127.4 million in~~ the ~~second quarter, and a reduction in the size of our balance sheet by $2.7 billion,~~accounting change our capital ratios ~~improved significantly~~increased since year-end even though Sovereign reported a net loss of $817 million during the ~~second quarter. Tangible Common Equity to Tangible Assets and~~three month period ended March 31, 2009.

Our Tier 1 ~~Leverage~~leverage for ~~the Parent Company increased~~Sovereign Bancorp was 7.28% at ~~June 30, 2008~~March 31, 2009 compared to ~~6.04% and 8.34% from 3.81% and 6.21%~~5.73% at ~~March~~December 31, 2008, respectively. The Bank’s total risk based capital ratio ~~increased~~was 12.43% compared to ~~11.41% from~~10.20% at December 31, 2008 and 10.24%~~. These~~ a year ago. Our capital levels and ratios are ~~now in line with our peers and significantly~~ in excess of the levels required to be considered well-capitalized. ~~We have also reduced wholesale funding sources, improved our operating metrics and increased our tangible book value per share over the past two quarters.~~ We continue to strengthen our balance sheet and position the Company for any further weakening in economic ~~conditions.~~conditions by increasing the amount of loan loss reserves on our balance sheet. Reserves for credit losses as a percentage of total loans have increased to 2.76% at March 31, 2009 from 2.10% at December 31, 2008.

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

In the fourth quarter of 2007, we piloted a new retail deposit strategy called “Customer First” in certain markets within our footprint. The goal of Customer First is to increase deposit retention and growth rates and increase the number of products and services our customers maintain and use at Sovereign. Customer First, which is a sales model/methodology that drives consistent team member behavior in each of our 750 community banking offices, was implemented throughout our entire branch network in the first quarter of ~~2008. We are seeing improved productivity within retail banking~~2009, Sovereign formed a new management team which is comprised of several executives from Santander and ~~improved deposit retention. Additionally,~~certain legacy Sovereign executives. The new management team is in the ~~first quarter~~process of ~~2008, Sovereign hired a senior level executive who reports~~reviewing Sovereign’s operating procedures and cost structure. We plan on making certain pricing changes to our ~~Chief Executive Officer~~loan and deposit portfolios, as well as an increased focus on cost controls to ~~lead~~improve the Company’s ~~Retail Banking Division. We believe these two steps helped stabilize our deposit base thus far in 2008, as average retail~~profitability.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents a ~~substantial~~significant portion of the Company’s revenues. Accordingly, the interest rate environment has a substantial impact on Sovereign’s earnings. Sovereign currently ~~has~~is in a mildly liability sensitive interest rate risk position. ~~Sovereign restructured its balance sheet and sold approximately $8.0 billion~~During the first quarter of low margin and/or high credit risk assets in early 2007. We utilized the proceeds to pay off higher cost borrowings. The impact of this balance sheet restructuring and our liability sensitive interest rate position helped increase2009, our net interest margin ~~during~~decreased to 1.96% from 2.84% in the ~~second~~first quarter of ~~2008 to 3.06% from 2.88%~~2008. Our net interest margin has been impacted by decreases in interest rates which resulted in the ~~first~~yields decreasing on our variable rate commercial loans. However our funding costs have not decreased by a similar amount due to the growth in fixed rate time deposits and money market accounts that we experienced in the fourth quarter of 2008. Net interest margin in future periods will be impacted by several factors such as but not limited to, our ability to grow and retain core deposits, the future interest rate environment, ~~and~~ loan and investment prepayment ~~rates.~~rates, and changes in non-accrual loans. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

The credit quality of our loan portfolio has a significant impact on our operating results. We have experienced asignificant deterioration in certain key credit quality performance indicators ~~that began~~in recent periods which has continued in the ~~second half of 2007 that has continued through the~~ first ~~half of 2008 which has resulted in higher levels of charge-offs and provision for credit losses. For the second~~ quarter of ~~2008,~~2009. We had charge-offs of $155.7 million during the ~~provision for credit losses and charge-offs were $132.0 million and $86.9 million, respectively,~~three months ended March 31, 2009 compared to ~~$51.0~~$74.3 million and $25.7 million in the second quarter of 2007, respectively. Our provision for credit losses and charge-offs for the six-month period ended June 30, 2008 were $267.0 million and $161.2 million compared to $97.0 million and $49.8 million, respectively, forduring the corresponding period in the prior year. ~~These negative trends persist throughout~~Our provision for credit losses was $505.0 million during the ~~majority of our loan portfolios. As of June 30, 2008 total non-performing loans were $490.5 million or 0.85% of total loans~~three months ended March 31, 2009 compared to ~~$291.5~~$135.0 million ~~or 0.52% at June 30, 2007.~~during the corresponding period in the prior year. The ~~increase in non-performing loans was primarily~~increases were driven by deterioration in our ~~residential Alt-A, commercial real estate, multi-family~~consumer and commercial ~~and industrial loan~~ portfolios.

During 2007, Sovereign expanded its indirect auto loan portfolio into the Southeastern and Southwestern United States (“out-of-market loans”). Sovereign originated $2.8 billion of out-of-market loans in 2007 at a weighted average yield of 8.04%. ~~However, credit losses were higher than our expectations for those new originations.~~ Effective January 31, 2008, Sovereign ceased originating new auto loans from these markets. We also strengthened our underwriting standards in the second half of 2007 on our entire auto loan portfolio. ~~We believe these two decisions will lower loss rates in future periods; however,~~However, losses remained elevated ~~thus far~~on these portfolios in 2008 as the newly originated loans continue to ~~season. Losses~~season and the US economy entered into a recession. Sovereign decided to exit its in ~~2008 have been~~footprint indirect auto portfolio and ceased originating these loans in ~~line with~~January 2009. For the three-month period ended March 31, 2009, net losses on our ~~forecast; however,~~auto loan portfolio were $47.1 million compared to $42.8 million for the three months ending March 31, 2008. Continued deterioration in the economy of the regions where we extended these loans could have a significant adverse impact on the amount of credit losses we experience in future periods. ~~The remaining balance of~~At March 31, 2009, our total auto ~~out-of-market~~ loan portfolio ~~at June 30, 2008~~ was ~~$2.2~~$4.9 billion ~~with reserves~~of which $1.7 billion consisted of loans originated in the Southeast and Southwest production offices. At March 31, 2009 our total allowance for ~~credit~~loan losses ~~of $86.1~~for the auto portfolio was $167.9 million.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

~~As discussed previously, conditions~~Conditions in the housing market have significantly impacted areas of our business. Certain segments of our consumer and commercial loan portfolios have exposure to the housing market. Sovereign ~~has~~had residential real estate loans totaling $11.9 billion at ~~June 30, 2008~~March 31, 2009 of which ~~$2.8~~$2.6 billion is comprised of Alt-A (also known as limited documentation) residential loans. Although losses have been increasing since the ~~prior year,~~first quarter of 2008, actual credit losses on these loans have been modest and totaled ~~$4.6 million and $9.5~~$5.7 million during the three-month period ~~and six-month period~~ ended ~~June 30, 2008~~March 31, 2009 compared to ~~$1.6 million and~~ $2.1 million for the corresponding ~~periods~~period in the prior year. However, non-performing assets and past due loans have been increasing particularly for the Alt-A portion of the residential portfolio. The increased loss experience and asset quality trends led us to increase our ~~reserves~~allowances for our residential ~~portfolio over the past three quarters.~~portfolio. Future ~~losses in~~performance of our residential loan portfolio will continue to be significantly influenced by home prices in the residential real estate market, unemployment and general economic conditions. Sovereign holds allowances of $99.2 million on its residential loan portfolio.

The homebuilder industry also has been impacted by a decline in new home sales and a reduction in the value of residential real estate which has decreased the profitability and liquidity of these companies. Declines in real estate prices have been the most pronounced in certain states where previous increases were the largest, such as California, Florida and Nevada. Additionally, foreclosures have increased sharply in various other areas due to increasing levels of unemployment. Sovereign provided financing to various homebuilder companies which is included in our commercial loan portfolio. The Company has been working on de-emphasizing this loan portfolio which has resulted in it declining to $0.8 billion at March 31, 2009 compared to $1.0 billion a year ago. Approximately eighty five percent of these loans at March 31, 2009 are to builders in our geographic footprint which generally have had more stable economic conditions on a relative basis compared to the national economy. We continue to monitor this portfolio in future periods given recent market conditions and determine the impact, if any, on the allowance for loan losses related to these homebuilder loans.

Sovereign also has ~~$6.1~~$6.5 billion of home equity loans and lines of credit (excluding our correspondent home equity loans). Net charge-offs on these loans for the three-month ~~and six-month periods~~period ended ~~June 30, 2008 were $4.4~~March 31, 2009 was $9.9 million ~~and $9.8 million, respectively,~~ compared ~~with $1.9 million and $3.5~~to $5.4 million for the corresponding ~~periods~~period in the prior year. This portfolio consists of loans with an average FICO at origination of ~~714~~777 and an average loan to value of ~~66%~~57.8%. We have total ~~reserves~~allowances of ~~$32.2~~$72.7 million for this loan portfolio at ~~June 30, 2008.~~March 31, 2009.

~~During the first half of 2008, we~~We have continued to experience increases in non-performing assets in our commercial lending, ~~and~~ commercial real estate ~~portfolios.~~and multifamily loan portfolios as a result of worsening credit and economic conditions. Non-performing assets for these portfolios increased to ~~$129.7~~$443.2 million, $556.6 million and ~~$117.3~~$139.4 million at ~~June 30, 2008~~March 31, 2009 from ~~$85.4~~$244.8 million, $319.6 million and ~~$61.8~~$42.8 million at December 31, ~~2007.~~2008. Net charge-offs on these portfolios for the three month period ended March 31, 2009 were $72.6 million, $5.6 million and $2.7 million compared to $11.8 million, $3.3 million and $0 for the corresponding period in the prior year. Given these changes, we increased our allowance for loan losses for these portfolios by approximately ~~$93.7~~$34.9 million, $81.2 million and $43.6 million during the first ~~half~~quarter of 2008. This increase was a significant component of our provision for credit losses of $132.0 million and $267.0 million for the three-month and six-month periods ended June 30, 2008. A large portion of these increases is tied to companies that are in housing related industries.2009. We ~~have decreased the amount of loan originations to these borrower types in 2008; however, we~~ expect that the difficult housing environment as well as deteriorating economic conditions will continue to impact our commercial lending and commercial real estate portfolios which may result in elevated levels of provisions for credit losses in future periods.

RESULTS OF OPERATIONS

General

Net (loss)/income was ~~$127.4~~$(817.3) million ~~or $0.22 per diluted share, and $227.6 million, or $0.42 per diluted share,~~ for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 as compared to ~~$147.5~~$100.1 million ~~or $0.29 per diluted share, and $195.5 million, or $0.39 per diluted share~~ for the three-month ~~and six-month periods~~period ended ~~June 30, 2007. Net income in 2007 included charges~~March 31, 2008. Results for the first quarter of ~~$216.0 million ($140.4 million after-tax or $0.27 per diluted share) related to our 2007 balance sheet restructuring and an expense saving initiative. Current year results~~2009 include ~~an elevated~~a higher provision for credit losses compared with the corresponding periods in the prior year due to the slowing economic conditions and the deterioration in most categories of our loan portfolios as discussed above. The provision for credit losses has increased to ~~$132.0 million and $267.0~~$505.0 million in the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to ~~$51.0 million and $97.0~~$135.0 million for the three-month period ended March 31, 2008.

In connection with the transaction with Santander, Sovereign incurred merger-related and ~~six-month periods ended June 30, 2007 due~~restructuring charges of $233.3 million. The majority of these costs related to change in control payments to certain executives and severance charges of $72.7 million, debt extinguishment charges of $68.7 million as well as restricted stock acceleration charges of $45.0 million. The Company also incurred fees of approximately $26 million to third parties to successfully close the transaction.

Subsequent to the ~~impact~~acquisition, the Company decided to prepay $1.4 billion of ~~the slowing economy~~higher cost FHLB advances to lower funding costs in future periods and ~~the deterioration~~as a result incurred a debt extinguishment charge of ~~credit quality in~~$68.7 million. First quarter 2009 results also included investment security impairment charges of $79.7 million on our ~~loan portfolios.~~FNMA/FHLMC preferred stock portfolio and certain non-agency mortgage backed securities. See Note 3 for further details. Additionally, non-interest income was impacted by mortgage banking losses of $44.8 million as a result of servicing right impairment charges of $17.6 million as well as a $48.1 million charge to increase our recourse reserves associated with sales of multi-family loans to Fannie Mae.

3231

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
~~SIX-MONTH~~THREE-MONTH PERIOD ENDED ~~JUNE 30,~~MARCH 31, 2009 AND 2008 ~~AND 2007~~
(in thousands)


	2008								2007								2009								2008
				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	$	12,571,679		$	384,816		6.13	%	$	14,605,167		$	446,257		6.12	%	$	12,086,998		$	100,468		3.33	%	$	13,034,150		$	200,922		6.17	%
LOANS:
Commercial loans		27,461,417			810,910		5.93	%		25,037,502			896,922		7.21	%		27,043,054			287,516		4.30	%		27,108,494			422,410		6.26	%
Multi-Family		4,411,480			132,892		6.03	%		5,260,766			170,970		6.51	%		4,538,867			63,946		5.66	%		4,316,489			65,907		6.12	%
Consumer loans
Residential mortgages		12,935,327			366,113		5.66	%		15,007,930			426,604		5.69	%		11,569,054			155,961		5.39	%		13,272,189			187,088		5.64	%
Home equity loans and lines of credit		6,303,688			184,741		5.89	%		7,705,765			267,154		6.98	%		6,919,015			78,508		4.60	%		6,217,574			96,072		6.21	%

Total consumer loans secured by real estate		19,239,015			550,854		5.74	%		22,713,695			693,758		6.13	%		18,488,069			234,469		5.10	%		19,489,763			283,160		5.82	%

Auto loans		6,767,900			234,243		6.96	%		5,558,312			189,007		6.86	%		5,198,255			88,065		6.87	%		7,170,696			121,196		6.80	%
Other		310,151			11,996		7.78	%		405,150			17,114		8.52	%		288,580			5,268		7.40	%		314,006			6,404		8.20	%

Total consumer		26,317,066			797,093		6.08	%		28,677,157			899,879		6.30	%		23,974,904			327,802		5.51	%		26,974,465			410,760		6.11	%

Total loans		58,189,963			1,740,895		6.00	%		58,975,425			1,967,771		6.71	%		55,556,825			679,264		4.93	%		58,399,448			899,077		6.18	%
Allowance for loan losses		(753,763	)		—		—			(484,122	)		—		—			(1,144,164	)		—		—			(721,543	)		—		—

NET LOANS		57,436,200			1,740,895		6.08	%		58,491,303			1,967,771		6.76	%		54,412,661			679,264		5.04	%		57,677,905			899,077		6.26	%

TOTAL EARNING ASSETS		70,007,879			2,125,711		6.09	%		73,096,470			2,414,028		6.63	%		66,499,659			779,732		4.72	%		70,712,055			1,099,999		6.24	%
Other assets		10,358,340			—		—			11,665,137			—		—			9,678,640			—		—			10,218,633			—		—

TOTAL ASSETS	$	80,366,219		$	2,125,711		5.31	%	$	84,761,607		$	2,414,028		5.72	%	$	76,178,299		$	779,732		4.12	%	$	80,930,688		$	1,099,999		5.45	%


FUNDING LIABILITIES
Deposits and other customer related accounts:
Retail and commercial deposits	$	31,977,082		$	420,002		2.64	%	$	31,013,559		$	460,616		3.00	%	$	33,356,324		$	181,560		2.21	%	$	32,028,952		$	236,454		2.97	%
Wholesale deposits		3,583,218			49,035		2.75	%		7,850,548			212,361		5.45	%		5,021,043			26,563		2.15	%		3,891,442			32,597		3.37	%
Government deposits		3,538,526			49,870		2.83	%		3,830,241			97,401		5.13	%		2,557,925			6,640		1.05	%		3,819,399			30,337		3.19	%
Customer repurchase agreements		2,655,607			24,742		1.87	%		2,326,334			52,489		4.55	%		1,648,713			1,635		0.40	%		2,739,973			15,715		2.31	%

TOTAL DEPOSITS		41,754,433			543,649		2.62	%		45,020,682			822,867		3.69	%		42,584,005			216,398		2.06	%		42,479,766			315,103		2.98	%

BORROWED FUNDS:
FHLB advances		18,307,665			419,306		4.59	%		16,155,849			404,590		5.03	%		12,122,630			160,489		5.33	%		18,685,052			214,819		4.61	%
Fed funds and repurchase agreements		1,131,420			16,125		2.87	%		1,451,213			38,748		5.38	%		1,379,056			1,389		0.41	%		1,131,202			9,417		3.35	%
Other borrowings		3,710,284			110,599		5.97	%		5,318,968			159,332		6.00	%		5,629,247			77,918		5.55	%		3,772,220			59,860		6.36	%

TOTAL BORROWED FUNDS		23,149,369			546,030		4.73	%		22,926,030			602,670		5.28	%		19,130,933			239,796		5.04	%		23,588,474			284,096		4.83	%

TOTAL FUNDING LIABILITIES		64,903,802			1,089,679		3.37	%		67,946,712			1,425,537		4.22	%		61,714,938			456,194		2.98	%		66,068,240			599,199		3.64	%
Demand deposit accounts		6,537,456			—		—			6,378,845			—		—			6,399,968			—		—			6,342,945			—		—
Other liabilities		1,657,959			—		—			1,660,284			—		—			2,400,130			—		—			1,575,453			—		—

TOTAL LIABILITIES		73,099,217			1,089,679		2.99	%		75,985,841			1,425,537		3.78	%		70,515,036			456,194		2.61	%		73,986,638			599,199		3.25	%
STOCKHOLDERS’ EQUITY		7,267,002			—		—			8,775,766			—		—			5,663,263			—		—			6,944,050			—		—

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	80,366,219			1,089,679		2.72	%	$	84,761,607			1,425,537		3.39	%	$	76,178,299			456,194		2.42	%	$	80,930,688			599,199		2.97	%

NET INTEREST INCOME				$	1,036,032							$	988,491							$	323,538							$	500,800

NET INTEREST SPREAD (1)							2.72	%							2.41	%							1.74	%							2.60	%


NET INTEREST MARGIN (2)							2.97	%							2.71	%							1.96	%							2.84	%

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 six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 was ~~$506.1 million and $988.3~~$309.1 million compared to ~~$453.4 million and $941.2~~$477.0 million for the same ~~periods~~period in ~~2007.~~2008. The ~~increase~~decrease in net interest income was due to ~~an increase~~a decline in net interest margin for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 to ~~3.06% and 2.97%,~~1.96% compared to the corresponding ~~periods~~period in the prior year of ~~2.71% and 2.71%~~2.84%. The reason for the ~~increase~~decrease has been due to the recent steepening of the yield curve, the balance sheet restructuring we executed in the first quarter of 2007 and reductions in short-term interest rates which has benefited us given our mildly liability sensitive interest rate position. Partially offsetting this positive impact in net interest income was a decrease in average interest earning assets to $69.5 billion and $70.0 billion for the three-month and six-month periods ending June 30, 2008 compared to $70.3 billion and $73.1 billion for the three-month and six-month periods ending June 30, 2007 as a result of the sale of $3.4 billion, $2.9 billion and $1.2 billion of correspondent home equity, residential mortgage loans and multi-family loans, respectively, in connection with our balance sheetan investment restructuring in the ~~first~~third quarter of ~~2007. Although we have reduced~~2008, a rise in non-performing assets, and the elimination of dividends received on our ~~exposure to these loan categories, Sovereign~~FNMA/FHLMC preferred stock and FHLB stock. Additionally, recent deposit growth has been ~~focused on generating commercial loan growth within~~in higher cost CD and money market categories. Management expects to reprice its ~~geographic footprint~~money market portfolio and its higher cost CDs will mature over the next several quarters which ~~has led to an increase of approximately $2.4 billion of average commercial loans.~~should help improve the Company’s net interest margin.

Interest on investment securities and interest earning deposits was ~~$163.8 million and $344.7~~$89.6 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$195.6 million and $405.9~~$180.9 million for the same ~~periods~~period in ~~2007.~~2008. The average balance of investment securities was ~~$12.6~~$12.1 billion with an average tax equivalent yield of ~~6.13%~~3.33% for the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 compared to an average balance of ~~$14.6~~$13.0 billion with an average yield of ~~6.12%~~6.17% for the same period in ~~2007.~~2008. The ~~decrease~~elimination of dividends by the FHFA on our Fannie Mae and Freddie Mac perpetual preferred stock and on FHLB stock has negatively impacted investment yields. Additionally, during the third quarter of 2008, we shortened the duration of our investment portfolio in ~~average balances was due~~order to mitigate the ~~2007~~impact of interest rate changes on the market value of our balance ~~sheet restructuring.~~sheet. Sovereign sold $4.2 billion of longer duration mortgage backed securities and $0.5 billion of longer duration municipal securities for a gain of $29.5 million. We reinvested $3.5 billion of these securities in shorter duration agency securities.

Interest on loans was ~~$838.0~~$675.7 million ~~and $1.7 billion~~ for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$943.9~~$895.3 million ~~and $2.0 billion~~ for the three-month ~~and six-month periods~~period in ~~2007.~~2008. The average balance of loans was ~~$58.2~~$55.6 billion with an average yield of ~~6.00%~~4.93% for the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 compared to an average balance of ~~$59.0~~$58.4 billion with an average yield of ~~6.71%~~6.18% for the same period in ~~2007. Average balances of commercial loans in 2008 increased $2.4 billion as compared to 2007, primarily due to strong organic growth in our commercial loan portfolio.~~2008. Commercial loan yields have decreased ~~128~~196 basis points due to the decline in short-term interest rates which has decreased the yields on our variable rate loan products. Average residential mortgages decreased ~~$2.1~~$1.7 billion due to ~~the sale~~our desire to sell more production to lower our on balance sheet portfolio. Average balances of ~~$2.9~~auto loans decreased to $5.2 billion ~~of residential loans~~from $7.2 billion due to our decision to cease originating this loan product in ~~the first quarter of 2007. Average home equity loans and lines of credit decreased $1.4 billion from~~ the prior year due to the sale of $3.4 billion of correspondent home equity loans in connection with the previously mentioned balance sheet restructuring at the end of the first quarter of 2007. Average multi-family loans decreased $0.8 billion from the prior year due to the sale of $1.3 billion of multi-family loans in the first quarter of 2007. Average balances of auto loans increased to $6.8 billion from $5.6 billion due to organic in-market growth and a decision towards the middle of 2006 to expand out-of-market loans. However, as previously discussed, losses on these loans have been higher than our expectations and effective January 31, 2008, management ceased originating loans from these channels. This has led to a reduction of average auto loans in the second quarter of 2008 as this portfolio declined to $6.6 billion for the three-month period ended June 30, 2008 compared to $7.0 billion for the three-month period ended March 31, 2008.anticipated credit losses.

Interest on deposits and related customer accounts was ~~$228.5 million and $543.6~~$216.4 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$409.6 million and $822.9~~$315.1 million for the same ~~periods~~period in ~~2007.~~2008. The average balance of deposits was ~~$41.8~~$42.6 billion with an average cost of ~~2.62%~~2.06% for the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 compared to an average balance of ~~$45.0~~$42.5 billion with an average cost of ~~3.69%~~2.98% for the same period in ~~2007.~~2008. The average balance of non-interest bearing demand deposits increased from $6.3 billion in 2008 to $6.4 billion in 2007 to $6.5 billion in 2008. The decrease in average cost is due primarily to decreases in costlier wholesale deposit categories due to our 2007 balance sheet restructuring and a de-emphasis on wholesale financings as well as a reduction in short-term interest rates.2009.

Interest on borrowed funds was ~~$267.1 million and $546.0~~$239.8 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$276.4 million and $602.7~~$284.1 million for the same ~~periods~~period in ~~2007.~~2008. The average balance of borrowings was ~~$23.1~~$19.1 billion with an average cost of ~~4.73%~~5.04% for the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 compared to an average balance of ~~$22.9~~$23.6 billion with an average cost of ~~5.28%~~4.83% for the same period in ~~2007.~~2008. The decrease in average cost has been due to a reduction in market interest rates. This benefit has been partially offset by our callable advance borrowings with the FHLB (which is discussed below) as well as, to a lesser extent, the impact of our recent $500 million subordinated debt issuance which has effective yield of 8.92%.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Sovereign currently has a series of callable advances totaling $2.6 billion with the FHLB. These advances provide variable funding (currently at 4.84%) during the non-call period which ranges from 6 to 18 months. The majority of these advances are past their non- call periods. After the non-call period, the interest rates on these advances reset to a fixed rate of interest with certain caps (ranging from 4.95% to 5.50%) and floors of 0%. If these advances are not called by the FHLB, they would mature on various dates ranging from August 2012 to September 2016.

Provision for Credit Losses

The provision for credit losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for credit losses for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 was ~~$132.0 million and $267.0~~$505.0 million, compared to ~~$51.0 million and $97.0~~$135.0 million for the same ~~periods~~period in ~~2007.~~2008. The significant increase in provision for credit losses ~~for~~was driven by an increase in non-accrual loans which increased $1.2 billion from $417.5 million in the ~~six months ended June 30, 2008 includes~~first quarter of 2008. The increase in non-accruals occurred primarily in our residential and commercial loan portfolios.

As a ~~higher level~~result of ~~provision versus 2007 due to several factors as discussed below.~~

~~Sovereign experienced further~~the deterioration in the credit quality of certain commercial loans due to weakening market conditions, particularly those associated with residential construction companies. As a result of an increase in criticized and non-accrual loans and growth of $1.1 billion in our ~~commercial real estate loans and commercial industrial loans,~~loan portfolio, Sovereign has significantly increased ~~the provision~~its reserve levels on its loan portfolios. Our reserve for credit losses ~~in excess~~as a percentage of ~~charge-offs by approximately $93.7 million for our commercial portfolio since year-end.~~total loans has increased to 2.76% from 2.10% at December 31, 2008. Although, we believe current levels of reserves are adequate to cover the inherent losses for these loans, future changes in housing values, interest rates and economic conditions could impact the provision for credit losses for these loans in future periods.

In late July 2008, a syndicated loan in the commercial loan portfolio declared bankruptcy. It appears the entity may have engaged in some high-risk business practices which caused a sudden liquidity crisis and ultimately led to the bankruptcy. Sovereign’s total exposure to this entity is approximately $73 million. Sovereign’s exposure is collateralized by accounts receivable, inventory, and fixed assets. The Company is in the process of gathering more facts about this situation and is working with the lead bank and our consultants to determine the appropriate course of action to mitigate any potential losses. Accordingly, at this point the loss severity, if any, on this loan can not be determined. However, to the extent that this matter is not resolved favorably, Sovereign’s third quarter results could include a significant charge-off related to this one loan.

Weakening credit conditions increased charge-offs for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 to ~~$86.9~~$155.7 million, ~~and $161.2 million, respectively,~~ compared to ~~$25.7~~$74.3 million ~~and $49.8 million, respectively,~~ for the corresponding ~~periods~~period in the prior year. This equates to annualized net loan charge-off to average loan ratios of ~~0.60% and 0.55%~~1.12% for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to ~~0.18% and 0.17%~~0.51% for the comparable ~~periods~~period in the prior year. The majority of the increase was related to our consumer loan portfolio including auto, residential mortgages and home equity loans. Sovereign’s auto charge-offs were $36.6 million and $79.4 million for the three-month and six-month periods ended June 30, 2008 compared to $12.3 million and $22.4 million for the corresponding periods in the prior year. As previously discussed, Sovereign significantly increased its auto loan portfolio, including an expansion of out-of-market loans in 2007. We stopped originating out-of-market loans effective January 31, 2008 due to unsatisfactory loss experience and also strengthened our underwriting standards in the second half of 2007 on our entire auto portfolio. We have also significantly curtailed auto loan originations in our geographic footprint in 2008 as second quarter loan originations totaled $239 million compared to $503 million last quarter, with the average FICO score improving to 745 from 718 a year ago. The decision to reduce origination volumes and exit the out-of-market auto loan portfolio has reduced this portfolio to $6.3 billion at June 30, 2008 compared to $7.0 billion at December 31, 2007.

Correspondent home equity charge-offs were $6.2 million and $10.2 million for the three-month and six-month periods ended June 30, 2008. As discussed in our 2007 Form 10-K, Sovereign ceased originating this loan product in the first quarter of 2006 and made the decision to exit this portfolio in December 2006. Sovereign sold $3.4 billion of the loans in the first quarter of 2007, but decided to retain $658 million due to adverse market conditions. The Company wrote the loans that we retained down to fair value. At June 30, 2008, the remaining balance of the correspondent home equity portfolio was $416.1 million which consisted of $308.2 million of first lien loans and $107.9 million of second lien loans with reserves for future credit losses of $51.2 million.

Although charge-off levels have been elevated on our indirect auto portfolio and our correspondent home equity portfolio, they have been within our expectations. Sovereign significantly increased reserve levels for these portfolios in 2007 in anticipation for losses that were inherent in the portfolio that have since been realized through charge-offs in 2008. We believe our remaining reserve levels are adequate to cover inherent losses in this portfolio; however, further deterioration in the regions of the U.S. economy where these loans were originated could result in additional credit quality deterioration that will require additional provisions for credit losses in future periods.

3533

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Non-performing assets were ~~$553.9 million~~$1.7 billion or ~~0.70%~~2.19% of total assets at ~~June 30, 2008,~~March 31, 2009, compared to ~~$361.6~~$985.4 million or ~~0.43%~~1.28% of total assets at December 31, ~~2007~~2008 and ~~$334.0~~$484.4 million or ~~0.40%~~0.59% of total assets at ~~June 30, 2007.~~March 31, 2008. The ~~reason for the~~ increase since year-end was primarily driven by our residential, ~~Alt-A,~~ commercial real estate, multi-family and commercial and industrial loan portfolios. We factored in these increases when establishing our loan loss reserves at ~~June 30, 2008~~March 31, 2009 and it was one of the factors that caused our provision for credit losses to be elevated over the past few quarters. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance as deemed necessary.

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


	Six-Month Period Ended				Three-Month Period Ended
	June 30,				March 31,
	2008		2007		2009		2008
Allowance for loan losses, beginning of period	$	709,444	$	471,030	$	1,102,753	$	709,444

Charge-offs:
Commercial		53,988		27,613		83,855		17,523
Consumer secured by real estate		34,610		11,476		25,814		16,119
Consumer not secured by real estate		126,846		46,159		74,462		66,586


Total Charge-offs		215,444		85,248		184,131		100,228


Recoveries:
Commercial		5,639		6,156		2,976		2,395
Consumer secured by real estate		5,175		5,897		2,401		1,901
Consumer not secured by real estate		43,397		23,431		23,100		21,636


Total Recoveries		54,211		35,484		28,477		25,932


Charge-offs, net of recoveries		161,233		49,764		155,654		74,296
Provision for loan losses (1)		260,537		94,828		397,381		140,293
Allowance released in connection with loan sales		—		12,409


Allowance for loan losses, end of period		808,748		503,685		1,344,480		775,441

Reserve for unfunded lending commitments, beginning of period		28,301		15,255		65,162		28,301
Provision/(benefit) for unfunded lending commitments (1)		6,463		2,172
Provision for unfunded lending commitments (1)						107,618		(5,293	)
Reserve for unfunded lending commitments, end of period		34,764		17,427		172,780		23,008

Total Allowance for credit losses	$	843,512	$	521,112	$	1,517,260	$	798,449

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Commercial banking fees were $53.7 million and $108.2 million for the three-month and six-month periods ended June 30, 2008, compared to $52.0 million and $101.5 million for the same periods in 2007, representing an increase of 3.3% and 6.6%, respectively. The increase for the six-months ended June 30, 2008 is due primarily to growth in deposit fees to $41.1 million for the six-month period ended June 30, 2008 compared to $27.4 million for the corresponding period in the prior year. This was partially offset by declines in income related to our precious metals lending business of $5.7 million due to a decision to focus on relationships within our core markets.

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

Three months ended Six months ended
June 30, June 30,
2008 2007 2008 2007
Sales of mortgage loans and related securities $ 4,999 $ 3,317 $ 8,977 $ 8,864
Sale of correspondent home equity loans — — — (119,892 )
Net gains under SFAS 133 1,602 783 2,972 395
Mortgage servicing fees 12,182 10,460 24,098 20,189
Amortization of mortgage servicing rights (11,034 ) (8,236 ) (19,103 ) (17,718 )
Residential mortgage servicing rights recoveries 19,837 656 1,134 656
Sales of multi-family loans 9,676 5,748 18,906 16,305
Recoveries/(impairments) to multi-family mortgage servicing rights 635 — (4,220 ) —
Net gain recorded on commercial mortgage backed securitization — 13,772 — 10,496

Total mortgage banking income $ 37,897 $ 26,500 $ 32,764 $ (80,705 )


	Three months ended March 31,
	2009			2008
Sales of mortgage loans and related securities	$	11,636		$	3,977
Net gains under SFAS 133		14,918			1,370
Mortgage servicing fees		13,209			11,917
Amortization of mortgage servicing rights		(16,818	)		(8,069	)
Residential mortgage servicing rights impairments		(14,114	)		(18,703	)
Sales and changes to recourse reserves of multi-family loans		(50,143	)		9,231
(Impairments) to multi-family mortgage servicing rights		(3,531	)		(4,856	)

Total mortgage banking losses	$	(44,843	)	$	(5,133	)

Mortgage banking ~~income~~losses consists of fees associated with servicing loans not held by Sovereign, as well as amortization and changes in the fair value of mortgage servicing ~~rights.~~rights and recourse reserves. Mortgage banking results also include gains or losses on the sales of mortgage, home equity loans and lines of credit and multi-family loans and mortgage-backed securities that were related to loans originated or purchased and held by Sovereign, as well as gains or losses on mortgage banking derivative and hedging transactions. Mortgage banking derivative instruments include principally interest rate lock commitments and forward sale commitments.

In the ~~second~~first quarter of ~~2008,~~2009, Sovereign recorded (losses)/gains on the sale of multi-family loans of ~~$9.7~~$(50.1) million on ~~$885.9~~$173.2 million of multi-family loans compared to gains of ~~$5.7~~$9.2 million on the sale of ~~$503.4 million~~$1.0 billion of loans for the corresponding period in the prior year. The loss on the sale of multi-family loans for the first quarter of 2009 includes a charge of $48.1 million related to increasing recourse reserves on multi-family loans sold to Fannie Mae. A portion of this increase related to one credit that was required to be repurchased from Fannie Mae which resulted in a charge of $10.0 million. The remaining increase in our recourse reserves was due to additional reserves established for the multi-family portfolio due to the weakening economic conditions. In the ~~second~~first quarter of ~~2008,~~2009, Sovereign recorded gains on the sale of mortgage loans of ~~$5.0~~$11.6 million on ~~$1.1~~$1.2 billion of mortgage loans compared to gains of ~~$3.3~~$4.0 million on ~~$592.1~~$909.1 million of loans for the corresponding period in the prior year.

At ~~June 30, 2008,~~March 31, 2009, Sovereign serviced approximately ~~$12.9~~$13.2 billion of residential mortgage loans for others and our net mortgage servicing asset was ~~$161.7~~$101.9 million, compared to ~~$11.2~~$13.1 billion of loans serviced for others and a net mortgage servicing asset of ~~$141.1~~$112.5 million at December 31, ~~2007.~~2008. For the quarter ended March 31, 2009, Sovereign recorded a $14.1 million impairment charge on our mortgage servicing rights due to a reduction in interest rates which resulted in higher expected prepayments on our mortgages reducing the value of our servicing rights. 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 market assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model. For the three-month period ended June 30, 2008, Sovereign recorded a $19.8 million of mortgage servicing right recovery due to a decrease in prepayment speed assumptions at June 30, 2008 compared to March 31, 2008 as shown below. This recovery was essentially a reversal of the $18.7 million residential mortgage servicing right impairment charge that we recorded in the three-month period ended March 31, 2008 due to increased market based prepayment speed assumptions at March 31, 2008 compared to December 31, 2007. Future changes to prepayment speeds may cause significant future charges or recoveries of previous impairments in future periods.

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


	June 30, 2008			March 31, 2008			December 31, 2007			June 30, 2007			March 31, 2007			March 31, 2009			December 31, 2008			March 31, 2008
CPR speed		12.19	%		20.64	%		14.70	%		11.43	%		14.81	%		32.44	%		29.65	%		20.64	%
Escrow credit spread		4.74	%		4.94	%		5.12	%		5.07	%		4.96	%		4.01	%		4.35	%		4.94	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Sovereign will periodically sell qualifying mortgage loans to FHLMC, GNMA, and FNMA in return for mortgage-backed securities issued by those agencies. Sovereign reclassifies the net book balance of the loans sold to such agencies from loans to investment securities available for sale. For those loans sold to the agencies in which Sovereign retains servicing rights, Sovereign allocates the net book balance transferred between servicing rights and investment securities based on their relative fair values. If Sovereign sells the mortgage-backed securities which relate to underlying loans previously held by the Company, the gain or loss on the sale is recorded in mortgage banking (losses)/income in the accompanying consolidated statement of operations. The gain or loss on the sale of all other mortgage-backed securities is recorded in gains on sales of investment securities on the consolidated statement of operations. During the second quarter of 2008, Sovereign sold $781 million of residential mortgage loans to FHLMC in return for mortgage-backed securities that were subsequently classified in our available for sale investment portfolio. Sovereign recorded a servicing asset of $8.4 million in connection with this transaction. At June 30, 2008, all of the investment securities have been retained on our balance sheet; therefore, this transaction did not have any impact on net income for the three-month or six-month periods ended June 30, 2008.

Sovereign originates and sells multi-family loans in the secondary market to Fannie Mae while retaining servicing. ~~Generally, the Company can originate and sell loans to Fannie Mae for not more than $20.0 million per loan.~~ Under the terms of the sales program with Fannie Mae, we retain a portion of the credit risk associated with such loans. As a result of this agreement with Fannie Mae, Sovereign retains a 100% first loss position on each multi-family loan sold to Fannie Mae under such program until the earlier to occur of (i) the aggregate losses on the multi-family loans sold to Fannie Mae reaching the maximum loss exposure for the portfolio as a whole ($250.9 million as of March 31, 2009) or (ii) until all of the loans sold to Fannie Mae under this program are fully paid off. The maximum loss exposure is available to satisfy any losses on loans sold in the program subject to the foregoing limitations.

The Company has established a liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae. This liability represents the amount that the Company estimates that it would have to pay a third party to assume the retained recourse obligation. The estimated liability represents the present value of the estimated losses that the portfolio is projected to incur based upon an industry-based default curve with a range of estimated losses. At ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, Sovereign had ~~a $24.2~~an $80.0 million and ~~$23.5~~$38.3 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program. The increase in our recourse reserve levels is due to weakening economic conditions.

At ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, Sovereign serviced ~~$12.2~~$13.1 billion and ~~$10.9~~$13.0 billion of loans of loans for Fannie Mae sold to it pursuant to this program with a maximum potential loss exposure of ~~$234.3~~$250.9 million and ~~$206.8~~$249.8 million, respectively. As a result of this retained servicing on multi-family loans sold to Fannie Mae, the Company had loan servicing assets of ~~$18.6~~$9.5 million and ~~$20.4~~$14.7 million at ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, respectively. During the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 and the corresponding period in the prior year, Sovereign recorded servicing asset amortization of ~~$5.2~~$2.2 million and ~~$3.1~~$1.7 million, respectively. Additionally, during the first ~~half~~three months of ~~2008,~~2009, Sovereign recorded a net servicing right asset impairment charge of ~~$4.2~~$3.5 million from lower escrow rate reinvestment yield assumptions due to recent interest rate cuts by the Federal Reserve.

Capital markets (losses)/revenues ~~increased~~decreased to ~~$7.2 million and $17.6~~$(3.3) million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$6.0 million and $11.7~~$10.4 million for the same ~~periods~~period in ~~2007. The reason~~2008. During the first quarter of 2009, Sovereign recorded charges of $6.4 million to increase reserves for ~~this increase was~~uncollectible swap receivables from customers due to deterioration in the ~~declining interest rate environment in 2008 which has allowed us to sell more interest rate derivative products to our customers.~~credit worthiness of these companies.

Bank owned life insurance (BOLI) income represents the increase in the cash surrender value of life insurance policies for certain employees where the Bank is the beneficiary of the policies, as well as the receipt of insurance proceeds. The decrease in BOLI income to ~~$19.1 million and $38.5~~$14.9 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$20.3 million and $40.8~~$19.4 million for the comparable ~~periods~~period in the prior year is primarily due to decreased death benefits ~~in 2008.~~as well as lower crediting rates on certain polices.

Net ~~gains~~losses on ~~sales of~~ investment securities were ~~$1.9 million and $16.0~~$77.7 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$0 and $1.0~~gains of $14.1 million for the same ~~periods~~period in ~~2007.~~2008. First quarter 2009 results an OTTI charge of $36.9 million on FNMA and FHLMC preferred stock and a $42.8 million OTTI charge on our non-agency mortgage backed securities. In the first quarter of 2008, we recorded net cash proceeds of $14.1 million on the mandatory redemption of approximately half of our Visa Initial Public Offering (IPO) shares. Our remaining ~~522,718~~ Visa shares are required to be held for 3 years pending settlement of other possible litigation that Visa and its member banks are exposed to. These shares are required to be valued at their historical cost of $0. In March 2011, we will no longer have any restrictions on these shares.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

General and Administrative Expenses

General and administrative expenses for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 were ~~$381.9 million and $741.1~~$350.2 million, compared to ~~$336.6 million and $666.6~~$349.6 million for the same ~~periods~~period in ~~2007. General and administrative expenses for~~2008. In the three-month and six-month periods ended June 30, 2008 were impacted by increased deposit insurance premiums and an increase in compensation costs due to severance charges of $5.3 million and $6.4 million for the three-month and six-month periods ended June 30, 2008, respectively, associated with the departure of various senior executives as well as annual merit increases effective April 1, 2008. Higher deposit premium assessment rates were established in 2007 by the FDIC; however, Sovereign received a $29 million credit to be applied against future assessments, which was exhausted in the fourthfirst quarter of ~~2007. As a result, we incurred higher deposit premiums of $15.4 million in the six-month period of~~ 2008, ~~compared to the corresponding period in the prior year. As previously discussed,~~ Sovereign received proceeds from the mandatory redemption of our Visa IPO shares. This amount was net of proceeds Visa funded to an escrow account to provide for possible costs associated with pending litigation against Visa and its member banks. This funding allowed member banks of Visa to reverse litigation related accruals made in 2007. Sovereign had accrued $7.8 million in 2007 for this exposure and reversed $6.4 million of this amount in the three-month period ended March 31, 2008.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Other Expenses

~~In July 2008, IndyMac Bank, F.S.B. (“IndyMac Bank”) was closed by~~Other expenses consist primarily of amortization of intangibles, minority interest expense, deposit insurance expense, merger related and integration charges, equity method investment expense and other restructuring and proxy and related professional fees. Other expenses were $284.8 million for the ~~Office of Thrift Supervision (“OTS”) and the Federal Deposit Insurance Corporation (“FDIC”) was appointed as receiver of IndyMac Bank. As of~~three-month period ended March 31, ~~2008, IndyMac Bank was a $32.3 billion financial institution which had $18.9 billion~~2009, compared to $41.9 million for the same period in ~~deposits and is~~2008. The reasons for the ~~third largest bank failure in the history of the U.S. banking system. It is estimated that this failure will cost the FDIC deposit assessment fund between $4 billion and $8 billion.~~variance are discussed below.

The FDIC charges financial institutions deposit premium assessments to ensure it has reserves to cover deposits that are under FDIC insured ~~limits (generally $100,000 per depositor and $250,000 for retirement accounts).~~limits. The FDIC Board of Directors has established a reserve ratio target percentage of 1.25%. This means that their “target” balance for the reserves is 1.25% of estimated insured deposits. As of March 31, 2008, the fund was $52.8 billion and insured deposits were $4.4 trillion, which resulted in a reserve ratio of 1.19% or 0.06 basis points below the FDIC Board’s target. If the fund falls below 1.15% of estimated insured deposits, the FDIC is required by lawDue to ~~adopt a restoration plan that will bring~~recent bank failures, the reserve ratio ~~back to 1.15% within five years. If~~is currently below its target balance. In December 2008, the ~~estimated loss to be incurred to~~FDIC published a final rule that raised the current deposit assessment ~~fund due~~rates uniformly for all institutions by 7 basis points, effective in the first quarter of 2009. The FDIC also has announced that in the second quarter of 2009, additional fees will be assessed to ~~the IndyMac Bank failure~~institutions who have secured borrowings in excess of 15% of their deposits. The FDIC is ~~correct, it would reduce~~also considering a one time assessment charge of 20 basis points on June 30, 2009 to help bolster the reserve ~~ratio percentage between 0.09%~~fund, which would be payable on September 30, 2009. Deposit insurance expense increased to 0.18% and result in the reserve ratio falling below 1.15% and require the adoption of a restoration plan which could entail increasing deposit premium assessment rates to all financial institutions. The timing and extent of any future increase is unknown at this time but could have an adverse impact on our general and administrative expenses in future periods.

~~Other Expenses~~

Other expenses consist primarily of amortization of intangibles, minority interest expense, merger related and integration charges, equity method investment expense and other restructuring and proxy and related professional fees. Other expenses were $42.8 million and $80.3$21.6 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009 compared to ~~$79.5 million and $196.2~~$9.2 million for the ~~same periods~~corresponding period in ~~2007. The reason for~~ the ~~variance is discussed below.~~prior year. Sovereign may be able to pass part or all of this cost onto its customers in the form of lower interest rates on deposits depending on market conditions.

Sovereign recorded charges of ~~$56.0 million and $40.1~~$233.3 million for the ~~six-month~~three-month period ended ~~June 30, 2007~~March 31, 2009 associated with merger-related and restructuring charges and ~~freezing its ESOP, respectively. Additionally, results for~~costs associated with the ~~three-month and six-month periods ended June 30, 2007 included $6.7 million and $12.9 million, respectively,~~Santander acquisition. The majority of ~~expense~~these costs related to ~~an equity method investment~~change in control payments to certain executives and severance charges of $72.7 million as well as restricted stock acceleration charges of $45.0 million. Sovereign ~~had~~also incurred fees of approximately $26 million to third parties to successfully close the transaction. Finally, during the first quarter of 2009, Sovereign redeemed $1.4 billion of high cost FHLB advances incurring a debt extinguishment charge of $68.7 million. This decision was made to reduce interest expense in ~~a synthetic fuel partnership that generated Section 29 tax credits for~~future periods since the ~~production of fuel from a non-conventional source. We amortized this through December 31, 2007 since this was~~advances were at above market interest rates due to the ~~period through which we received the tax credits. Therefore, we did not incur any expense nor did we record any tax credits in 2008 related to this investment.~~current low rate environment.

Sovereign recorded intangible amortization expense of ~~$28.1 million and $57.2~~$20.0 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$32.3 million and $65.5~~$29.1 million for the corresponding ~~periods~~period in the prior year. The decreases in the current year periods are due primarily to decreased core deposit intangible amortization expense on previous acquisitions.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Income Tax (Benefit)/Provision

An income tax ~~provision~~benefit of ~~$29.1 million and $51.2~~$(0.7) million was recorded for the three-month ~~and six-month periods~~period ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$29.2 million and $23.1~~a tax provision of $22.1 million for the same ~~periods~~period in 2007. The effective tax rate for the three-month and six-month periods ended June 30, 2008 was 18.6% and 18.4%, respectively, compared to 16.5% and 10.6% for the same periods in 2007. The income tax provision in the second quarter of 2008 includes a $10.4 million provision to increase our reserves2008. Sovereign’s valuation allowance for income taxes ~~based on recent rulings in certain states.~~was increased by $258.6 million during the three-months ended March 31, 2009. The ~~effective tax rate differs from~~Company recorded a valuation allowance during the ~~statutory rate of 35% primarily~~three-month period ended March 31, 2009, due to ~~income from tax-exempt investments, income related to bank-owned life insurance,~~our current period loss and ~~tax credits associated with low income housing investment partnerships. The lower effective tax rate for~~significant losses in the six-month period ended June 30, 2007 results from the lower amount of pre-tax income of the Company for that time period. Additionally, as discussed above, the three-month and six-month periods ended June 30, 2008 did not have any tax credits associated with the synthetic fuel partnership.prior two calendar years.

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Actual income taxes paid may vary from estimates depending upon changes in income tax laws, actual results of operations, and the final audit of tax returns by taxing authorities. Tax assessments may arise several years after tax returns have been filed. Sovereign reviews its tax balances quarterly and as new information becomes available, the balances are adjusted, as appropriate. The Company is subject to ongoing tax examinations and assessments in various jurisdictions. ~~The~~In 2008, the Internal Revenue Service (the “IRS”) ~~is currently examining~~completed an examination of the Company’s federal income tax returns for the years 2002 through 2005. ~~The Company anticipates that the IRS will complete this review in the second half of 2008.~~ Included in this examination cycle ~~are~~were two separate financing transactions with an international bank totaling $1.2 ~~billion, which are discussed in Note 12 in the Company’s Form 10-K.~~billion. As a result of these transactions, Sovereign was subject to foreign taxes of $154.0 million during the years 2003 through 2005 and claimed a corresponding foreign tax credit for foreign taxes paid during those years. In 2006 and 2007, Sovereign was subject to an additional $87.6 million and $22.5 million, respectively, of foreign taxes related to these financing transactions and claimed a corresponding foreign tax credit. ~~While the~~The IRS ~~audit is not complete, recent developments in our IRS audit leads us to expect that the IRS will propose to disallow~~issued a notification of adjustment disallowing the foreign tax credits taken in 2003-2005 in the amount of $154.0 million related to these ~~transactions~~transactions; disallowing deductions for issuance costs and interest expense related to ~~assess~~the transaction which would result in an additional tax liability of $24.9 million and assessed interest and potential penalties, the combined amount of which totaled approximately ~~$73.4 million~~$71.0 million. Sovereign has paid the additional tax due resulting from the IRS adjustments, as well as the assessed interest and penalties and is now going through the IRS administrative process to challenge the adjustments and to obtain a refund of ~~June 30, 2008.~~the amounts paid. In addition, ~~while~~ the IRS has ~~not yet initiated an~~commenced its audit for the years 2006 and ~~2007, we~~2007. We expect that in the future the IRS will propose to disallow the foreign tax credits and deductions taken in 2006 and 2007 of $87.6 million and $22.5 million, ~~respectively,~~respectively; disallowing deductions for issuance costs and interest expense which would result in an additional tax liability of $37.1 million; and to assess interest and ~~potential penalties, the combined amount of which totals approximately $16.9 million as of June 30, 2008.~~penalties. Sovereign ~~may~~expects that it will need to litigate this matter with the IRS. Sovereign ~~believes~~continues to believe that it is entitled to claim these foreign tax credits taken with respect to the transactions and also continues to believe it is entitled to tax deductions for the related issuance costs and interest deductions. Sovereign also believes that its recorded tax reserves for ~~this~~its position of ~~$58.7~~$57.6 million adequately provides for any potential exposure to the IRS related to ~~foreign tax credits and other tax assessments.~~these items. However, as the Company continues to go through the IRS administrative process, and if necessary litigation, we will continue to evaluate the appropriate tax reserve levels for this position, and any changes made to the tax reserves may materially affect Sovereign’s income tax provision, net income and regulatory capital in future periods.

~~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 to each of our segments. Funds transfer pricing methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The provision for credit losses recorded by each segment is based on the net charge-offs of each line of business and the difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business line at the time of charge-off is allocated to each business line based on the risk profile of their loan portfolio. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. Where practical, the results are adjusted to present consistent methodologies for the segments. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

~~During~~ In connection with the acquisition of Sovereign by Santander in the first quarter of ~~2008, as previously discussed in our 2008 first quarter Form 10-Q,~~2009, certain changes to our executive management team were announced such as the hiring of a new head of Retail Banking and a new Chief Financial Officer. In addition, we centralized the responsibility for the major businesses within the Company naming a new head of Retail, Commercial Lending, Corporate Specialty Businesses and Corporate Support Services. The head of these business units report directly to the Chief Executive Officer and, along with our Chief Financial Officer and Chief Risk Officer, comprise the Executive Management Group.announced. These events ~~changed~~are anticipated to impact how our executive management team ~~measures~~will measure and ~~assesses~~assess our business ~~performance. During the second quarter we finalized~~performance in future periods. We are in the process of updating our business unit profitability system and once these reporting changes have been finalized, we expect certain changes to ~~reflect~~ our ~~new organizational structure.~~reportable segments.

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

The Retail Banking Division’s net interest income decreased ~~$46.1 million and $107.2~~$56.9 million to ~~$264.9 million and $514.6~~$192.3 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to the corresponding period in the preceding year. The decrease in net interest income was due to margin compression on a matched funded basis due to the recent Federal Reserve interest rate cuts which have reduced the spreads that our Retail Banking Division receives on their deposits. The net spread on a match funded basis for this segment was ~~2.17%~~1.28% for the first ~~six~~three months of ~~2008~~2009 compared to ~~2.70%~~1.76% for the same period in the prior year. The average balance of loans was ~~$6.3~~$7.0 billion for the ~~six~~three months ended ~~June 30, 2008~~March 31, 2009 compared to an average balance of ~~$5.5~~$6.1 billion for the corresponding period in the preceding year. The average balance of deposits was ~~$42.3~~$36.3 billion for the ~~six~~three months ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$42.0~~$35.2 billion for the same period a year ago. The provision for credit losses increased ~~$7.0 million and $16.8~~$54.6 million for the three months ~~and six months~~ ended ~~June 30, 2008,~~March 31, 2009, and is driven by ~~the charge-offs in the~~increased allowance allocations for division’s loan portfolio. General and administrative expenses totaled ~~$266.6 million and $533.3~~$248.9 million for the three months ~~and six months~~ ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$267.1 million and $528.6~~$265.6 million for the three months ended March 31, 2008. The decrease in general and ~~six months ended June 30, 2007.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion~~administrative expenses is due to tighter cost controls and ~~Analysis of Financial Condition and Results of Operations (continued)~~a lower headcount within our retail banking division.

The Corporate Specialty Group segment net interest income ~~increased $7.1 million and~~ decreased ~~$27.9~~$4.7 million to ~~$106.3 million and $210.8~~$90.5 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to the corresponding ~~periods~~period in the preceding year. The decrease from prior year in net interest income was due a decrease in average loans due to the sale of $3.4 billion of correspondent home equity loans and $2.9 billion of residential mortgage loans as part of the balance sheet restructuring executed in early 2007. The net spread on a match funded basis for this segment was ~~1.38%~~1.29% for the first ~~six~~three months of ~~2008~~2009 compared to ~~1.39%~~1.31% for the same period in the prior year. The average balance of loans for the ~~six-month~~three-month period ended ~~June 30, 2008~~March 31, 2009 was ~~$29.5~~$27.4 billion compared with ~~$33.5~~$30.1 billion for the corresponding period in the prior year. Fees and other income were ~~$52.2 million and $59.5~~$(40.5) million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to ~~$47.9 million and a loss of $44.4~~$7.3 million for the corresponding ~~periods~~period in the prior year. The ~~prior~~current year results included a charge of ~~$119.9~~$48.1 million onto increase our recourse reserves associated with the ~~correspondent home equity loan portfolio.~~sales of multi-family loans to Fannie Mae. The provision for credit losses increased ~~$45.5 million and $107.0~~$112.5 million to ~~$69.7 million and $148.6~~$191.4 million at ~~June 30, 2008~~March 31, 2009 due to a higher level of ~~losses~~allowances on our ~~indirect auto portfolio particularly related to out-of-market auto loans.~~Alt-A residential loan portfolio. Charge-offs on ~~out-of-market auto loans~~this portfolio increased to ~~$51.6~~$5.7 million during the first ~~half~~three months of ~~2008~~2009 compared to ~~$5.6~~$2.1 million during the first ~~half~~three months of ~~2007.~~2008. General and administrative expenses totaled ~~$44.2 million and $87.2~~$42.0 million for the three months ~~and six months~~ ended ~~June 30, 2008,~~March 31, 2009, compared to ~~$39.4 million and $81.5~~$44.2 million for the three months ~~and six months~~ ended ~~June 30, 2007.~~March 31, 2008.

The Commercial Lending segment net interest income ~~increased $21.0 million and $48.7~~decreased $15.7 million to ~~$128.8 million and $255.8~~$111.2 million for the three-month ~~and six-month periods~~period ended ~~June 30, 2008~~March 31, 2009 compared to the corresponding periods in the preceding year due to ~~growth~~a decrease in our commercial loan portfolios from reduced demand for these loan products due to ~~our emphasis on this asset class and a de-emphasis on wholesale residential loans, investment securities and other lower yielding asset classes.~~the current economic environment. The net spread on a match funded basis for this segment was ~~2.36%~~2.09% for the first ~~six~~three months of ~~2008~~2009 compared to ~~2.25%~~2.43% for the same period in the prior year. The average balance of loans for the ~~six~~three months ended ~~June 30, 2008~~March 31, 2009 was ~~$22.3~~$21.0 billion compared with ~~$19.8~~$22.0 billion for the corresponding period in the prior year. The provision for credit losses increased ~~$28.5 million and $46.3~~$202.9 million to ~~$48.6 million and $89.6~~$243.9 million for the three months ~~and six months~~ ended ~~June 30, 2008~~March 31, 2009 due to higher reserve allocations on certain segments within our commercial loan portfolio, particularly those related to the residential real estate industry. General and administrative expenses (including allocated corporate and direct support costs) were ~~$56.3 million and $103.9~~$48.6 million for the three months ~~and six months~~ ended ~~June 30, 2008~~March 31, 2009 compared with ~~$45.5 million and $89.0~~$48.5 million for the corresponding ~~periods~~period in the prior year. ~~The reason for the increase is due to compensation and benefit cost increases needed to support the growth of this reporting segment.~~

The net ~~loss~~income/(loss) before income taxes for Other decreased ~~$78.8 million and $224.2~~$434.8 million to a net loss of ~~$24.4 million and $18.8~~$418.2 million for the three months ~~and six months~~ ended ~~June 30, 2008~~March 31, 2009 compared to the corresponding ~~periods~~period in the preceding year. Results for the three ~~and six~~ months ended ~~June 30, 2007~~March 31, 2009 included charges of ~~$56.0~~$36.9 million and ~~$40.1~~$42.8 million related to ~~freezing our ESOP plan~~the OTTI charge on FNMA and FHLMC preferred stock and the non-agency mortgage backed securities portfolio, respectively. Results for the three months ended March 31, 2009 included charges of $233.3 million related to certain restructuring and merger charges, respectively. Net interest ~~income increased $70.7 million and $133.4~~income/(expense) decreased $90.6 million to ~~$6.1 million and $7.2~~$(84.9) million for the three months ~~and six months~~ ended ~~June 30, 2008~~March 31, 2009 compared to the corresponding ~~periods~~period in the preceding year due primarily to investment yields ~~increasing 1 basis points while borrowings decreased 55~~decreasing 284 basis points for the ~~six-month~~three-month period ended ~~June 30, 2008.~~March 31, 2009. Average borrowings for the ~~six-month~~three-month period ended ~~June 30,~~March 31, 2009 and 2008 ~~and 2007~~ were ~~$23.1~~$19.1 billion and ~~$22.9~~$23.6 billion, respectively, with an average cost of ~~4.73%~~5.04% and ~~5.28%~~4.83%. Average investments for the ~~six-month~~three-month period ended ~~June 30,~~March 31, 2009 and 2008 ~~and 2007~~ was ~~$12.6~~$12.1 billion and ~~$14.6~~$13.0 billion respectively, at an average yield of ~~6.13%~~3.33% and ~~6.12%~~6.17%.

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the December 31, ~~2007~~2008 consolidated financial statements filed on 2008 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, income taxes 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, ~~2007~~2008 Management’s Discussion and Analysis filed onin our 2008 Form 10-K.

~~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 ~~June 30, 2008,~~March 31, 2009, commercial loans totaled ~~$27.8~~$26.4 billion representing ~~48.4%~~48.1% of Sovereign’s loan portfolio, compared to ~~$26.7~~$27.3 billion, or ~~46.2%~~48.8% of the loan portfolio, at December 31, ~~2007~~2008 and ~~$25.5~~$27.9 billion, or ~~45.2%~~47.1% of the loan portfolio, at ~~June 30, 2007.~~March 31, 2008. At both ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, only 7%8% of our total commercial portfolio was unsecured. The ~~increase~~decrease in commercial loans since December 31, ~~2007~~2008 has been driven by ~~organic~~reduced demand for these loan ~~growth.~~products due to the current recessionary environment. The increase in commercial loans as a percentage of the total loan portfolio is consistent with management’s 2007 restructuring plan to deemphasize lower yielding residential loans. Sovereign is focused on limiting its balance sheet growth given the difficult economic and credit conditions.

At ~~June 30, 2008,~~March 31, 2009, multi-family loans totaled ~~$4.7~~$4.6 billion representing ~~8.1%~~8.3% of Sovereign’s loan portfolio, compared to ~~$4.2~~$4.5 billion, or 8.1% of the loan portfolio, at December 31, 2008 and $4.3 billion or 7.3% of the loan portfolio at ~~December~~March 31, ~~2007 and $4.0 billion or 7.1% of the loan portfolio at June 30, 2007.~~2008.

The consumer loan portfolio secured by real estate (consisting of home equity loans and lines of credit of ~~$6.5~~$6.9 billion and residential loans of $11.9 billion) totaled ~~$18.4~~$18.8 billion at ~~June 30, 2008,~~March 31, 2009, representing ~~32.0%~~34.1% of Sovereign’s loan portfolio, compared to ~~$19.5~~$18.3 billion, or ~~33.8%~~32.8%, of the loan portfolio at December 31, ~~2007~~2008 and ~~$20.3~~$19.6 billion or ~~36.0%~~33.1% of the loan portfolio at ~~June 30, 2007.~~March 31, 2008.

The consumer loan portfolio not secured by real estate (consisting of automobile loans of ~~$6.3~~$4.9 billion and other consumer loans of ~~$302.8~~$0.3 million) totaled ~~$6.6~~$5.2 billion at ~~June 30, 2008,~~March 31, 2009, representing ~~11.5%~~9.4% of Sovereign’s loan portfolio, compared to ~~$7.3~~$5.8 billion, or ~~12.7%~~10.3%, of the loan portfolio at December 31, ~~2007~~2008 and ~~$6.6~~$7.3 billion or ~~11.7%~~12.4% of the loan portfolio at ~~June 30, 2007. The decrease~~March 31, 2008. Sovereign ceased originating auto loan production within its geographic footprint in the ~~consumer loan portfolio not secured by real estate from prior~~fourth quarter ~~is primarily due to the cessation~~ of ~~out-of-market~~2008 and stopped originating out of footprint auto ~~lending~~loans on January 31, 2008. ~~Additionally, the Company has tightened~~The remaining auto portfolio will liquidate over its underwriting standards on its in-market auto loans portfolio which slowed originations. Second quarter 2008 auto loan originations within our geographic footprint totaled $239 million compared with $503 million in the first quarterremaining estimated life of ~~2008. As previously discussed, effective January 31, 2008, management ceased originating out-of-market auto loans.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion~~approximately two and ~~Analysis of Financial Condition and Results of Operations (continued)~~a half to three years.

Non-Performing Assets

At ~~June 30, 2008,~~March 31, 2009, Sovereign’s non-performing assets increased by ~~$192.3~~$728.0 million to ~~$553.9 million~~$1.7 billion compared to ~~$361.6~~$985.4 million at December 31, ~~2007.~~2008. This increase is primarily related to residential mortgages, commercial real estate loans, multi-family loans and commercial and industrial loans. Non-performing assets as a percentage of total loans, real estate owned and repossessed assets increased to ~~0.96%~~3.12% at ~~June 30, 2008~~March 31, 2009 from ~~0.63%~~1.77% at December 31, ~~2007.~~2008. In response to these increases, Sovereign increased its ~~reserves~~allowance for credit losses on our loan portfolio to ~~$843.5 million~~$1.52 billion or ~~1.47%~~2.76% of total loans at ~~June 30, 2008~~March 31, 2009 from ~~$737.7 million~~$1.17 billion or ~~1.28%~~2.09% at December 31, ~~2007.~~2008. Sovereign generally places all commercial and residential loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer ~~and residential~~ loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved for. Loans secured by residential real estate with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved for or charged off.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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


	June 30,			December 31,			March 31,			December 31,
	2008			2007			2009			2008
Non-accrual loans:

Consumer:
Residential mortgages	$	133,114		$	90,881		$	425,200		$	233,176
Home equity loans and lines of credit		65,213			56,099			78,636			69,247
Auto loans and other consumer loans		2,750			3,446			11,166			3,777

Total consumer loans		201,077			150,426			515,002			306,200
Commercial		129,693			85,406			443,157			244,847
Commercial real estate		117,251			61,750			556,637			319,565
Multi-family		42,230			6,336			139,376			42,795


Total non-accrual loans		490,251			303,918			1,654,172			913,407
Restructured loans		280			370			287			268


Total non-performing loans		490,531			304,288			1,654,459			913,675

Other real estate owned		48,228			43,226			40,091			49,900
Other repossessed assets		15,168			14,062			18,822			21,836


Total other real estate owned and other repossessed assets		63,396			57,288			58,913			71,736


Total non-performing assets	$	553,927		$	361,576		$	1,713,372		$	985,411


Past due 90 days or more as to interest or principal and accruing interest	$	73,694		$	68,770		$	44,420		$	123,301
Annualized net loan charge-offs to average loans		.55	%		.25	%		1.12	%		.83	%
Non-performing assets as a percentage of total assets		.70	%		.43	%		2.19	%		1.28	%
Non-performing loans as a percentage of total loans		.85	%		.53	%		3.01	%		1.64	%
Non-performing assets as a percentage of total loans, real estate owned and repossessed assets		.96	%		.63	%		3.12	%		1.77	%
Allowance for credit losses as a percentage of total non-performing assets⁽¹⁾		152.3	%		204.0	%		88.6	%		118.5	%
Allowance for credit losses as a percentage of total non-performing loans⁽¹⁾		172.0	%		242.4	%		91.7	%		127.8	%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

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

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

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

Commercial Portfolio. The portion of the allowance for loan losses related to the commercial portfolio has increased from ~~$434.0~~$752.8 million at December 31, ~~2007 (1.40%~~2008 (2.37% of commercial loans) to ~~$527.6~~$912.6 million at ~~June 30, 2008 (1.63%~~March 31, 2009 (2.94% of commercial loans). This is a result of an increase in non-performing assets and other criticized assets at June 30, 2008 and loan growth which required additional reserves. Additionally, Sovereign increased its reserve allocations in the first quarter of 2008 in anticipation of continued deteriorating in these loan portfolios in the near term.March 31, 2009. A large portion of this increase was related to our multifamily loans ~~to companies that are in housing related industries. We expect that the difficult housing environment as well as economic conditions will continue to impact our commercial~~and small business lending ~~and commercial real estate portfolios which may result in increased reserve allocations~~loans and higher ~~provisions for~~allowances were assigned to these loan ~~losses in future periods.~~categories.

Consumer Secured by Real Estate Portfolio. The allowance for the consumer loans secured by real estate portfolio increased to ~~$131.9~~$236.9 million at ~~June 30, 2008~~March 31, 2009 from ~~$117.4~~$193.4 million at December 31, ~~2007.~~2008. The increase is primarily ~~the result of increased reserves allocated to our residential loan portfolio~~ due to continued weaknesses in residential real estate prices. Non-performing assets and past due loans for our residential portfolios, particularly in our ~~$2.8~~$2.6 billion Alt-A portfolio, continue to increase. Additionally, our in market home equity portfolio losses have been steadily increasing. As a result of this trend, Sovereign provided additional reserves to this portfolio during the first quarter of 2009. As a result of these increased reserves, the percentage of consumer loans secured by real estate ~~the~~to its related allowance was ~~0.72%~~1.26% at ~~June 30, 2008~~March 31, 2009 compared with ~~0.60%~~1.06% at December 31, ~~2007.~~2008. We expect that the difficult housing environment as well as general economic conditions will continue to impact our residential ~~portfolio~~and home equity portfolios which may result in higher loss levels. In response, during the first ~~and second quarters~~three months of ~~2008,~~2009, we increased the reserve for consumer loans secured by real estate by ~~$9.4 million and $8.3 million, respectively.~~$43.4 million.

Sovereign entered into a credit default swap in 2006 on a portion of its residential real estate loan portfolio through a synthetic securitization structure. Under the terms of the credit default swap, Sovereign is responsible for the first ~~$5.2~~$3.2 million of losses on the remaining loans in the structure which totaled ~~$3.1~~$2.8 billion at ~~June 30, 2008.~~March 31, 2009. Sovereign is reimbursed for the next ~~$55~~$52.9 million of losses under the terms of the credit default swap. Losses above ~~$60.2~~$56.1 million are borne by Sovereign. This credit default swap term is equal to the term of the loan portfolio.

Consumer Not Secured by Real Estate Portfolio. The allowance for the consumer not secured by real estate portfolio ~~decreased~~increased from ~~$149.8~~$149.1 million at December 31, ~~2007~~2008 to ~~$140.8~~$192.1 million at ~~June 30, 2008~~March 31, 2009 primarily due to ~~a decrease in auto loans of $722.4 million. This decline was~~higher reserve allocations for this portfolio due to ~~our decision to stop originating out of market loans effective January 31, 2008 as well as a reduction~~continued deterioration in the amount of auto loan originations in 2008 compared to 2007 origination levels within our geographic footprint, as we have strengthened our underwriting standards. In footprint auto loan originations for the six-month period ended June 30, 2008 were $742 million compared to $1.1 billion for the corresponding period in the prior year. During 2007, Sovereign originated $2.8 billion of out-of-market auto loans.portfolio. The allowance as a percentage of consumer loans not secured by real estate was ~~2.13%~~3.71% at ~~June 30, 2008~~March 31, 2009 and ~~2.04%~~2.65% at December 31, ~~2007.~~2008.

Unallocated Allowance. The unallocated allowance for loan losses was ~~$8.5~~$3.0 million at ~~June 30, 2008~~March 31, 2009 and ~~$8.3~~$7.4 million at December 31, ~~2007.~~2008. Management continuously evaluates its class allowance reserving methodology; however the unallocated allowance is subject to changes each reporting period due to a level of imprecision in management’s estimation process.

Reserve for unfunded lending commitments. The reserve for unfunded lending commitments has increased from $65.2 million at December 31, 2008 to $172.8 million at March 31, 2009 due to credit downgrades on our commercial letters and line of credit portfolios.

4643

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Reserve for unfunded lending commitments. The reserve for unfunded lending commitments has increased from $28.3 million at December 31, 2007 to $34.8 million at June 30, 2008 due to increases in the amount of criticized commercial loan commitments since year-end.

Investment Securities

Investment securities consist primarily of mortgage-backed securities, tax-free municipal securities, U.S. Treasury and government agency securities, corporate debt securities ~~collateralized debt obligations~~ 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~~average life of the available for sale investment portfolio at ~~June 30, 2008~~March 31, 2009 was ~~5.6 years.~~5.90 years compared to 4.62 years at December 31, 2008.

Total investment securities available-for-sale were ~~$11.1~~$8.7 billion at ~~June 30, 2008~~March 31, 2009 and ~~$13.9~~$9.3 billion at December 31, ~~2007.~~2008. For additional information with respect to Sovereign’s investment securities, see Note 3 in the Notes to Consolidated Financial Statements.

Sovereign ~~holds~~recorded an OTTI charge of $36.9 million on FNMA and FHLMC preferred stock ~~in Fannie Mae~~ and ~~Freddie Mac which has~~ a ~~cost basis of $622.6~~$42.8 million ~~and an unrealized loss of $34.4 million at June 30, 2008. These losses are related to liquidity spreads due to negative events~~OTTI charge on ~~the issuers of these securities. These~~our non-agency mortgage backed securities have experienced significant changes in prices month-to-month based on movements in credit spreads and as recently as May 31, 2008, the securities were in a net unrealized gain position of $11.3 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 June 30, 2008, each of the individual securities was investment grade. Given the short duration of the losses and the fact that the losses were not severe, we concluded that the above unrealized losses are temporary in nature at June 30, 2008.

~~Recent news stories in July and concerns~~ in the ~~marketplace have resulted in significant decreases in the share prices~~first quarter of Fannie Mae and Freddie Mac. Since June 30, 2008, the common stock prices for Fannie Mae and Freddie Mac have been very volatile and have declined significantly. It is widely believed that the U.S. government will support these two government sponsored entities if needed and has publicly stated so, but it is unclear whether the support would extend to their common and preferred shareholders. Their primary regulator has also stated that both institutions are adequately capitalized. In July, a housing and economic recovery bill was signed into law by the President of the United States which allows the U.S. Treasury Department the authority to purchase equity in both Fannie Mae and Freddie Mac. The housing and recovery bill also permits the Treasury Department to provide a temporary increase in a long standing line of credit for the two companies. The Fed’s Board also granted the New York Fed authority to lend to Fannie Mae and Freddie Mac should such lending prove necessary. Finally, the housing and recovery bill also includes an increase in the federal debt limit to $10.6 trillion and a $300 billion program to refinance loans for struggling borrowers in an effort to help stabilize the U.S. housing market.

The concerns around capital adequacy and the likely dilution on existing shareholders when capital is raised for these two companies has caused the market valuations of the Company’s Fannie Mae and Freddie Mac perpetual preferred stock to decrease significantly in July. It is unclear whether the values of Sovereign’s investment in Fannie Mae and Freddie Mac perpetual preferred stock will change once additional facts and circumstances become known which may not be until Fannie Mae and Freddie Mac release second quarter earnings and the U.S. Government determines the final form of any changes to support Fannie Mae and Freddie Mac. To the extent the market conditions do not improve and the values for these securities do not stabilize, it is possible that Sovereign could have an additional other than temporary impairment charge in future periods.2009.

Other investments, which consists of FHLB stock and repurchase agreements, ~~decreased to $944.6 million~~remained constant at ~~June 30, 2008 from $1.2~~$0.7 billion at March 31, 2009 and December 31, ~~2007 due to a reduction in FHLB stock as Sovereign reduced its amount of FHLB borrowings since year-end in connection with its plan to reduce wholesale borrowings.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations (continued)~~2008.

Goodwill and Other Intangible Assets

Goodwill was $3.4 billion at both ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007.~~2008. Other intangibles decreased by ~~$57.2~~$20.0 million at ~~June 30, 2008~~March 31, 2009 compared to December 31, ~~2007~~2008 due to year-to-date amortization expense.

The Company follows SFAS No. 142, “Goodwill and Other Intangible Assets,” to account for its goodwill. This statement provides that goodwill and other indefinite lived intangible assets will not be amortized on a recurring basis, but rather will be subject to periodic impairment testing. ~~There were no goodwill~~This testing is required annually, or ~~core deposit intangible asset impairment charges recorded in~~more frequently if events or circumstances indicate there may be impairment. Impairment testing is performed at the ~~six months ended June 30, 2008 or June 30, 2007.~~

~~During 2007 Sovereign’s financial results were negatively impacted by~~reporting unit level, and not on an ~~increase in credit losses, slower than anticipated growth in low cost core deposits~~individual acquisition basis and is a ~~continued unfavorable interest rate environment.~~two step process. The ~~market conditions and related concerns surrounding credit caused valuations for banking and other financial service companies~~first step is to decrease significantly during the fourth quarter of 2007. The market price of our common stock decreased from a high of $25.16 during the second quarter of 2007 to a low of $10.08 in the fourth quarter of 2007, a 60% decrease. The significant drop in value caused our book value per common share to be significantly higher than our market stock price. Additionally, in response to the credit downturn in 2007, we tightened our underwriting standards and made strategic changes to our business, including exiting activities that were not within the Sovereign footprint.

During the fourth quarter of 2007, we completed our annual assessment of goodwill using a third party valuation firm who considered the impact of current credit conditions, the exiting of certain business activities, our 2007 actual results, expected results for 2008, as well as current market valuations. We evaluated goodwill for impairment for each of our reporting units under 3 different valuation approaches (transaction market approach, guideline company approach, and discounted net income approach) to ensure thatcompare the fair value of ~~our~~the reporting ~~units was in excess of our net book values including goodwill. Based on this analysis, we concluded that we had a goodwill impairment charge of $1.58 billion.~~

~~Determining~~unit to its carrying value (including its allocated goodwill). If the fair value of ~~each~~the reporting unit is in excess of ~~our segments involves~~its carrying value then no impairment charge is recorded. If the carrying value of a ~~significant amount~~reporting unit is in excess of ~~judgment, and the results are dependent on the Company attaining results consistent with the forecasts and assumptions used in~~ its ~~valuation model. Assumptions such as growth, credit risk, interest rates, and expense expectations, have a significant impact on each segment’s overall~~ fair value ~~and are all subject~~then a second step needs to ~~change as market conditions worsen or improve. During~~be performed. The second step entails calculating the second quarter of 2008, we reorganized our reporting units and updated our impairment analysis based on these new segments. Although market conditions in 2008 have remained challenging and valuations for banking and other financial institutions have declined since year-end, we believe theimplied fair value of ~~our segments continues to be~~goodwill as if a reporting unit is purchased at its step 1 fair value. This is determined in the same manner as goodwill in a business combination. If the implied fair value of goodwill is in excess of ~~their book value. However, in response to a longer term credit down cycle, management may change~~ the ~~assumptions in the Company’s business plan which could have implications to the fair value derived from our valuation models.~~

~~In the fourth quarter of 2008, we will be performing our annual assessment of~~reporting units allocated goodwill amount then no impairment ~~with the assistance of a third party valuation firm.~~charge is required. We ~~will continue to evaluate future performance and market conditions and will consider these developments in~~evaluated our goodwill ~~impairment valuation in future periods.~~at March 31, 2009 and determined that it was not impaired.

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


	Calendar				Remaining		Calendar				Remaining
	Year		Recorded		Amount		Year		Recorded		Amount
Year	Amount		To Date		To Record		Amount		To Date		To Record
2008	$	100,467	$	55,540	$	44,927
2009		71,341		—		71,341	$	71,341	$	19,299	$	52,042
2010		56,617		—		56,617		56,617		—		56,617
2011		44,963		—		44,963		44,963		—		44,963
2012		33,108		—		33,108		33,108		—		33,108
2013								23,630		—		23,630

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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 ~~June 30, 2008~~March 31, 2009 were ~~$47.3~~$50.5 billion compared to ~~$49.9~~$48.4 billion at December 31, ~~2007.~~2008.

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. In the third quarter of 2008, Sovereign began to borrow from the Federal Reserve discount window through the pledging of certain assets. Sovereign also utilizes reverse repurchase agreements, which are short-term obligations collateralized by securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof, and federal funds lines with other financial institutions. Total borrowings at ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007~~2008 were ~~$22.1~~$18.6 billion and ~~$26.1~~$21.0 billion, respectively. The reason for this decline is ~~primarily~~ due to our decision to terminate $1.4 billion of higher cost FHLB advances as well the reduction in ~~short-term assets that Sovereign needed~~the size of our auto and C&I loan portfolios as proceeds were utilized to ~~acquire to maintain compliance with HOLA (See~~pay down FHLB advances. Note ~~3). See Note 5~~6 for further discussion and details on our borrowings and other debt obligations.

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Off Balance Sheet Arrangements

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

In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has interests that continue to be held in the QSPEs. Off-balance sheet QSPEs had ~~$1.9~~$1.0 billion of assets that Sovereign sold to the QSPEs which are not included in Sovereign’s Consolidated Balance Sheet at ~~June 30, 2008.~~March 31, 2009. Sovereign’s interests that continue to be held and servicing assets in such QSPEs was ~~$61.9~~$2.1 million at ~~June 30, 2008~~March 31, 2009 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 ~~June 30, 2008,~~March 31, 2009, 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 10~~

Sovereign enters into partnerships, which are variable interest entities under FIN 46, with real estate developers for ~~a description~~the construction and development of ~~Sovereign’s interests~~low-income housing. The partnerships are structured with the real estate developer as the general partner and Sovereign as the limited partner. Sovereign is not the primary beneficiary of these variable interest entities. The Company’s risk of loss is limited to its investment in the partnerships, which totaled $151.3 million at March 31, 2009 and any future cash obligations that ~~continue~~Sovereign has committed to ~~be held~~the partnerships. Future cash obligations related to these partnerships totaled $8.6 million at March 31, 2009. Sovereign investments in ~~its off-balance sheet asset securitizations.~~these partnerships are accounted for under the equity method.

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 tangible capital ratio equal to 1.5% of tangible assets, and a minimum leverage ratio equal to 4% of tangible 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 ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, 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 ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007~~2008 (in thousands):


	TIER 1			TIER 1			TOTAL			TIER 1			TIER 1			TOTAL
	LEVERAGE			RISK-BASED			RISK-BASED			LEVERAGE			RISK-BASED			RISK-BASED
	CAPITAL			CAPITAL			CAPITAL			CAPITAL			CAPITAL			CAPITAL
REGULATORY CAPITAL	RATIO			RATIO			RATIO			RATIO			RATIO			RATIO
Sovereign Bank at June 30, 2008:
Sovereign Bank at March 31, 2009:
Regulatory capital	$	5,538,038		$	5,262,374		$	7,642,694		$	5,671,910		$	5,485,872		$	7,650,673
Minimum capital requirement (1)		3,041,782			2,678,158			5,356,315			3,022,936			2,461,477			4,922,954

Excess	$	2,496,256		$	2,584,216		$	2,286,379		$	2,648,974		$	3,024,395		$	2,727,719

Sovereign Bank capital ratio		7.28	%		7.86	%		11.41	%		7.51	%		8.91	%		12.43	%

Sovereign Bank at December 31, 2007:
Sovereign Bank at December 31, 2008:
Regulatory capital	$	5,289,889		$	5,030,620		$	6,939,602		$	4,434,350		$	4,166,510		$	6,449,472
Minimum capital requirement (1)		3,237,187			2,668,712			5,337,424			2,979,778			2,528,501			5,057,002

Excess	$	2,052,702		$	2,361,908		$	1,602,178		$	1,454,572		$	1,638,009		$	1,392,470

Sovereign Bank capital ratio		6.54	%		7.54	%		10.40	%		5.95	%		6.59	%		10.20	%

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

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

Listed below are capital ratios for Sovereign Bancorp.

TANGIBLE TANGIBLE
COMMON COMMON TANGIBLE TANGIBLE
EQUITY TO EQUITY TO EQUITY TO EQUITY TO
TANGIBLE TANGIBLE TANGIBLE TANGIBLE TIER 1
ASSETS ASSETS ASSETS ASSETS LEVERAGE
EXCLUDING INCLUDING EXCLUDING INCLUDING CAPITAL
REGULATORY CAPITAL OCI₍₂₎ OCI₍₂₎ OCI₍₂₎ OCI₍₂₎ RATIO
Capital ratio at June 30, 2008₍₁₎
6.92 % 6.04 % 7.18 % 6.29 % 8.34 %
Capital ratio at December 31, 2007₍₁₎
4.43 % 4.04 % 4.67 % 4.28 % 5.89 %

TANGIBLE

COMMON

TANGIBLE

EQUITY TO

TANGIBLE

TIER 1

ASSETS

LEVERAGE

EXCLUDING

INCLUDING

EXCLUDING

INCLUDING

CAPITAL

REGULATORY CAPITAL

OCI (2)

RATIO

Capital ratio at March 31, 2009 (1)

2.86

1.73

5.50

4.41

7.28

Capital ratio at December 31, 2008 (1)

3.60

2.57

3.86

2.83

5.73


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

(2)		Tangible equity and tangible assets are defined as total equity and total assets less goodwill and other intangibles, net of any deferred tax liabilities.

~~The~~As discussed in Note 2 in the Notes to Consolidated Financial Statements, we determined that the Transaction resulted in Santander obtaining control of Sovereign ~~Bancorp capital ratios at~~as Santander acquired all the voting shares of Sovereign. If push down accounting had been applied to the separate stand-alone financial statements of Sovereign, the measurement amounts for assets and liabilities as of January 30, 2009 would be based on the guidance in SFAS 141 (R), and would have approximated the purchase price of approximately $1.9 billion, as compared to Sovereign’s equity as of December 31, ~~2007 were negatively impacted 0 basis points~~2008 of approximately $5.6 billion. Such adjustments to ~~33 basis points depending on~~fair value, if recorded, would have the ~~ratio due to~~effect of significantly reducing our regulatory capital and would require a ~~balance sheet gross up of $4 billion of investments and cash deposits~~capital infusion in order to ~~comply with a loan limitation test required by HOLA. As discussed in our Form 10-K, HOLA limits the amount of non-residential mortgage loans a savings institution, such as~~ensure Sovereign Bank ~~may make. The law limits a savings institution~~would remain well-capitalized.

Sovereign’s capital ratios were positively impacted by previously mentioned $1.8 billion preferred stock issuance to Santander and to a ~~maximum~~lesser extent the adoption of ~~20%~~FSP FAS 115-2 and FAS 124-2.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

Item 2. Management’s Discussion and Analysis of ~~its total assets in commercial loans not secured by real estate, however, only 10% can be large commercial loans not secured by real estate (defined as loans in excess~~Financial Condition and Results of $2 million). Commercial loans secured by real estate can be made in an amount up to four times an institutions total risk-based capital. Due to Sovereign’s decreased emphasis of lower yielding asset classes since year-end (primarily investment securities, multi-family loans and residential loans) and increased emphasis on higher yielding commercial loans, Sovereign was required to increase the amount of assets that were not considered large commercial loans in order to comply with the regulation at December 31, 2007. During the second quarter of 2008, Sovereign was able to reduce the amount of large non-real estate commercial loans and maintain compliance with this regulation without temporarily increasing its balance sheet at June 30, 2008. The Company is working on a more permanent solution to maintain compliance with this regulation in future periods.

As discussed in our Form 10-K, all OTS savings institutions are required to meet a qualified thrift lender (QTL) test to avoid certain restrictions on their operations. The QTL test under HOLA requires a savings institution to have at least 65% of its portfolio assets, as defined by regulation, in qualified thrift investments. Such assets primarily consist of residential housing related loans, certain consumer and small business loans, as defined by the regulations, and mortgage related investments. Sovereign is currently in compliance with the QTL; however, as a result of our 2007 balance sheet restructuring and our recent change in strategy to deemphasize the retention of multi-family and residential mortgage loans to be held on our balance sheet, ongoing compliance with the QTL test in future periods may be challenging. We are currently working with the OTS on a more permanent solution to maintain compliance with this regulation. However, if we are not successful in these efforts, we may need to take certain actions to reduce the amount of commercial loans or increase the amount of qualified thrift investments that are held on our balance sheet. These actions are inconsistent with our current strategy and could adversely impact future earnings and capital levels.Operations (continued)

Liquidity and Capital Resources

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

Factors which impact the liquidity position of Sovereign Bank include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, general market conditions, investment portfolio cash flows and maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of ~~June 30, 2008,~~March 31, 2009, Sovereign had ~~$20.4~~$24.8 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.

The Company has increased its liquidity position, and, as of March 31, 2009, we had over $28.0 billion in committed liquidity from the FHLB and the Federal Reserve Bank. The Company also has cash deposits at March 31, 2009 of $6.2 billion compared with $3.8 billion at year end. We believe that this provides adequate liquidity in this difficult economic environment.

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. However, due to recent market conditions, our ability to raise significant amounts of unsecured debt or equity capital at favorable funding costs is limited. Sovereign Bank may pay dividends to ~~its parent~~Santander subject to approval of the OTS, as discussed above. Sovereign also has approximately $87.5 million of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets. During the ~~second~~first quarter of ~~2008,~~2009, Sovereign issued ~~$1.39~~$1.8 billion of ~~common~~preferred stock ~~through its shelf registration.~~

~~SOVEREIGN BANCORP, INC. AND SUBSIDIARIES~~

~~Item 2. Management’s Discussion and Analysis~~to Santander. The preferred stock pays non-cumulative dividends of ~~Financial Condition and Results of Operations (continued)~~10% per annum.

As previously mentioned, Sovereign adopted FAS 157 on January 1, 2008. Sovereign’s level 3 investments are comprised of certain non-agency mortgage backed securities ~~collateralized debt obligations and FNMA/FHLMC preferred stock,~~ which are not actively traded. In certain instances, Sovereign is the sole investor of the issued security. Sovereign ~~receives~~evaluates prices from a third party pricing service, third party broker quotes for certain securities and from another independent third party valuation source to determine their estimated ~~fair value. The prices of our securities are benchmarked against similar securities that are more actively traded to validate the reasonableness of their~~ fair value. Our fair value estimates assume liquidation in an orderly market and not under distressed circumstances. If Sovereign was required to sell these securities in an unorderly fashion, actual proceeds received could potentially be significantly less than their estimated fair values.

Cash and cash equivalents decreased $2.0 billion from December 31, 2007. The reason for the decline is due to a temporary increase in year-end cash deposits to comply with a loan limitation test required by the Home Owners Loan Act (HOLA). HOLA limits the amount of non-residential mortgage loans a savings institution, such as Sovereign Bank, may make. The law limits a savings institution to a maximum of 20% of its total assets in commercial loans not secured by real estate; however, only 10% can be large commercial loans not secured by real estate (defined as loans in excess of $2 million). Commercial loans secured by real estate can be made in an amount up to four times an institutions total risk-based capital. Sovereign was required to increase the amount of assets that were not considered large commercial loans in order to comply with the regulation at December 31, 2007. No such increase was necessary at June 30, 2008. The Company is working on a more permanent solution to maintain compliance with this regulation in future periods.

Net cash ~~provided~~used by operating activities was ~~$750.1 million~~$2.1 billion for ~~2008.~~2009. Net cash provided by investing activities for ~~2008~~2009 was ~~$2.6~~$3.0 billion and consisted primarily of proceeds from the ~~maturity~~sale of investments of $2.6 billion, maturities and repayments of investments of ~~$3.4~~$1.3 billion and a net decrease in loans of $2.4 billion, offset by ~~originations in excess~~purchases of ~~repayments~~investments of ~~loans of $593.4 million.~~$3.3 billion. Net cash ~~used~~provided by financing activities for ~~2008~~2009 was ~~$5.3~~$1.5 billion, which was primarily due to an increase in deposits of $2.1 billion and proceeds of $1.8 billion from the sale of preferred stock, offset by a $2.2 billion reduction in wholesale ~~borrowings of $4.4 billion and a decrease in deposits of $2.6 million, offset by $1.4 billion of proceeds from the issuance of common stock.~~borrowings. See the Consolidated Statement of Cash Flows for further details on our sources and uses of cash.

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

5147

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Contractual Obligations and Commercial Commitments

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

Contractual Obligations (in thousands of dollars):


	Payments Due by Period										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)	$	18,679,037	$	10,274,808	$	2,810,496	$	1,323,292	$	4,270,441	$	13,069,340	$	6,495,252	$	1,021,073	$	868,777	$	4,684,238
Securities sold under repurchase agreements (1)		77,264		77,264		—		—		—
Fed Funds (1)		1,202,067		1,202,067		—		—		—		2,000,014		2,000,014		—		—		—
Other debt obligations (1)		3,561,554		339,623		1,092,994		844,250		1,284,687		4,977,721		472,915		2,187,654		1,365,589		951,563
Junior subordinated debentures due to Capital Trust entities (1)(2)		3,998,467		87,314		178,361		181,911		3,550,881		3,837,184		84,283		167,293		174,062		3,411,546
Certificates of deposit (1)		12,010,961		10,447,452		1,256,491		229,038		77,980		17,913,907		16,799,228		891,012		182,038		41,629
Investment partnership commitments (3)		21,295		14,557		6,627		26		85		8,563		8,148		322		26		67
Operating leases		782,078		97,037		175,882		143,510		365,649		834,694		101,853		187,313		154,233		391,295


Total contractual cash obligations	$	40,332,723	$	22,540,122	$	5,520,851	$	2,722,027	$	9,549,723	$	42,641,423	$	25,961,693	$	4,454,667	$	2,744,725	$	9,480,338

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

~~Amount of Commitment Expiration per Period (in thousands of dollars):~~

Total
Other Commercial Amounts Less than Over 1 yr Over 3 yrs
Commitments Committed 1 year to 3 yrs to 5 yrs Over 5 yrs

Commitments to extend credit $ 19,772,570 $ 8,240,534 $ 4,060,896 $ 2,351,923 $ 5,119,217
Standby letters of credit 3,057,532 572,441 846,540 1,145,749 492,802
Loans sold with recourse 296,569 6,382 31,593 68,677 189,917
Forward buy commitments 767,840 635,772 132,068 — —

Total commercial commitments $ 23,894,511 $ 9,455,129 $ 5,071,097 $ 3,566,349 $ 5,801,936

Sovereign’s standby letters of credit meet the definition of a guarantee under FASB Interpretation No. 45 “Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others”. These transactions are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. The weighted average term of these commitments is ~~3.4~~2.8 years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, Sovereign would be required to honor the commitment. Sovereign has various forms of collateral, such as real estate assets and customer business assets. The maximum undiscounted exposure related to these commitments at ~~June 30, 2008~~March 31, 2009 was ~~$3.1~~$2.7 billion, and the approximate value of the underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was ~~$2.6~~$2.3 billion. The fees related to standby letters of credit are deferred and amortized over the life of the commitment. These fees are immaterial to Sovereign’s financial statements at ~~June 30, 2008.~~March 31, 2009. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

~~See Note 14 for a description of pending litigation against the Company.~~

Asset and Liability Management

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

Interest rate risk ~~is managed centrally by~~focuses on managing four elements of risk associated with interest rates: basis risk, repricing risk, yield curve risk and option risk. Basis risk stems from rate index timing differences with rate changes, such as differences in the ~~treasury group~~extent of changes in fed funds compared with ~~oversight by~~three month LIBOR. Repricing risk stems from the ~~Asset~~different timing of contractual repricing such as, one month versus three month reset dates. Yield curve risk stems from the impact on earnings and ~~Liability Committee. Management reviews~~market value due to different shapes and levels of yield curves. Optionality risk stems from prepayment or early withdrawal risk embedded in various ~~forms~~products. These four elements of ~~analysis to monitor interest rate~~ risk ~~including~~are analyzed through a combination of net interest income ~~sensitivity,~~simulations, shocks to the net interest income simulations, scenarios and market value ~~sensitivity, repricing frequency of assets versus liabilities~~analysis and ~~scenario analysis.~~the subsequent results are reviewed by management. 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.~~various scenarios that help management understand the potential risks in net interest income sensitivity. These scenarios ~~shift interest rates up~~include both parallel and ~~down. Certain~~non-parallel rate shocks as well as other scenarios ~~shift short-term rates up while holding longer-term rates constant and vice versa. These shocks~~that are ~~instantaneous and~~consistent with quantifying the ~~analysis helps management to better understand its short-term interest rate~~four elements of 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~~Sovereign’s risk position remains close to neutral so that future earnings are not ~~overly sensitive to the~~significantly adversely affected by future ~~direction of~~ interest rates.

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


	~~The following estimated percentage~~
~~If interest rates changed in parallel by the~~	~~increase/(decrease) to net interest~~
~~amounts below at June 30, 2008~~	~~income would result~~

~~Up 100 basis points~~		~~(0.87~~	)%
~~Down 100 basis points~~		~~1.12~~	%


	The following estimated percentage
If interest rates changed in parallel by the	increase/(decrease) to
amounts below at March 31, 2009	net interest income would result			Policy Limits
Up 100 basis points		4.08	%		(5.00)	%
Down 50 basis points		(4.83	)%		(5.00)	%

Sovereign also focuses on calculating the market value of equity (“MVE”). This analysis is very useful as it measures the present value of all estimated future interest income and interest expense cash flows of the Company over the estimated remaining life of the balance sheet. MVE is calculated as the difference between the market value of assets and liabilities. The MVE calculation utilizes only the current balance sheet and therefore does not factor in any future changes in balance sheet size, balance sheet mix, yield curve relationships, and product spreads which may mitigate the impact of any interest rate changes.

5349

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

~~The matching~~Management then looks at the effect of ~~assets and liabilities may be analyzed by examining the extent to which such assets and liabilities are “interest rate sensitive” and by monitoring a bank’s~~ interest rate changes on MVE. The sensitivity ~~“gap.” An asset or liability~~of MVE to changes in interest rates is ~~said to be interest rate sensitive within~~ a ~~specific time frame if it will mature or reprice within that period~~measure of time. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specific time frame and the amount of interest-bearing liabilities maturing or repricing within that same period of time. In a rising interest rate environment, an institution with a negative gap would generally be expected, absent the effects of other factors, to experience a greater increase in the cost of its interest-bearing liabilities than it would in the yield on its interest-earning assets, thus producing a decline in its net interest income. Conversely, in a declining rate environment, an institution with a negative gap would generally be expected to experience a lesser reduction in the yield on its interest-earning assets than it would in the cost of its interest-bearing liabilities, thus producing an increase in its net interest income. As of June 30, 2008, the one year cumulative gap was 4.03%, compared to (1.58)% at December 31, 2007.

Finally, Sovereign calculates the market value of its balance sheet including all assets, liabilities and hedges. This market value analysis is very useful because it measures the present value of all estimated future interest income and interest expense cash flows of the Company. Management calculates a Net Portfolio Value (NPV) which is the market value of assets minus the market value of liabilities and is used to assess long-term interest rate risk. A higher NPV ratio indicates lower long-termlonger-term interest rate risk and ~~a more valuable franchise.~~also highlights the potential capital at risk due to adverse changes in market interest rates. The following table ~~below~~ discloses the estimated sensitivity to Sovereign’s ~~estimated net portfolio value based on interest rate changes:~~MVE at March 31, 2009 and December 31, 2008:


If interest rates changed in parallel by the	Estimated NPV Ratio
amounts below at June 30, 2008	June 30, 2008			December 31, 2007
Base		12.91	%		9.60	%
							The following estimated percentage
							increase/(decrease) to MVE would result
If interest rates changed in parallel by							March 31, 2009			December 31, 2008			Policy limits
Base (in thousands)							$	7,618,456		$	6,735,655			N/A
Up 200 basis points		12.40	%		8.90	%		(3.34)	%		(5.80)	%		(15.00	)%
Up 100 basis points		12.69	%		9.30	%		(2.11)	%		(2.51)	%		(7.50	)%
Down 100 basis points		12.96	%		9.69	%		(1.76)	%		(1.34)	%		7.50	%

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Item 4. Controls and Procedures

The Company’s management, with the participation of the Company’s principal executive officer and principal financial officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures, as such term is defined under Rule 13a-15(e) promulgated under the Securities Exchange Act of 1934, as amended, as of ~~June 30, 2008.~~March 31, 2009. Based on this evaluation, our principal executive officer and our principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of ~~June 30, 2008~~March 31, 2009 to ensure that information required to be disclosed by the Company in reports the Company files or submits under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms and (ii) accumulated and communicated to the Company’s management, including the Company’s principal executive officer and principal financial officer, as appropriate to allow timely decisions regarding required disclosures. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended ~~June 30, 2008,~~March 31, 2009, that has materially affected or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

5551

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II — OTHER INFORMATION

Item 1 — Legal Proceedings

Sovereign is not involved in any pending material legal proceeding other than routine litigation occurring in the ordinary course of business.

Item 1A — Risk Factors

~~There has been no material change~~The risk factors in the ~~Corporation’s risk factors as previously disclosed in our~~Company’s Annual Report on Form 10-K ~~for the fiscal year ended December 31, 2007 in response to Item 1A to Part I of such Form 10-K. Such risk factors are incorporated herein by reference.~~has not changed materially.

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 ~~June 30, 2008:~~March 31, 2009:

Total Number of Maximum Number
Total Average Price Shares Purchased of Shares that
Number of Paid as Part of Publicly may be Purchased
Shares Per Announced Plans Under the Plans
Period Purchased Share or Programs (1) Or Programs (1)
4/1/08 through 4/30/08 25,378 $ 9.57 N/A 19,500,000
5/1/08 through 5/31/08 864 9.19 N/A 19,500,000
6/1/08 through 6/30/08 10,439 8.54 N/A 19,500,000

Average

Total Number of

Maximum Number

Total

Price

Shares Purchased

of Shares that

Number of

Paid

as Part of Publicly

may be Purchased

Per

Announced Plans

Under the Plans

Period

Purchased

or Programs (1)

Or Programs

1/1/09 through 1/31/09

4,510

2.15

N/A

19,500,000

2/1/09 through 2/28/09

—

N/A

3/1/09 through 3/31/09

—

N/A


~~(1)~~		Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40,500,000 shares of common stock as of June 30, 2008 of which approximately twenty one million shares have been purchased under these repurchase programs as of June 30, 2008. 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 36,681 shares outside of publicly announced repurchase programs during the second quarter of 2008.

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

~~The 2008 annual~~A special meeting of stockholders was held on January 28, 2009. A proposal was submitted to shareholders to approve and adopt the ~~shareholders~~Transaction Agreement dated as of October 13, 2008, between Sovereign Bancorp, Inc. and Banco Santander, S.A. The vote with respect to such proposal was ~~held on May 8, 2008. The following is a brief description of each matter voted on at the meeting.~~as follows:

SHARES
BROKER
PROPOSAL FOR AGAINST WITHHELD ABSTENTIONS NON-VOTES

1. To elect four (4) Class III directors of Sovereign, each to serve for a term of three years and until their successors shall have been elected and qualified:
Joseph P. Campanelli 361,705,710 N/A 36,137,820 — —
William J. Moran 363,229,262 N/A 34,614,269 — —
Maria Fiorini Ramirez 362,913,316 N/A 34,930,214 — —
Alberto Sanchez 312,536,170 N/A 85,307,360 — —
2. To ratify the appointment by the Audit Committee of Sovereign’s Board of Directors of Ernst & Young LLP as Sovereign’s independent auditors for the fiscal year ending December 31, 2008 391,807,577 3,265,820 — 2,770,132 —
3. To approve the shareholder proposal to amend the Sovereign Bancorp, Inc. 2004 Broad-Based Stock Incentive Plan 309,495,948 13,318,750 — 3,414,827 71,614,005


For	Against		Abstentions		Broker Non-Votes
450,558,106		16,794,132		1,088,004		195,510,315

5652

Item 6 — Exhibits

(a) Exhibits


(2.1)		Transaction Agreement, dated as of October 13, 2008, between Sovereign Bancorp, Inc. and Banco Santander, S.A. (Incorporated by reference to Exhibit 2.1 to Sovereign Bancorp’s Current Report on Form 8-K filed October 16, 2008).

(3.1)		Amended and Restated Articles of Incorporation of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 ofto Sovereign Bancorp’s ~~Quarterly~~Current Report on Form ~~10-Q for the quarter ended March 31, 2007)~~8-K filed January 30, 2009).

(3.2)		Amended and Restated Bylaws of Sovereign Bancorp, Inc.~~, as amended and restated~~ (Incorporated by reference to Exhibit 3.2 to Sovereign Bancorp’s ~~Quarterly~~Current Report on Form ~~10-Q for the quarter ended March 31, 2007)~~8-K filed January 30, 2009).

~~(10.1)~~(3.3)		Certificate of Designations for the Series D Preferred Stock (Incorporated by reference to Exhibit 3.1 of Sovereign Bancorp’s Current Report on Form ~~of Letter~~ 8-K filed on March 27, 2009).

(10.43)		Agreement and General Release, dated ~~May 9, 2008, by and~~February 12, 2009, between Sovereign Bancorp, Inc. and ~~Banco Santander, S.A. (incorporated~~Kirk W. Walters (Incorporated by ~~referenced~~reference to Exhibit ~~10.1 to Sovereign’s Current~~10.43 of Sovereign Bancorp’s Annual Report on Form ~~8-K, SEC File No. 001-16581, filed May~~10-K for the fiscal year ended December 31, 2008)

(10.44)		Agreement and General Release, dated February 12, 2009, between Sovereign Bancorp, Inc. and Patrick J. Sullivan (Incorporated by reference to Exhibit 10.44 of Sovereign Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008).

(10.45)		Agreement and General Release, dated February 16, 2009, between Sovereign Bancorp, Inc. and Roy J. Lever (Incorporated by reference to Exhibit 10.45 of Sovereign Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008).

(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.

5753

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

EXHIBITS INDEX


(2.1)		Transaction Agreement, dated as of October 13, 2008, between Sovereign Bancorp, Inc. and Banco Santander, S.A. (Incorporated by reference to Exhibit 2.1 to Sovereign Bancorp’s Current Report on Form 8-K filed October 16, 2008).

(3.1)		Amended and Restated Articles of Incorporation of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 ofto Sovereign Bancorp’s ~~Quarterly~~Current Report on Form ~~10-Q for the quarter ended March 31, 2007)~~8-K filed January 30, 2009).

(3.2)		Amended and Restated Bylaws of Sovereign Bancorp, Inc.~~, as amended and restated~~ (Incorporated by reference to Exhibit 3.2 to Sovereign Bancorp’s ~~Quarterly~~Current Report on Form ~~10-Q for the quarter ended March 31, 2007)~~8-K filed January 30, 2009).

~~(10.1)~~(3.3)		Certificate of Designations for the Series D Preferred Stock (Incorporated by reference to Exhibit 3.1 of Sovereign Bancorp’s Current Report on Form ~~of Letter~~ 8-K filed on March 27, 2009).

(10.43)		Agreement and General Release, dated ~~May 9, 2008, by and~~February 12, 2009, between Sovereign Bancorp, Inc. and ~~Banco Santander, S.A. (incorporated~~Kirk W. Walters (Incorporated by ~~referenced~~reference to Exhibit ~~10.1 to Sovereign’s Current~~10.43 of Sovereign Bancorp’s Annual Report on Form ~~8-K, SEC File No. 001-16581, filed May~~10-K for the fiscal year ended December 31, 2008)

(10.44)		Agreement and General Release, dated February 12, 2009, between Sovereign Bancorp, Inc. and Patrick J. Sullivan (Incorporated by reference to Exhibit 10.44 of Sovereign Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008).

(10.45)		Agreement and General Release, dated February 16, 2009, between Sovereign Bancorp, Inc. and Roy J. Lever (Incorporated by reference to Exhibit 10.45 of Sovereign Bancorp’s Annual Report on Form 10-K for the fiscal year ended December 31, 2008).

(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.

5955


	December 31, 2007								December 31, 2008
	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	$	85,948	$	480	$	—	$	86,428	$	243,796	$	991	$	—	$	244,787
Debentures of FHLB, FNMA, and FHLMC		186,482		5,918		1		192,399		4,597,607		21,175		64		4,618,718
Corporate debt and asset-backed securities		947,992		10		194,239		753,763		164,648		9		18,861		145,796
Equity securities (1)		638,881		4,282		1		643,162		63,317		533		36,757		27,093
State and municipal securities		2,505,772		23,055		26,403		2,502,424		1,840,080		—		210,967		1,629,113
Mortgage-backed securities:
U.S. government agencies		2,251,022		4,376		56		2,255,342		13,329		78		164		13,243
FHLMC and FNMA debt securities		4,099,515		46,484		1,597		4,144,402		470,522		8,508		2,744		476,286
Non-agency securities(2)		3,459,284		2,797		98,154		3,363,927		2,698,673		1		552,371		2,146,303


Total investment securities available-for-sale	$	14,174,896	$	87,402	$	320,451	$	13,941,847	$	10,091,972	$	31,295	$	821,928	$	9,301,339


	At December 31, 2007															At December 31, 2008
	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
Debentures of FHLB, FNMA and FHLMC	$	—	$	—		$	1,009	$	(1	)	$	1,009	$	(1	)	$	99,762	$	(64	)	$	—	$	—		$	99,762	$	(64	)
Corporate debt and asset-backed securities		223,813		(81,066	)		398,924		(113,173	)		622,737		(194,239	)		11		—			43,896		(18,861	)		43,907		(18,861	)
Equity securities		253		(1	)		—		—			253		(1	)		19,892		(36,756	)		253		(1	)		20,145		(36,757	)
State and municipal securities		1,510,114		(25,880	)		18,697		(523	)		1,528,811		(26,403	)		259,702		(20,875	)		1,367,975		(190,092	)		1,627,677		(210,967	)
Mortgage-backed Securities:
U.S. government agencies		26		—			1,392		(56	)		1,418		(56	)		10,197		(142	)		879		(22	)		11,076		(164	)
FHLMC and FNMA debt securities		11,020		(46	)		91,600		(1,551	)		102,620		(1,597	)		228,474		(2,196	)		13,970		(548	)		242,444		(2,744	)
Non-agency securities(1)		1,511,132		(41,875	)		1,475,522		(56,279	)		2,986,654		(98,154	)		467,437		(139,985	)		1,331,833		(412,386	)		1,799,270		(552,371	)


Total investment securities available-for-sale	$	3,256,358	$	(148,868	)	$	1,987,144	$	(171,583	)	$	5,243,502	$	(320,451	)	$	1,085,475	$	(200,018	)	$	2,758,806	$	(621,910	)	$	3,844,281	$	(821,928	)


	Notional						Receive			Pay			Life		Notional						Receive			Pay			Life
	Amount		Asset		Liability		Rate			Rate			(Years)		Amount		Asset		Liability		Rate			Rate			(Years)
June 30, 2008
March 31, 2009
Fair value hedges:
Receive fixed — pay variable interest rate swaps	$	204,000	$	708	$	506		4.26	%		2.57	%		1.2	$	660,000	$	995	$	6,201		6.05	%		4.57	%		7.7
Cash flow hedges:
Pay fixed — receive floating interest rate swaps		7,950,000		—		213,541		2.76	%		5.15	%		1.8		6,150,000		—		320,258		1.24	%		5.14	%		1.4


Total derivatives used in SFAS 133 hedging relationships	$	8,154,000	$	708	$	214,047		2.80	%		5.09	%		1.8	$	6,810,000	$	995	$	326,459		1.71	%		5.08	%		2.0


December 31, 2007
December 31, 2008
Fair value hedges:
Receive fixed — pay variable interest rate swaps	$	925,000	$	413	$	2,220		4.29	%		4.87	%		0.9	$	678,000	$	6,262	$	369		6.02	%		5.02	%		7.7
Cash flow hedges:
Pay fixed — receive floating interest rate swaps		8,100,000		—		214,548		5.02	%		5.15	%		2.2		6,800,000		4,154		357,969		2.45	%		5.13	%		1.5


Total derivatives used in SFAS 133 hedging relationships	$	9,025,000	$	413	$	216,768		4.94	%		5.12	%		2.1	$	7,478,000	$	10,416	$	358,338		2.77	%		5.12	%		2.1


	June 30,			December 31,			March 31,			December 31,
	2008			2007			2009			2008
	Net Asset			Net Asset			Asset			Asset
	(Liability)			(Liability)			(Liability)			(Liability)
Mortgage banking derivatives:
Forward commitments to sell loans	$	2,346		$	(4,711	)	$	(22,002	)	$	(9,598	)
Interest rate lock commitments		1,064			2,085			11,969			8,573


Total mortgage banking risk management		3,410			(2,626	)		(10,033	)		(1,025	)

Swaps receive fixed		118,456			134,764			462,443			511,581
Swaps pay fixed		(79,390	)		(100,713	)		(431,142	)		(478,398	)
Market value hedge		(134	)		740			(247	)		(134	)


Net customer related interest rate hedges		38,932			34,791			31,054			33,049

Precious metals forward sale agreements		(8,931	)		(35,247	)		(2,595	)		(1,227	)
Precious metals forward purchase arrangements		8,868			34,234			2,595			1,227
Foreign exchange contracts		5,349			1,906			5,779			7,736


Total	$	47,628		$	33,058		$	26,800		$	39,760


	Three-Month Period						Six-Month Period						Three-Month Period
	Ended June 30,						Ended June 30,						Ended March 31,
	2008			2007			2008			2007			2009			2008
Net income	$	127,439		$	147,452		$	227,574		$	195,511
Net (loss)/income													$	(817,291	)	$	100,135
Adoption of FSP 115-2 and FAS 124-2														88,190			—
Change in accumulated losses on cash flow hedge derivative financial instruments, net of tax		124,925			48,427			883			39,712			30,759			(124,042	)
Change in unrealized gains/(losses) on investment securities available-for-sale, net of tax		(93,634	)		(160,184	)		(385,978	)		(142,345	)		(9,755	)		(292,343	)
Less reclassification adjustment, net of tax:
Derivative instruments		(2,194	)		(2,603	)		(4,219	)		(5,550	)		(5,516	)		(2,025	)
Pensions		(124	)		(1,146	)		(249	)		(1,263	)		(796	)		(125	)
Investments available-for-sale		4,088			—			13,276			618			(50,667	)		9,188

Comprehensive income	$	156,960		$	39,444		$	(166,329	)	$	99,073
Comprehensive (loss)/income													$	(651,118	)	$	(323,288	)


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

(2)		Unrealized loss at December 31, 2008 is prior to the adoption of FSP FAS 115-2 and FAS 124-2.


(1)		Includes residential and commercial construction loans of ~~$2.6 billion and $2.3~~$2.7 billion at ~~June 30, 2008~~both March 31, 2009 and December 31, ~~2007, respectively.~~2008.

(2)		Total loans held for investment includes deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts as well as purchase accounting adjustments. These items resulted in a net ~~decrease~~increase in loans of ~~$7.6~~$19.8 million and ~~$7.2~~$11.9 million at ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, respectively. Loans pledged as collateral totaled ~~$33.8~~$43.3 billion and ~~$31.3~~$42.7 billion at ~~June 30, 2008~~March 31, 2009 and December 31, ~~2007,~~2008, respectively.


Gross balance as of December 31, 2007	$	141,076
Gross balance as of December 31, 2008				$	161,288
Mortgage servicing assets recognized		36,531			18,140
Amortization		(15,556	)		(14,626	)

Gross balance at June 30, 2008		162,051
Gross balance at March 31, 2009					164,802
Valuation allowance		(339	)		(62,929	)

Balance as June 30, 2008	$	161,712
Balance as March 31, 2009				$	101,873


Balance as of December 31, 2007	$	1,473
Decrease in valuation allowance for mortgage servicing rights		(1,134	)

Balance as June 30, 2008	$	339


	Retail		Corporate
For the six-month period ended	Banking		Specialty			Commercial
June 30, 2008	Division		Group			Lending			Other			Total
Net interest income (expense)	$	514,569	$	210,778		$	255,784		$	7,179		$	988,310
Fees and other income⁽¹⁾		192,886		59,536			67,811			42,601			362,834
Provision for credit losses		28,833		148,617			89,550			—			267,000
General and administrative expenses		533,338		87,157			103,900			16,732			741,127
Depreciation/amortization		21,520		21,460			1,432			75,119			119,531
Income (loss) before income taxes		145,284		29,787			122,496			(18,793	)		278,774
Intersegment revenues (expense)⁽²⁾		798,715		(662,852	)		(399,151	)		263,288			—
Total average assets	$	6,703,294	$	30,597,994		$	22,307,026		$	20,757,905		$	80,366,219


(1)		Included in fees and other income ~~for the three-month period ended June 30, 2008,~~ in the Corporate Specialty Group ~~segment is a $19.8~~are $14.1 million and $18.7 million residential mortgage servicing right ~~recovery. The majority of this recovery related to the $18.7 million~~ impairment ~~charge~~charges that ~~was~~were recorded in the first quarter of ~~2008. Fees~~2009 and ~~other income in~~2008, respectively. Additionally, the ~~Corporate Specialty Group for the six-month period ended June 30, 2007 included~~first quarter of 2009 includes a charge of ~~$119.9~~$48.1 million ~~on our correspondent home equity loan portfolio.~~associated with increasing multi-family recourse reserves for loans sold to Fannie Mae.

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

(3)		Included in Other in 2009 were OTTI charges of $36.9 million on FNMA and FHLMC preferred stock and an OTTI charge of $42.8 million on non-agency mortgage backed securities. Results also included net merger, restructuring, severance and debt extinguishment charges of $233.3 million.


	June 30, 2008						December 31, 2007
			Principal		Net				Principal		Net
	Total		90 Days		Credit		Total		90 Days		Credit
	Principal		Past Due		Losses		Principal		Past Due		Losses
Mortgage Loans	$	11,856,434	$	180,085	$	9,482	$	13,397,822	$	130,101	$	7,498
Home Equity Loans and Lines of Credit		6,598,027		97,708		11,666		6,300,558		88,848		11,063
Commercial Real Estate and Multi-family Loans		17,943,548		144,265		43,095		17,526,885		57,623		15,540
Automotive Floor Plan Loans		1,176,478		8,998		2,039		1,255,729		—		335


Total Owned and Securitized	$	37,574,487	$	431,056	$	66,282	$	38,480,994	$	276,572	$	34,436


Less:
Securitized Mortgage Loans	$	—	$	—	$	—	$	56,629	$	638	$	30
Securitized Home Equity Loans		93,289		14,973		1,916		103,410		15,764		2,915
Securitized Commercial Real Estate and Multi-family Loans		958,964		—		—		973,601		—		—
Securitized Automotive Floor Plan Loans		855,000		—		2,039		855,000		—		335


Total Securitized Loans	$	1,907,253	$	14,973	$	3,955	$	1,988,640	$	16,402	$	3,280


Net Loans	$	35,667,234	$	416,083	$	62,327	$	36,492,354	$	260,170	$	31,156


	Home
	Equity						Commercial
	Loans &			Auto			Loans
	Lines of			Floor			Secured by
	Credit			Plan Loans			Real Estate			Total
Interests that continue to be held by Sovereign:
Accrued interest receivable	$	—		$	3,448		$	—		$	3,448
Subordinated interest retained		—			43,996			6,867			50,863
Interest only strips		2,223			1,010			—			3,233
Cash reserve		—			4,381			—			4,381


Total Interests that continue to be held by Sovereign	$	2,223		$	52,835		$	6,867		$	61,925


Weighted-average life (in yrs)		3.42			0.41			8.07
Prepayment speed assumption (annual rate)
As of the date of the securitization		22	%		50	%		10	%
As of December 31, 2007		17	%		49	%		10	%
As of June 30, 2008		13	%		43	%		10	%
Impact on fair value of 10% adverse change	$	(148	)	$	(42	)	$	—
Impact on fair value of 20% adverse change	$	(299	)	$	(92	)	$	—
Expected credit losses (annual rate)
As of the date of the securitization		0.75	%		.25	%		.50	%
As of December 31, 2007		5.25	%		.25	%		.50	%
As of June 30, 2008		3.74	%		.25	%		.60	%
Impact on fair value of 10% adverse change	$	(382	)	$	(42	)	$	(60	)
Impact on fair value of 20% adverse change	$	(740	)	$	(84	)	$	(119	)
Residual cash flows discount rate (annual)
As of the date of the securitization		12	%		8	%		12	%
As of December 31, 2007		12	%		8	%		17	%
As of June 30, 2008		12	%		8	%		28	%
Impact on fair value of 10% adverse change	$	(90	)	$	(95	)	$	(91	)
Impact on fair value of 20% adverse change	$	(174	)	$	(191	)	$	(178	)


	(in thousands)
Gross unrecognized tax benefits at December 31, 2007	$	87,461
Additions based on tax positions related to the current year		10,861
Additions based on tax positions related to prior years (1)		16,847
Reductions to unrecognized tax benefits as a result of a lapse of the applicable statute of limitations		(1,142	)

Gross unrecognized tax benefits at June 30, 2008		114,027
Less: Federal, state and local income tax benefits		21,884

Net unrecognized tax benefits at June 30, 2008		92,143
Less: Unrecognized tax benefits included above that relate to acquired entities that would impact goodwill if recognized		13,708

Total unrecognized tax benefits that, if recognized, would impact the effective income tax rate as of June 30, 2008	$	78,435


Related party loans at December 31, 2007	$	13,963
Loan fundings		4,785
Loan repayments		(672	)
Reduction of executive officers		(1,637	)


Related party loan balance at June 30, 2008	$	16,439


	Fair Value Measurements at Reporting Date Using:
	Quoted Prices in
	Active Markets for		Significant Other			Significant		Balance at
	Identical Assets		Observable Inputs			Unobservable		June 30,
	(Level 1)		(Level 2)			Inputs (Level 3)		2008
Assets:
US Treasury and government agency securities	$	—	$	66,296		$	—	$	66,296
Debentures of FHLB, FNMA and FHLMC		—		22,331			—		22,331
Corporate debt and asset-backed securities		—		53,370			458,040		511,410
Equity securities		—		16,586			588,171		604,757
State and municipal securities		—		2,417,826			—		2,417,826
Mortgage backed securities		—		6,338,223			1,157,341		7,495,564

Total investment securities available for sale		—		8,914,632			2,203,552		11,118,184
Loans held for sale		—		469,189			—		469,189
Derivatives		—		(165,711	)		—		(165,711	)
Mortgage servicing rights		—		—			181,129		181,129
Other assets		—		44,417			3,448		47,865

Total	$	—	$	9,262,527		$	2,388,129	$	11,650,656


	Investments			Mortgage
	Available			Servicing			Other
	for Sale			Rights			Assets			Total
Balance at December 31, 2007	$	2,700,513		$	162,623		$	7,104		$	2,870,240
Gains/(losses) in other comprehensive income		(382,813	)		—			—			(382,813	)
Gains/(losses) in earnings		(4,381	)		(3,086	)		—			(7,467	)
Purchases/Additions		104			42,449			—			42,553
Repayments		(109,871	)		—			(735	)		(110,606	)
Sales/Amortization		—			(20,857	)		(2,921	)		(23,778	)

Balance at June 30, 2008	$	2,203,552		$	181,129		$	3,448		$	2,388,129


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

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


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


	Three months ended						Six months ended
	June 30,						June 30,
	2008			2007			2008			2007
Sales of mortgage loans and related securities	$	4,999		$	3,317		$	8,977		$	8,864
Sale of correspondent home equity loans		—			—			—			(119,892	)
Net gains under SFAS 133		1,602			783			2,972			395
Mortgage servicing fees		12,182			10,460			24,098			20,189
Amortization of mortgage servicing rights		(11,034	)		(8,236	)		(19,103	)		(17,718	)
Residential mortgage servicing rights recoveries		19,837			656			1,134			656
Sales of multi-family loans		9,676			5,748			18,906			16,305
Recoveries/(impairments) to multi-family mortgage servicing rights		635			—			(4,220	)		—
Net gain recorded on commercial mortgage backed securitization		—			13,772			—			10,496


Total mortgage banking income	$	37,897		$	26,500		$	32,764		$	(80,705	)


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


	June 30, 2008					December 31, 2007
			% of					% of			March 31, 2009					December 31, 2008
			Loans					Loans					% of					% of
			to					to					Loans to					Loans to
			Total					Total					Total					Total
	Amount		Loans			Amount		Loans			Amount		Loans			Amount		Loans
Allocated allowance:
Commercial loans	$	527,645		57	%	$	433,951		54	%	$	912,569		56	%	$	752,835		57	%
Consumer loans secured by real estate		131,884		32			117,380		34			236,854		34			193,430		33
Consumer loans not secured by real estate		140,757		11			149,768		12			192,080		10			149,099		10
Unallocated allowance		8,462		n/a			8,345		n/a			2,977		n/a			7,389		n/a


Total allowance for loan losses	$	808,748		100	%	$	709,444		100	%	$	1,344,480		100	%	$	1,102,753		100	%
Reserve for unfunded lending commitments		34,764					28,301					172,780					65,162


Total allowance for credit losses	$	843,512				$	737,745				$	1,517,260				$	1,167,915


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


(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 ~~June 30, 2008.~~March 31, 2009. 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.


	Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs

Commitments to extend credit	$	15,347,951	$	5,741,521	$	3,453,117	$	1,353,239	$	4,800,074
Standby letters of credit		2,688,054		683,609		1,049,675		659,550		295,220
Loans sold with recourse		476,767		174,404		37,533		79,290		185,540
Forward buy commitments		408,970		395,790		13,180		—		—


Total commercial commitments	$	18,921,742	$	6,995,324	$	4,553,505	$	2,092,079	$	5,280,834


	SHARES
									BROKER
PROPOSAL	FOR		AGAINST		WITHHELD		ABSTENTIONS		NON-VOTES

1. To elect four (4) Class III directors of Sovereign, each to serve for a term of three years and until their successors shall have been elected and qualified:
Joseph P. Campanelli		361,705,710		N/A		36,137,820		—		—
William J. Moran		363,229,262		N/A		34,614,269		—		—
Maria Fiorini Ramirez		362,913,316		N/A		34,930,214		—		—
Alberto Sanchez		312,536,170		N/A		85,307,360		—		—
2. To ratify the appointment by the Audit Committee of Sovereign’s Board of Directors of Ernst & Young LLP as Sovereign’s independent auditors for the fiscal year ending December 31, 2008		391,807,577		3,265,820		—		2,770,132		—
3. To approve the shareholder proposal to amend the Sovereign Bancorp, Inc. 2004 Broad-Based Stock Incentive Plan		309,495,948		13,318,750		—		3,414,827		71,614,005


		SOVEREIGN BANCORP, INC.
		(Registrant)

Date: ~~July 31, 2008~~May 11, 2009		/s/ ~~Joseph P. Campanelli~~Gabriel Jaramillo

		Gabriel Jaramillo
		~~Joseph P. Campanelli,~~
		Chairman of the Board, Chief Executive Officer ~~and President~~
		(Authorized Officer)

Date: ~~July 31, 2008~~May 11, 2009		/s/ ~~Kirk W. Walters~~Guillermo Sabater


		~~Kirk W. Walters~~Guillermo Sabater
		Chief Financial Officer
		(Principal Financial Officer)

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