Santander Holdings USA (SOV) 10-Q 2006 Q3 Quarterly report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

for the quarter ended September 30, 2006

OR

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

for the transition period from                    to                    .

Commission File Number: 001-16581

SOVEREIGN BANCORP, INC.

(Exact name of Registrant as specified in its charter)

Pennsylvania	23-2453088
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
1500 Market Street, Philadelphia, Pennsylvania	19102
(Address of principal executive offices)	(Zip Code)

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

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

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

Large accelerated filerþ     Accelerated filero      Non-accelerated filero

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

APPLICABLE ONLY TO CORPORATE ISSUERS:

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

Class	Outstanding at October 31, 2006
Common Stock (no par value)	472,910,533 shares

FORWARD LOOKING STATEMENTS

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

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

• growth in earnings per share;

• return on equity;

• return on assets;

• efficiency ratio;

• Tier 1 leverage ratio;

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

• fee income as a percentage of total revenue;

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

• book value and tangible book value per share; and

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

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

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

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

• inflation, interest rate, market and monetary fluctuations;

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

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

1

FORWARD LOOKING STATEMENTS
(continued)

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

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

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

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

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

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

• technological changes;

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

• changes in consumer spending and savings habits;

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

• regulatory or judicial proceedings;

• changes in asset quality;

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

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

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

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

2

INDEX

	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at September 30, 2006 and December 31, 2005		4
Consolidated Statements of Operations for the three-month and nine-month periods ended September 30, 2006 and 2005		5-6
Consolidated Statement of Stockholders’ Equity for the nine-month period ended September 30, 2006		7
Consolidated Statements of Cash Flows for the nine-month periods ended September 30, 2006 and 2005		8
Notes to Consolidated Financial Statements		9-35
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		36-58
Item 3. Quantitative and Qualitative Disclosures About Market Risk		59
Item 4. Controls and Procedures		59
PART II. OTHER INFORMATION
1. Legal Proceedings		60
1A. Risk Factors		60
Item 5. Other information		60
Item 6. Exhibits		61
SIGNATURES		62
EXHIBITS INDEX		63
Ex-31.1 Certification
Ex-31.2 Certification
Ex-32.1 Certification
Ex-32.2 Certification
Chief Executive Officer certification
Chief Financial Officer certification
Chief Executive Officer certification, pursuant to Section 906
Chief Financial Officer certification, pursuant to Section 906

3

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)

	September 30,			December 31,
	2006			2005
	(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	1,932,603		$	1,131,936
Investment securities:
Available-for-sale		12,821,075			7,258,402
Held-to-maturity		—			4,647,627
Other investments		1,020,723			651,299
Loans (including loans held for sale of $712,073 and $311,578 at September 30, 2006 and December 31, 2005, respectively)		63,177,720			43,803,847
Allowance for loan losses		(544,482	)		(419,599	)
Net loans		62,633,238			43,384,248
Premises and equipment		591,601			412,017
Accrued interest receivable		413,018			286,300
Goodwill		4,989,539			2,716,826
Core deposit intangibles and other intangibles, net of accumulated amortization of $594,916 and $519,380 at September 30, 2006 and December 31, 2005, respectively		532,626			213,975
Bank owned life insurance		1,704,955			1,018,125
Other assets		3,770,681			1,957,971
TOTAL ASSETS	$	90,410,059		$	63,678,726
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	52,783,614		$	37,977,706
Borrowings and other debt obligations		27,100,522			18,720,897
Advance payments by borrowers for taxes and insurance		125,933			49,313
Other liabilities		1,456,241			914,451
TOTAL LIABILITIES		81,466,310			57,662,367
Minority interests		209,972			205,660
STOCKHOLDERS’ EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares authorized; 4,000,000 shares issued and outstanding		195,445			—
Common stock; no par value; 800,000,000 shares authorized; 478,808,877 shares issued at September 30, 2006 and 382,582,202 shares issued at December 31, 2005		6,166,992			3,657,543
Warrants and employee stock options issued		338,867			337,346
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 3,105,149 shares at September 30, 2006 and December 31, 2005		(21,396	)		(21,396	)
Treasury stock at cost; 3,098,115 shares at September 30, 2006 and 21,606,549 shares at December 31, 2005		(57,646	)		(478,734	)
Accumulated other comprehensive loss		(74,543	)		(170,798	)
Retained earnings		2,186,058			2,486,738
TOTAL STOCKHOLDERS’ EQUITY		8,733,777			5,810,699
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	90,410,059		$	63,678,726

See accompanying notes to consolidated financial statements.

4

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)

	Three-Month Period				Nine-Month Period
	Ended September 30,				Ended September 30,
	2006		2005		2006			2005
			(in thousands, except, per share data)
INTEREST INCOME:
Interest-earning deposits	$	5,408	$	2,022	$	10,478		$	6,151
Investment securities:
Available-for-sale		201,766		86,411		408,514			268,529
Held-to-maturity		1,065		47,624		105,091			137,834
Other investments		13,287		4,443		31,906			13,087
Interest on loans		1,019,325		620,742		2,516,413			1,725,950
TOTAL INTEREST INCOME		1,240,851		761,242		3,072,402			2,151,551
INTEREST EXPENSE:
Deposits and customer accounts		412,858		169,084		950,725			423,141
Borrowings and other debt obligations		336,206		183,817		787,161			499,564
TOTAL INTEREST EXPENSE		749,064		352,901		1,737,886			922,705
NET INTEREST INCOME		491,787		408,341		1,334,516			1,228,846
Provision for credit losses		45,000		20,000		118,500			64,000
NET INTEREST INCOME AFTER PROVISION FOR CREDIT LOSSES		446,787		388,341		1,216,016			1,164,846
NON-INTEREST INCOME:
Consumer banking fees		74,298		65,738		202,563			191,920
Commercial banking fees		47,690		39,519		130,655			102,576
Mortgage banking income		14,329		28,671		31,845			61,616
Capital markets revenue		4,009		5,382		10,211			13,768
Bank owned life insurance		20,116		12,066		46,802			35,887
Miscellaneous income		11,409		6,856		26,091			25,299
TOTAL FEES AND OTHER INCOME		171,851		158,232		448,167			431,066
Net gain/ (loss) on investment securities		29,154		1,675		(275,873	)		13,009
TOTAL NON-INTEREST INCOME		201,005		159,907		172,294			444,075
GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		182,607		140,532		475,852			401,460
Occupancy and equipment expenses		78,594		61,096		210,942			185,314
Technology expense		25,128		21,349		69,808			61,623
Outside services		17,928		15,362		49,275			43,815
Marketing expense		14,552		14,455		39,322			37,259
Other administrative expenses		33,009		24,107		89,891			77,935
TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		351,818		276,901		935,090			807,406

5

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

	Three-Month Period					Nine-Month Period
	Ended September 30,					Ended September 30,
	2006		2005			2006		2005
OTHER EXPENSES:
Amortization of intangibles	$	34,092	$	18,284		$	75,536	$	56,055
Loss on economic hedges		—		—			11,387		—
Minority interest expense		6,149		5,837			18,220		17,257
Merger-related and integration charges (reversal)		28,403		(2,000	)		31,862		12,744
Equity method investments		6,701		11,656			27,697		33,392
Lease and contract termination charges		—		(1,222	)		—		3,982
Proxy and related professional fees		—		—			14,337		—
TOTAL OTHER EXPENSES		75,345		32,555			179,039		123,430
INCOME BEFORE INCOME TAXES		220,629		238,792			274,181		678,085
Income tax provision		36,620		57,749			7,830		167,420
NET INCOME	$	184,009	$	181,043		$	266,351	$	510,665
EARNINGS PER SHARE:
Basic	$	0.39	$	0.48	*	$	0.62	$	1.33	*
Diluted	$	0.37	$	0.45	*	$	0.62	$	1.27	*
DIVIDENDS DECLARED PER COMMON SHARE	$	0.08	$	0.04		$	0.22	$	0.11

* After giving retroactive effect to the 5% stock dividend declared on June 15, 2006.

See accompanying notes to consolidated financial statements.

6

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY

FOR THE NINE-MONTH PERIOD ENDED SEPTEMBER 30, 2006
(unaudited)
(in thousands)

											Unallocated
	Common										Common						Accumulated						Total
	Shares							Warrants			Stock						Other						Stock-
	Out-			Common		Preferred		& Stock			Held by			Treasury			Comprehensive			Retained			Holders’
	Standing			Stock		Stock		Options			ESOP			Stock			Income/(Loss)			Earnings		��	Equity
Balance, December 31, 2005		358,018		$	3,657,543	$	—	$	337,346		$	(21,396	)	$	(478,734	)	$	(170,798	)	$	2,486,738		$	5,810,699
Comprehensive income:
Net income		—			—		—		—			—			—			—			266,351			266,351
Change in unrealized gain/loss, net of tax:
Investment securities available for sale		—			—		—		—			—			—			121,079			—			121,079
Cash flow hedge derivative financial instruments		—			—		—		—			—			—			(24,824	)		—			(24,824	)
Total comprehensive income																								362,606
Stock issued in connection with employee benefit and incentive compensation plans		2,284			8,166		—		(3,293	)		—			36,388			—			—			41,261
Employee stock options earned		—			—		—		4,814			—			—			—			—			4,814
Dividends paid on common stock		—			—		—		—			—			—			—			(88,212	)		(88,212	)
Dividends paid on preferred stock		—			—		—		—			—			—			—			(4,258	)		(4,258	)
Stock dividend		22,607			474,561		—		—			—			—			—			(474,561	)		—
Issuance of common stock		89,944			2,026,722		—		—			—			389,954			—			—			2,416,676
Issuance of preferred stock, net of issuance costs		—			—		195,445		—			—			—			—			—			195,445
Stock repurchased		(247	)		—		—		—			—			(5,254	)		—			—			(5,254	)
Balance, September 30, 2006		472,606		$	6,166,992	$	195,445	$	338,867		$	(21,396	)	$	(57,646	)	$	(74,543	)	$	2,186,058		$	8,733,777

See accompanying notes to consolidated financial statements.

7

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)

	Nine-Month Period
	Ended September 30,
	2006			2005
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	266,351		$	510,665
Adjustments to reconcile net income to net cash provided by operating activities, net of acquisitions:
Provision for credit losses		118,500			64,000
Depreciation and amortization		155,427			125,565
Net amortization/accretion of investment securities and loan premiums and discounts		90,022			56,129
Net gain on sale of loans		(34,453	)		(64,405	)
Net (gain)/loss on investment securities		275,873			(13,009	)
Net (gain)/loss on real estate owned and premises and equipment		896			(317	)
Net loss on economic hedges		11,387			—
Stock-based compensation		22,442			24,197
Origination and purchases of loans held for sale, net of repayments		(2,157,720	)		(1,217,578	)
Proceeds from sales of loans held for sale		1,819,931			1,027,693
Net change in:
Accrued interest receivable		(47,882	)		(39,108	)
Other assets and bank owned life insurance		(1,955,915	)		97,626
Other liabilities		69,645			199,490
Net cash provided by operating activities		(1,365,496	)		770,948
CASH FLOWS FROM INVESTING ACTIVITIES:
Adjustments to reconcile net cash used in investing activities, net of acquisitions:
Proceeds from sales of investment securities:
Available-for-sale		9,644,535			1,585,817
Held-to-maturity		1,774,475			—
Proceeds from repayments and maturities of investment securities:
Available-for-sale		1,496,817			1,196,649
Held-to-maturity		186,845			443,297
Net change in FHLB stock		(331,916	)		(559,193	)
Purchases of available-for-sale investment securities		(10,481,973	)		(2,532,052	)
Purchases of held-to-maturity investment securities		(557,704	)		(1,023,411	)
Proceeds from sales of loans		4,003,156			5,602,784
Purchase of loans		(6,546,275	)		(4,981,500	)
Net change in loans other than purchases and sales		(3,394,957	)		(3,876,106	)
Proceeds from sales of premises and equipment		13,408			13,177
Purchases of premises and equipment		(76,074	)		(68,175	)
Proceeds from sales of real estate owned		5,249			5,991
Net cash (paid)/received from business combinations		(2,713,208	)		281,229
Net cash used in investing activities		(6,977,622	)		(3,911,493	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Adjustments to reconcile net cash provided by financing activities, net of acquisitions:
Net increase/(decrease) in deposits and other customer accounts		3,771,155			1,895,196
Net increase/(decrease) in borrowings		2,545,871			1,537,718
Proceeds from senior notes and credit facility		875,000			800,000
Repayments of borrowings and other debt obligations		(550,000	)		(350,000	)
Net increase (decrease) in advance payments by borrowers for taxes and insurance		(32,640	)		3,516
Cash dividends paid to preferred stockholders		(4,258	)		—
Cash dividends paid to common stockholders		(88,212	)		(39,493	)
Proceeds from issuance of preferred stock, net of transaction costs		195,445			—
Proceeds from issuance of common stock, net of transaction costs		2,033,649			28,892
Treasury stock repurchases, net of proceeds		397,775			(457,966	)
Net cash provided by financing activities		9,143,785			3,417,863
Net change in cash and cash equivalents		800,667			277,318
Cash and cash equivalents at beginning of period		1,131,936			1,160,922
Cash and cash equivalents at end of period	$	1,932,603		$	1,438,240
Supplemental Disclosures:
Income taxes paid	$	82,081		$	9,712
Interest paid	$	1,316,197		$	860,938

     Non cash transactions: On January 21, 2005, Sovereign issued 29,812,669 shares in partial consideration for the acquisition of Waypoint Financial Corp.

See accompanying notes to consolidated financial statements.

8

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(dollars in thousands, except per share amounts)
(Unaudited)

(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

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

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

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

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

     In accordance with banking regulatory reporting guidance issued in the first quarter of 2006, Sovereign reclassified prepayment fees and late fees on loans from non-interest income to interest income. Prior periods were reclassified to conform to the current period presentation.

(2) EARNINGS PER SHARE

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

9

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

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

	Three-Month Period					Nine-Month Period
	Ended September 30,					Ended September 30,
	2006			2005		2006			2005
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income as reported and for basic EPS	$	184,009		$	181,043	$	266,351		$	510,665
Less preferred dividend		(1,825	)		—		(4,258	)		—
Net income available to common stockholders		182,184			181,043		262,093			510,665
Contingently convertible trust preferred interest expense, net of tax		6,344			6,344		19,006			19,074
Net Income for diluted EPS available to common stockholders	$	188,528		$	187,387	$	281,099		$	529,739
WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares		472,447			378,314		420,673			383,904
Dilutive effect of:
Warrants		27,435			27,399		27,427			27,393
Stock options		6,253			7,053		6,165			6,837
Weighted average diluted shares		506,135			412,766		454,265			418,134
EARNINGS PER SHARE:
Basic	$	0.39		$	0.48	$	0.62		$	1.33
Diluted	$	0.37		$	0.45	$	0.62		$	1.27

10

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

(3) INVESTMENT SECURITIES

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

	September 30, 2006
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	78,141	$	—	$	551	$	77,590
Debentures of FHLB, FNMA, and FHLMC		256,700		1,634		3,938		254,396
Corporate debt and asset-backed securities		956,205		1,698		2,030		955,873
Equity securities (1)		894,381		41,809		—		936,190
State and municipal securities		2,512,528		35,844		3,037		2,545,335
Mortgage-backed securities:
U.S. government agencies		908,727		695		30,685		878,737
FHLMC and FNMA debt securities		2,244,497		12,238		9,121		2,247,614
Non-agency securities		5,020,613		6,107		101,380		4,925,340
Total investment securities available-for-sale	$	12,871,792	$	100,025	$	150,742	$	12,821,075

	December 31, 2005
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	48,507	$	—	$	764	$	47,743
Debentures of FHLB, FNMA and FHLMC		182,809		2,098		2,970		181,937
Corporate debt and asset-backed securities		105,810		36		—		105,846
Equity securities (1)		967,515		1,231		13,595		955,151
State and municipal securities		4,758		11		301		4,468
Mortgage-backed securities:
U.S. government agencies		1,153,497		705		31,332		1,122,870
FHLMC and FNMA debt securities		2,094,665		1,751		59,626		2,036,790
Non-agency securities		2,860,278		1,396		58,077		2,803,597
Total investment securities available-for-sale	$	7,417,839	$	7,228	$	166,665	$	7,258,402

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

11

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

(3) INVESTMENT SECURITIES (continued)

     The following table presents the composition and fair value of investment securities held-to-maturity at the dates indicated (in thousands):

	December 31, 2005
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	7,241	$	—	$	147	$	7,094
Corporate debt and asset-backed securities		103,954		6		895		103,065
State and municipal securities		1,752,739		23,515		17,167		1,759,087
Mortgage-backed securities:
U.S. government agencies		99,640		—		2,864		96,776
FHLMC and FNMA debt securities		1,940,582		3,505		74,988		1,869,099
Non-agency securities		743,471		29		17,224		726,276
Total investment securities held-to-maturity	$	4,647,627	$	27,055	$	113,285	$	4,561,397

     Investment securities available for sale and held to maturity with an estimated fair value of $9.7 billion and $8.4 billion were pledged as collateral for borrowings, interest rate protection agreements and certain deposits at September 30, 2006 and December 31, 2005, respectively.

     During the second quarter following the acquisition of Independence Community Bank Corp. (discussed in Note 18), Sovereign sold $3.5 billion of investment securities with a combined effective yield of 4.40% for asset/liability management purposes and to offset, in part, the negative effect of the current yield curve on net interest margin for future periods and incurred a pre-tax loss of $238.3 million ($154.9 million after-tax or $0.38 per diluted share). Of the total $3.5 billion of investments sold, $1.8 billion had been previously classified as held-to-maturity and Sovereign recorded a pretax loss of $130.1 million related to the sale of the held-to-maturity securities. As a result of the sale of the held-to-maturity securities, Sovereign concluded that we were required to reclassify the remaining $3.2 billion of held to maturity investment securities to the available for sale investment category.

12

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

(3) INVESTMENT SECURITIES (continued)

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

		At September 30, 2006
		Less than 12 months					12 months or longer					Total
				Unrealized					Unrealized					Unrealized
		Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities		$	31,162	$	(184	)	$	39,952	$	(367	)	$	71,114	$	(551	)
Debentures of FHLB, FNMA and FHLMC			122,714		(2,298	)		110,335		(1,640	)		233,049		(3,938	)
Corporate debt and asset-backed securities			149,579		(546	)		62,444		(1,484	)		212,023		(2,030	)
Equity securities			—		—			—		—			—		—
State and municipal securities	��		111,624		(24	)		650,898		(3,013	)		762,522		(3,037	)
Mortgage-backed Securities:
U.S. government agencies			441		(9	)		832,139		(30,676	)		832,580		(30,685	)
FHLMC and FNMA debt securities			227,268		(1,418	)		307,194		(7,703	)		534,462		(9,121	)
Non-agency securities			1,268,464		(19,992	)		2,381,948		(81,388	)		3,650,412		(101,380	)
Total investment securities available-for-sale		$	1,911,252	$	(24,471	)	$	4,384,910	$	(126,271	)	$	6,296,162	$	(150,742	)

	At December 31, 2005
	Less than 12 months					12 months or longer					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
Investment Securities
U.S. Treasury and government agency securities	$	25,937	$	(368	)	$	28,899	$	(543	)	$	54,836	$	(911	)
Debentures of FHLB, FNMA and FHLMC		150,671		(2,799	)		9,835		(171	)		160,506		(2,970	)
Corporate debt and asset-backed securities		63,748		(895	)		4		—			63,752		(895	)
Equity securities		858,985		(13,595	)		—		—			858,985		(13,595	)
State and municipal securities		1,141,155		(17,468	)		—		—			1,141,155		(17,468	)
Mortgage-backed Securities:
U.S. government agencies		796,850		(22,276	)		384,197		(11,920	)		1,181,047		(34,196	)
FHLMC and FNMA securities		1,180,024		(35,160	)		2,490,404		(99,454	)		3,670,428		(134,614	)
Non-agency securities		1,462,615		(32,091	)		1,359,094		(43,210	)		2,821,709		(75,301	)
Total investment securities available-for-sale and held to maturity	$	5,679,985	$	(124,652	)	$	4,272,433	$	(155,298	)	$	9,952,418	$	(279,950	)

13

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

(3) INVESTMENT SECURITIES (continued)

     As of September 30, 2006, management has concluded that the unrealized losses above on its debt securities (which totaled 257 individual securities) are temporary in nature since they are not related to the underlying credit quality of the issuers, and the Company has the intent and ability to hold these investments for the time necessary to recover its cost and will ultimately recover its cost at maturity (i.e. these investments have contractual maturities that ensure Sovereign will ultimately recover its cost). In making its other than temporary impairment evaluation, Sovereign considered the fact that the principal and interest on these securities are from U.S. Government and Government Agencies as well as issuers that are investment grade (Aaa rated). The change in the unrealized losses on the U.S. Government and Government Agencies mortgage-backed securities, Federal Home Loan Mortgage Corporation (“FHLMC”) and Federal National Mortgage Association (“FNMA”) securities and the non-agency mortgage-backed securities were caused by changes in interest rates. Because the decline in market value is attributable to changes in interest rates and not credit quality, and because the Company has the intent and ability to hold those investments until a recovery of fair value, which may be maturity, the Company does not consider those investments to be other-than-temporarily impaired.

     During the second quarter, the Company recorded an other-than-temporary impairment charge of $67.5 million ($43.9 million after-tax or $0.11 per diluted share) on FNMA and FHLMC perpetual preferred stock as management concluded that in accordance with SFAS No. 115 “Accounting for Certain Investments in Debt and Equity Securities” and the SEC’s Staff Accounting Bulletin No. 59 “Accounting for Non-current Marketable Equity Securities” as recovery to Sovereign’s cost basis on these securities was not probable within a reasonable period of time based on the near-term prospects of the issuers and the anticipated interest rate and liquidity spreads expected in the near term. As of September 30, 2006, Sovereign held nine securities totaling $917 million of perpetual preferred stock of FHLMC and FNMA, which had an unrealized gain of $40.7 million.

(4) OTHER INVESTMENTS

     Other investments of $1.0 billion and $651 million at September 30, 2006 and December 31, 2005, respectively, represent Sovereign’s investment in the stock of the Federal Home Loan Bank (FHLB) of Boston, New York and Pittsburgh. The increase in other investments is due to the investment in the FHLB stock of New York acquired in connection with the Independence acquisition, which is discussed in Note 18. Although FHLB stock is an equity interest in a FHLB, it does not have a readily determinable fair value for purposes of FASB Statement No. 115, because its ownership is restricted and it lacks a market. FHLB stock can be sold back only at its par value of $100 per share and only to the FHLB or to another member institution.

14

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

(5) LOANS

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

	September 30, 2006					December 31, 2005
	Amount		Percent			Amount		Percent
Commercial real estate loans (1)	$	11,401,902		18.0	%	$	7,209,180		16.5	%
Commercial and industrial loans		12,611,627		20.0			9,426,466		21.5
Multifamily loans (1)		5,970,796		9.5			—		—
Total Commercial Loans		29,984,325		47.5			16,635,646		38.0
Residential mortgages		17,817,283		28.2			12,462,802		28.4
Home equity loans and lines of credit		10,506,606		16.6			9,793,124		22.4
Total consumer loans secured by real estate		28,323,889		44.8			22,255,926		50.8
Auto loans		4,431,891		7.0			4,434,021		10.1
Other		437,615		0.7			478,254		1.1
Total Consumer Loans		33,193,395		52.5			27,168,201		62.0
Total Loans (2)	$	63,177,720		100.0	%	$	43,803,847		100.0	%
Total Loans with:
Fixed rate	$	40,521,873		64.1	%	$	26,141,411		59.7	%
Variable rate		22,655,847		35.9			17,662,436		40.3
Total Loans (2)	$	63,177,720		100.0	%	$	43,803,847		100.0	%

(1)

Effective with the acquisition of Independence on June 1, 2006, Sovereign acquired $5.6 billion of multifamily loans. As this was primarily a new asset class of Sovereign we have disclosed these loans separately in the table above. At December 31, 2005, Sovereign had approximately $475 million of multifamily loans which is classified in commercial real estate loans.

(2)

Loan totals include deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts. These items resulted in a net increase in loans of $291.6 million and $312.8 million at September 30, 2006 and December 31, 2005, respectively. Loans pledged as collateral totaled $25.8 billion and $15.8 billion at September 30, 2006 and December 31, 2005, respectively.

     Included in mortgage banking income on the Consolidated Statement of Operations are gains on the sale of mortgage loans, home equity loans, and multifamily loans. Sovereign had gains on the sales of these products for the three-month and nine-month periods ended September 30, 2006 of $14.7 million and $27.6 million compared with gains of $21.3 million and $56.0 million for the corresponding periods in the prior year.

15

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

(6) DEPOSIT PORTFOLIO COMPOSITION

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

	September 30, 2006								December 31, 2005
						Weighted								Weighted
						Average								Average
Account Type	Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	6,687,150		12.7	%		—	%	$	5,331,659		14.0	%		—	%
NOW accounts		10,517,818		19.9			2.67			8,844,875		23.3			2.07
Customer repurchase agreements		1,457,129		2.8			4.68			1,012,574		2.7			3.71
Savings accounts		4,919,190		9.3			0.64			3,460,292		9.1			0.79
Money market accounts		12,449,563		23.6			3.74			7,989,846		21.0			2.21
Certificates of deposit		16,752,764		31.7			4.50			11,338,460		29.9			3.79
Total Deposits	$	52,783,614		100.0	%		3.03	%	$	37,977,706		100.0	%		2.25	%

(7) BORROWINGS AND OTHER DEBT OBLIGATIONS

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

	September 30, 2006					December 31, 2005
			Effective					Effective
	Balance		Rate			Balance		Rate
Sovereign Bank borrowings and other debt obligations:
Securities sold under repurchase agreements	$	258,824		3.92	%	$	189,112		4.19	%
Fed funds purchased		1,605,000		5.20			819,000		4.14
FHLB advances		19,854,235		4.69			13,295,493		4.46
Asset-backed floating rate notes and secured financings		1,971,000		3.56			1,971,000		2.50
Subordinated notes		1,378,407		4.76			772,063		5.27
Holding company borrowings and other debt obligations:
Senior notes		498,444		5.16			797,916		4.76
Junior subordinated debentures due to Capital Trust Entities		1,534,612		7.66			876,313		8.09
Total borrowing and other debt obligations	$	27,100,522		4.81	%	$	18,720,897		4.45	%

     Sovereign currently has a series of callable advances totaling $2.8 billion with the FHLB. These advances provide variable funding (currently at 3.15%) during the non-call period which ranges from 6 to 18 months. After the non-call period, the interest rates on these advances resets to a fixed rate of interest with certain caps (ranging from 4.90% to 5.50%) and floors of 0%. Based on the current interest rate environment, these instruments may be called by the FHLB upon the expiration of the non-call period.

16

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

(7) BORROWINGS AND OTHER DEBT OBLIGATIONS (continued)

     On May 22, 2006, Sovereign’s wholly-owned subsidiary, Sovereign Capital Trust V issued $175 million capital securities which are due May 22, 2036. Principal and interest on Trust V Capital Securities are paid by junior subordinated debentures due to Trust V from Sovereign whose terms and conditions mirror the Capital Securities. The capital securities represent preferred beneficial interests in Trust V. Distributions on the capital securities accrue from the original issue date and are payable, quarterly in arrears on the 15th day of February, May, August and November of each year, beginning on August 15, 2006 at an annual rate of 7.75%. The capital securities are not redeemable prior to May 22, 2011. The proceeds from the offering were used to finance a portion of the purchase price for Sovereign’s acquisition of Independence, which closed on June 1, 2006. Sovereign presents the junior subordinated debentures due to Trust V as a component of borrowings.

     On May 31, 2006, Sovereign’s wholly-owned subsidiary, Sovereign Capital Trust IX (the “Trust”) issued $150 million capital securities which are due July 7, 2036. Principal and interest on Trust IX Capital Securities are paid by junior subordinated debentures due to Trust IX from Sovereign whose terms and conditions mirror the Capital Securities. The capital securities represent preferred beneficial interests in Trust IX. Distributions on the capital securities accrue from the original issue date and are payable, quarterly in arrears on the 7th day of January, April, July and October of each year, beginning on July 7, 2006 at an annual rate of three-month LIBOR plus 1.75%. The capital securities are callable at a redemption price of 105% of par during the first five years, after which they are callable at par. The proceeds from the offering were used to finance a portion of the purchase price for Sovereign’s pending acquisition of Independence, which closed on June 1, 2006. Sovereign presents the junior subordinated debentures due to Trust IX as a component of borrowings.

     On June 13, 2006, Sovereign’s wholly owned subsidiary, Sovereign Capital Trust VI issued $300 million capital securities which are due June 13, 2036. Principal and interest on Trust VI Capital Securities are paid by junior subordinated debentures due to Trust VI from Sovereign whose terms and conditions mirror the Capital Securities. The capital securities will represent preferred beneficial interests in Trust VI. Distributions on the capital securities accrue from the original issue date and are payable, semiannually in arrears on the 13th day of June and December of each year, beginning on December 13, 2006 at an annual rate of 7.91%. The capital securities are not redeemable prior to June 13, 2016. The proceeds from the offering were used for general corporate purposes. Sovereign presents the junior subordinated debentures due to Trust VI as a component of borrowings.

     The Capital Trusts above are variable interest entities as defined by FASB Interpretation No. 46(R), “Consolidation of Variable Interest Entities, an Interpretation of ARB No. 51”. Sovereign has determined that it is not the primary beneficiary of any of these trusts, and as a result, they are not consolidated by the Company.

     In connection with the acquisition of Independence, Sovereign assumed $250 million of senior notes and $400 million of subordinated borrowing obligations. The senior notes mature in September 2010 and carry a fixed rate of interest of 4.90%. The $400 million of subordinated notes include $250 million of 3.75% Fixed Rate/ Floating Rate Subordinated Notes Due March 2014 (“2004 Notes”) which bear interest at a fixed rate of 3.75% per annum for the first five years, and convert to a floating rate thereafter until maturity based on the US Dollar three-month LIBOR plus 1.82%. Beginning on April 1, 2009 Sovereign has the right to redeem the 2004 Notes at par plus accrued interest. The subordinated notes also include $150.0 million aggregate principal amount of 3.50% Fixed Rate/ Floating Rate Subordinated Notes Due June 2013 (“2003 Notes”). The 2003 Notes bear interest at a fixed rate of 3.50% per annum for the first five years, and convert to a floating rate thereafter until maturity based on the US Dollar three-month LIBOR plus 2.06%. Beginning on June 20, 2008 Sovereign has the right to redeem the 2003 Notes at par plus accrued interest.

17

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

(8) DERIVATIVES

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

     Fair Value Hedges. Sovereign has entered into pay-variable, receive-fixed interest rate swaps to hedge changes in fair values of certain brokered certificates of deposits and certain debt obligations. For the quarter ended September 30, 2006 and 2005, hedge ineffectiveness of $2.2 million and $0.2 million was recorded in earnings associated with fair value hedges.

     During the second quarter of 2006, Sovereign terminated certain derivative positions that were previously designated as fair value hedges against $500 million of subordinated notes maturing in March 2013. The $41.3 million basis adjustment is being amortized under the effective yield method over the remaining term of the debt.

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

     Cash Flow Hedges. Sovereign hedges exposures to changes in cash flows associated with forecasted interest payments on variable-rate liabilities, through the use of pay-fixed, receive variable interest rate swaps. For the nine-months ended September 30, 2006 and 2005, no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. No gains or losses deferred in accumulated other comprehensive income were reclassified into earnings during the nine-months ended September 30, 2006 or 2005 as a result of discontinuance of cash flow hedges for which the forecasted transaction was not probable of occurring. As of September 30, 2006, Sovereign expects approximately $25.0 million of the deferred net after-tax loss on derivative instruments included in accumulated other comprehensive income to be reclassified to earnings during the next twelve months.

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

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

18

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

(8) DERIVATIVES (continued)

     Shown below is a summary of the derivatives designated as hedges under SFAS No. 133 at September 30, 2006 and December 31, 2005 (dollars in thousands):

							Weighted Average
	Notional						Receive			Pay			Life
	Amount		Asset		Liability		Rate			Rate			(Years)
September 30, 2006
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	1,066,000	$	—	$	22,931		4.20	%		5.32	%		2.2
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		8,500,000		20,336		53,824		5.44	%		5.09	%		2.6
Total derivatives used in SFAS 133 hedging relationships	$	9,566,000	$	20,336	$	76,755		5.30	%		5.11	%		2.6
December 31, 2005
Fair value hedges:
Receive fixed – pay variable interest rate swaps	$	2,440,000	$	—	$	52,885		4.05	%		4.54	%		3.4
Cash flow hedges:
Pay fixed – receive floating interest rate swaps		3,650,000		21,295		2,730		4.38	%		4.17	%		2.0
Total derivatives used in SFAS 133 hedging relationships	$	6,090,000	$	21,295	$	55,615		4.25	%		4.32	%		2.5

19

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

(8) DERIVATIVES (continued)

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

	September 30,			December 31,
	2006			2005
	Net Asset			Net Asset
	(Liability)			(Liability)
Mortgage banking derivatives:
Forward commitments to sell loans	$	(1,281	)	$	(538	)
Interest rate lock commitments		691			475
Total mortgage banking risk management		(590	)		(63	)
Swaps receive fixed		(216	)		(4,955	)
Swaps pay fixed		26,479			27,919
Market value hedge		1,265			—
Net customer related interest rate hedges		27,528			22,964
Precious metals forward sale commitments		(22,248	)		(47,982	)
Precious metals forward settlement arrangements		22,580			46,430
Foreign exchange		452			740
Total activity	$	27,722		$	22,089

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

	Balance Sheet Effect at	Income Statement Effect For The Nine-Months Ended
Derivative Activity	September 30, 2006	September 30, 2006
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to CDs of $22.9 million and an increase to other liabilities of $22.9 million.	Resulted in a decrease of net interest income of $14.4 million.
Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other assets, other liabilities, and deferred taxes of $20.3 million, $53.8 million and $11.7 million, respectively, and decrease to stockholder’s equity of $21.8 million.	Resulted in an increase in net interest income of $6.7 million.
Other hedges:
Forward commitments to sell loans	Increase to other liabilities of $1.3 million.	Decrease to mortgage banking income of $0.7 million.
Interest rate lock commitments	Increase to mortgage loans of $0.7 million.	Increase to mortgage banking income of $0.2 million.
Net customer related hedges	Increase to other assets of $27.5 million.	Increase in capital markets revenue of $3.3 million.
Forward commitments and forward settlement arrangements on precious metals	Increase to other assets of $0.3 million	Increase to commercial banking fees of $1.9 million.
Foreign exchange	Increase to other assets of $0.5 million.	Decrease to commercial banking revenues of $0.7 million.

20

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

(8) DERIVATIVES (continued)

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

	Balance Sheet Effect at	Income Statement Effect For The Nine-Months
Derivative Activity	December 31, 2005	Ended September 30, 2005
Fair value hedges:
Receive fixed-pay variable interest rate swaps	Decrease to borrowings and CDs of $24.0 million and $28.9 million, respectively, and an increase to other liabilities of $52.9 million.	Resulted in an increase of net interest income of $11.6 million.
Cash flow hedges:
Pay fixed-receive floating interest rate swaps	Increase to other assets, other liabilities, and stockholders’ equity of $21.3 million, $2.7 million, and $12.1 million, respectively and a decrease to deferred taxes of $6.5 million	Resulted in a decrease in net interest income of $17.3 million.
Other hedges:
Forward commitments to sell loans	Increase to other liabilities of $0.5 million.	Increase to mortgage banking income of $1.8 million.
Interest rate lock commitments	Increase to mortgage loans of $0.5 million.	Increase to mortgage banking income of $0.3 million.
Net customer related swaps	Increase to other assets of $23.0 million.	Increase in capital markets revenue of $1.5 million.
Forward commitments and forward settlement arrangements on precious metals	Decrease to other assets of $1.6 million	Decrease to commercial banking fees of $1.5 million.
Foreign exchange	Increase to other assets of $0.7 million.	Increase to commercial banking revenues of $0.4 million.

     Net interest income resulting from interest rate exchange agreements included $107.6 million and $225.5 million of income and $107.3 million and $233.3 million of expense for the three-month and nine-month periods ended September 30, 2006 compared with $32.5 million and $88.5 million of income and $35.3 million and $94.6 million of expense for the corresponding period in the prior year.

     Net gains generated from derivative instruments (including trading revenues) executed with customers are included as capital markets revenue on the income statement and totaled $4.2 million and $9.0 million for the three-months and nine-months ended September 30, 2006, compared with $2.9 million and $7.0 for the three-months and nine-months ended September 30, 2005.

21

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

(9) COMPREHENSIVE INCOME

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

	Three-Month Period						Nine-Month Period
	Ended September 30,						Ended September 30,
	2006			2005			2006			2005
Net (loss)/income	$	184,009		$	181,043		$	266,351		$	510,665
Change in accumulated losses on cash flow hedge derivative financial instruments, net of tax		(66,252	)		5,068			(33,836	)		12,361
Change in unrealized gains on investment securities available-for-sale, net of tax		200,808			(71,907	)		51,954			(75,443	)
Add unrealized loss resulting from HTM to AFS reclass, net of tax		—			—			(25,625	)		—
Less reclassification adjustment, net of tax:
Derivative instruments		(3,037	)		(3,037	)		(9,012	)		(9,011	)
Investments available-for-sale		18,950			1,089			(94,750	)		8,456
Comprehensive income	$	302,652		$	116,152		$	362,606		$	448,138

     Accumulated other comprehensive income, net of related tax, consisted of net unrealized losses on securities of $10.2 million and net accumulated losses on derivatives of $64.4 million at September 30, 2006 and net unrealized losses on securities of $131.3 million and net accumulated losses on derivatives of $39.5 million at December 31, 2005.

(10) CORE DEPOSIT INTANGIBLE ASSETS AND OTHER INTANGIBLES

     Core deposit intangibles, net of amortization, at September 30, 2006 was $508.9 million compared to $214.0 million at December 31, 2005, with the difference due to the addition of Independence core deposit intangibles of $369.1 million and amortization expense of $74.2 million for the nine-month period ended September 30, 2006.

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

	Calendar				Remaining
	Year		Recorded		Amount
Year	Amount		To Date		To Record
2006	$	107,403	$	74,200	$	33,203
2007		122,897		—		122,897
2008		100,467		—		100,467
2009		71,341		—		71,341
2010		56,617		—		56,617

     Sovereign recorded other intangibles of $25.1 million in connection with its acquisition of Independence related to fair market value adjustments associated with operating lease agreements of $22.3 million and certain non-competition agreements with key employees totaling $2.8 million. These intangibles are amortized on a straight-line basis over the term of the lease and the non-competition term, respectively. Amortization expense associated with these intangibles totaled $1.0 million for the third quarter of 2006 and $0.3 million for the second quarter of 2006.

22

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

(11) BUSINESS SEGMENT INFORMATION

     On June 1, 2006, the Company added Independence’s results in the Other segment. Beginning in the third quarter of 2006, Sovereign reorganized its reporting structure to include a Metro New York Banking Division. This new segment is comprised of the net assets of Independence and substantially all of Sovereign’s New Jersey banking offices, which were moved from the Mid-Atlantic segment. Prior period results have been reclassified to conform to the current presentation.

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

			New		Metro New
	Mid-Atlantic		England		York		Shared			Shared
For the three-month period ended	Banking		Banking		Banking		Services			Services
September 30, 2006	Division		Division		Division		Consumer			Commercial			Other			Total
Net interest income (expense)	$	80,714	$	164,778	$	154,218	$	81,952		$	60,262		$	(50,137	)	$	491,787
Fees and other income		21,825		43,012		39,653		7,129			39,411			20,821			171,851
Provision for credit losses		6,108		3,077		2,307		29,572			3,936			—			45,000
General and administrative expenses		72,581		124,536		104,837		26,478			37,242			(13,856	)		351,818
Depreciation/Amortization		2,792		4,145		7,038		5,525			1,808			43,150			64,458
Income (loss) before income taxes		23,850		80,177		86,136		29,915			57,790			(57,239	)		220,629
Intersegment revenues (expense) (1)		49,460		170,255		59,921		(314,743	)		(144,488	)		179,595			—
Total Average Assets	$	4,889,186	$	6,034,875	$	19,355,785	$	27,263,751		$	11,943,506		$	20,467,150		$	89,954,253

			New		Metro New
	Mid-Atlantic		England		York		Shared			Shared
For the nine-month period ended	Banking		Banking		Banking		Services			Services
September 30, 2006	Division		Division		Division		Consumer			Commercial			Other			Total
Net interest income (expense)	$	243,086	$	493,547	$	299,570	$	248,358		$	170,017		$	(120,062	)	$	1,334,516
Fees and other income		62,993		126,803		72,582		29,839			105,088			50,862			448,167
Provision for credit losses		10,126		10,816		19,683		69,331			8,544			—			118,500
General and administrative expenses		212,111		369,750		202,926		91,860			100,423			(41,980	)		935,090
Depreciation/Amortization		8,147		12,721		11,841		19,792			4,865			98,061			155,427
Income (loss) before income taxes		83,842		239,783		145,509		104,123			168,955			(468,031	)		274,181
Intersegment revenues (expense) (1)		150,770		497,683		196,280		(837,957	)		(379,000	)		372,224			—
Total Average Assets	$	4,742,221	$	5,793,126	$	9,840,829	$	25,339,675		$	11,268,081		$	18,922,741		$	75,906,673

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

23

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

(11) BUSINESS SEGMENT INFORMATION (continued)

			New		Metro New
	Mid-Atlantic		England		York		Shared			Shared
For the three-month period ended	Banking		Banking		Banking		Services			Services
September 30, 2005	Division		Division		Division		Consumer			Commercial			Other			Total
Net interest income (expense)	$	85,785	$	170,331	$	64,224	$	83,189		$	60,061		$	(55,249	)	$	408,341
Fees and other income		20,779		41,154		12,905		31,080			37,800			14,514			158,232
Provision for credit losses		3,701		1,272		1,459		12,222			1,346			—			20,000
General and administrative expenses		66,824		117,436		36,366		29,464			35,999			(9,188	)		276,901
Depreciation/Amortization		2,671		3,644		1,230		8,928			1,752			23,983			42,208
Income (loss) before income taxes		36,669		93,278		39,320		70,606			60,951			(62,032	)		238,792
Intersegment revenues (expense) (1)		49,077		153,636		62,094		(205,668	)		(89,279	)		30,140			—
Total Average Assets	$	4,835,380	$	5,774,949	$	1,757,276	$	21,716,475		$	10,450,070		$	17,066,705		$	61,600,855

			New		Metro New
	Mid-Atlantic		England		York		Shared			Shared
For the nine-month period ended	Banking		Banking		Banking		Services			Services
September 30, 2005	Division		Division		Division		Consumer			Commercial			Other			Total
Net interest income (expense)	$	249,762	$	493,743	$	188,150	$	250,142		$	171,861		$	(124,812	)	$	1,228,846
Fees and other income		58,981		120,510		38,133		73,710			94,336			45,396			431,066
Provision for credit losses		15,346		5,705		3,042		35,000			4,907			—			64,000
General and administrative expenses		195,469		349,379		107,828		92,267			101,915			(39,452	)		807,406
Depreciation/Amortization		7,537		12,471		3,683		23,195			4,337			74,342			125,565
Income (loss) before income taxes		100,363		261,011		115,447		186,443			161,667			(146,846	)		678,085
Intersegment revenues (expense) (1)		142,014		430,452		180,531		(579,210	)		(216,653	)		42,866			—
Total Average Assets	$	4,793,288	$	5,627,217	$	1,734,804	$	21,100,498		$	9,514,384		$	17,032,974		$	59,803,165

24

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

(12) RECENT ACCOUNTING PRONOUNCEMENTS

     In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123(R), a revision of FASB statement No. 123, “Accounting for Stock-Based Compensation.” This statement supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees” and its related implementation guidance. SFAS 123(R) requires that the cost resulting from all share based payment transactions be recognized in the financial statements. This statement establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value-based measurement method in accounting for such arrangements with employees and non-employees. Since Sovereign previously adopted the fair value recognition provisions of SFAS No. 123, the adoption of SFAS No. 123(R) did not have a material impact on Sovereign’s results of operations or financial position. See Note 16 for additional details.

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

     In February 2006, the FASB issued SFAS No. 155, “Accounting for Certain Hybrid Instruments”. This statement permits fair value measurement for any hybrid financial instrument that contains an embedded derivative that otherwise would require bifurcation, clarifies which interest-only strips are not subject to the requirements of SFAS No. 133, establishes a requirement to evaluate interests in securitized financial assets to identify interests that are freestanding derivatives or that are hybrid financial instruments that contain an embedded derivative requiring bifurcation, clarifies that concentrations of credit risk in the form of subordination are not embedded derivatives and amends SFAS No. 140 to eliminate the prohibition on a qualifying special-purpose entity from holding a derivative financial instrument that pertains to a beneficial interest other than another derivative instrument. This statement will be effective for Sovereign for all financial instruments acquired or issued after January 1, 2007 although early adoption is permitted. Sovereign adopted this pronouncement on January 1, 2006 which did not have any impact on our results of operations or financial position.

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

     In July 2006, the Financial Accounting Standards Board (FASB) issued FIN No. 48, “Accounting for Uncertainty in Income Taxes — An Interpretation of FASB Statement No. 109”. This interpretation clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements. It prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

     The evaluation of a tax position in accordance with this interpretation is a two-step process. The first step is recognition: The enterprise determines whether it is more likely than not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that has full knowledge of all relevant information. The second step is measurement: A tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements.

25

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

(12) RECENT ACCOUNTING PRONOUNCEMENTS (continued)

The tax position is measured at the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement.

     Differences between tax positions taken in a tax return and amounts recognized in the financial statements will generally result in one of the following: a) an increase in a liability for income taxes payable or a reduction of an income tax refund receivable; b) a reduction in a deferred tax asset or an increase in a deferred tax liability; or c) both (a) and (b).

     Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. Use of a valuation allowance as described in SFAS No. 109 is not an appropriate substitute for the derecognition of a tax position. The requirement to assess the need for a valuation allowance for the deferred tax assets based on the sufficiency of future taxable income is unchanged by this interpretation.

     This interpretation is effective for fiscal years beginning after December 15, 2006. Sovereign will adopt this interpretation on January 1, 2007 and is evaluating the impact of this interpretation on its financial statements.

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

     In September 2006, the Financial Accounting Standards Board (FASB) issued Statement No. 158, Employers’ Accounting for Defined Benefit Pension and Other Postretirement Plans — An Amendment of FASB Statements No. 87, 88, 106, and 132R. This new standard requires an employer to: (a) recognize in its statement of financial position an asset for a plan’s overfunded status or a liability for a plan’s underfunded status; (b) measure a plan’s assets and its obligations that determine its funded status as of the end of the employer’s fiscal year (with limited exceptions); and (c) recognize changes in the funded status of a defined benefit postretirement plan in the year in which the changes occur. Those changes will be reported in comprehensive income. The requirement to recognize the funded status of a benefit plan and the disclosure requirements are effective as of the end of the fiscal year ending after December 15, 2006, for entities with publicly traded equity securities The requirement to measure plan assets and benefit obligations as of the date of the employer’s fiscal year-end statement of financial position is effective for fiscal years ending after December 15, 2008. Sovereign will adopt the provisions of this standard related to recognizing funded status in equity as of December 31, 2006. The adoption of this standard is not expected to have a material effect on our financial statements.

26

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

(13) MERGER RELATED AND INTEGRATION CHARGES

          The following is a summary of amounts charged to earnings and the status of reserves related to business combinations (in thousands):

	First Essex			Seacoast			Waypoint			Independence
	acquisition			acquisition			acquisition			acquisition			Total
Reserve balance at December 31, 2005	$	9,839		$	12,748		$	12,224		$	—		$	34,811
Charge recorded in earnings		—			—			—			32,193			32,193
Amount provided in purchase accounting		—			—			—			26,185			26,185
Payments		(2,842	)		(2,754	)		(2,953	)		(24,351	)		(32,900	)
Changes in estimates(1)		2,467			(1,606	)		(1,029	)		—			(168	)
Reserve balance as of September 30, 2006	$	9,464		$	8,388		$	8,242		$	34,027		$	60,121

	For the nine-month
	period ended September 30,
	2006		2005
Merger related and integration charges (1)	$	31,862	$	12,744

(1) Sovereign incurred a merger related charge of $2.5 million in the third quarter of 2006 related to a revised lease termination assumption for the First Essex acquisition. Additionally, Sovereign recorded merger and integration reserve reversals in the first quarter due to favorable conversion costs and other merger-related items being lower than amounts initially estimated. In addition to the Seacoast and Waypoint reversals above, Sovereign recorded a reversal of $0.2 million related to a bank that the Company acquired in 2002.

(14) RETAINED INTERESTS IN ASSET SECURITIZATIONS

     As described more fully in our annual report filed on Form 10-K, Sovereign has securitized certain financial assets to qualified special purpose entities which were deconsolidated in accordance with SFAS No. 140. During the third quarter of 2006, Sovereign securitized $900 million of automotive floor plan loans under a three-year revolving term securitization. Sovereign retained servicing responsibilities for the loans and maintained other retained interests in the securitized loans. These retained interests include an interest-only strip, a cash reserve account and a subordinated note. The Company estimated the fair value of these retained interests by determining the present value of the expected future cash flows using modeling techniques that incorporate management’s best estimates of key assumptions, including prepayment speeds, credit losses and discount rates. The investors and the trusts have no recourse to the Company’s assets, other than the retained interests, if the off-balance sheet loans are not paid when due. Sovereign receives annual contractual servicing fees of 1% for servicing the securitized loans. However, no servicing asset or liability was recorded for these rights since the contractual servicing fee represents adequate compensation for these types of loans.

     In connection with the $900 million securitization, Sovereign recorded a gain of $0.8 million, which is included in commercial banking revenues. This gain was determined based on the carrying amount of the loans sold, including any related allowance for loan loss, and was allocated to the loans sold and the retained interests, based on their relative fair values at the sale date. The transaction costs involved in this securitization are being amortized over the three year revolving period in accordance with SFAS No. 140.

27

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

(14) RETAINED INTERESTS IN ASSET SECURITIZATIONS (continued)

Shown below are the types of assets underlying the securitizations for which Sovereign owns a retained interest and the related balances and delinquencies at September 30, 2006 and December 31, 2005, and the net credit losses for the nine-month period ended September 30, 2006 and the year ended December 31, 2005 (in thousands):

	September 30, 2006						December 31, 2005
			Principal		Net				Principal		Net
	Total		90 Days		Credit		Total		90 Days		Credit
	Principal		Past Due		Losses		Principal		Past Due		Losses
Mortgage Loans	$	17,900,252	$	66,034	$	431	$	12,575,319	$	55,941	$	932
Home Equity Loans and lines of credit		10,645,781		108,747		22,636		9,966,031		102,112		22,253
Automotive Floor Plan Loans		1,199,614		—		—		1,468,176		832		—
Total Owned and Securitized	$	29,745,647	$	174,781	$	23,067	$	24,009,526	$	158,885	$	23,185
Less:
Securitized Mortgage Loans	$	82,969	$	632	$	9	$	112,517	$	1,737	$	154
Securitized Home Equity Loans		139,175		15,358		2,727		172,907		20,635		5,989
Securitized Automotive Floor Plan Loans		855,000		—		—		1,021,698		—		—
Total Securitized Loans	$	1,077,144	$	15,990	$	2,736	$	1,307,122	$	22,372	$	6,143
Net Loans	$	28,668,503	$	158,791	$	20,331	$	22,702,404	$	136,513	$	17,042

28

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

(14) RETAINED INTERESTS IN ASSET SECURITIZATIONS (continued)

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

				Home			Auto
	Mortgage			Equity			Floor Plan
	Loans			Loans			Loans			Total
Components of Retained Interest and Servicing Rights:
Accrued interest receivable	$	—		$	—		$	6,300		$	6,300
Subordinated interest retained		21,924			—			43,996			65,920
Servicing rights		1,172			325			—			1,497
Interest only strips		—			7,346			1,010			8,356
Cash reserve		—			—			4,230			4,230
Total Retained Interests and Servicing Rights	$	23,096		$	7,671		$	55,536		$	86,303
Weighted-average life (in yrs)
Prepayment speed assumption (annual rate)		0.77			1.46			0.32
As of the date of the securitization		40	%		22	%		50	%
As of December 31, 2005		40	%		23	%		45	%
As of September 30, 2006		40	%		21	%		49	%
Impact on fair value of 10% adverse change	$	(36	)	$	(37	)	$	(68	)
Impact on fair value of 20% adverse change	$	(44	)	$	(90	)	$	(147	)
Expected credit losses (annual rate)
As of the date of the securitization		0.12	%		0.75	%		0.25	%
As of December 31, 2005		0.12	%		1.74	%		0.25	%
As of September 30, 2006		0.12	%		1.61	%		0.25	%
Impact on fair value of 10% adverse change	$	(6	)	$	(155	)	$	(37	)
Impact on fair value of 20% adverse change	$	(13	)	$	(327	)	$	(74	)
Residual cash flows discount rate (annual)
As of the date of the securitization		9	%		12	%		8	%
As of December 31, 2005		9	%		12	%		8	%
As of September 30, 2006		9	%		12	%		8	%
Impact on fair value of 10% adverse change	$	(9	)	$	(121	)	$	(93	)
Impact on fair value of 20% adverse change	$	(18	)	$	(240	)	$	(186	)

     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.

29

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

(15) PROXY AND RELATED PROFESSIONAL FEES

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

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

(16) STOCK BENEFIT PLANS

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

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

	GRANT DATE YEAR
	2006			2005			2004
Expected volatility		.262 – .278			.280 – .293			.296 – .317
Expected life in years		6.00			6.00			6.00
Stock price on date of grant	$	19.98-$21.37		$	19.40-$22.95		$	19.40-$21.64
Exercise price	$	19.98-$21.37		$	19.40-$22.95		$	19.40-$21.64
Weighted average exercise price	$	20.25		$	22.11		$	21.49
Weighted average fair value	$	6.41		$	7.52		$	7.63
Expected dividend yield		1.11 – 1.50	%		0.53% – 1.11	%		.45% – .55	%
Risk-free interest rate		4.28 – 5.13	%		3.91% – 4.45	%		2.80% – 4.23	%
Vesting period in years		2-5			5			5

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

     Sovereign has plans, which are shareholder approved, that grant restricted stock and stock options for a fixed number of shares to key officers, certain employees and directors with an exercise price equal to the fair market value of the shares at the date of grant. Sovereign believes that such awards better align the interest of its employees with those of its shareholders. Sovereign’s stock options expire not more than 10 years and one month after the date of grant and generally become fully vested and exercisable within a five year period after the date of grant and, in certain limited cases, based on the attainment of specified targets. Restricted stock awards vest over a period of three to five years. Stock option and restricted stock awards provide for accelerated vesting in certain circumstances, such as a change in control and in certain cases upon an employee’s retirement. Sovereign records compensation expense over the shorter of the contractual vesting term or the employee’s retirement date in the event the award vests. These circumstances are defined in the plan agreements.

30

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

(16) STOCK BENEFIT PLANS (continued)

     The following table summarizes Sovereign’s stock options outstanding at September 30, 2006:

	OPTIONS OUTSTANDING
						Weighted
				Weighted		Average
				Average		Remaining
				Exercise		Contractual
	Shares			Price		Life
Outstanding at December 31, 2005		14,840,809		$	11.74
Granted		1,853,901			20.25
Exercised		(1,339,644	)		9.40
Expired		(15,845	)		9.97
Forfeited		(253,672	)		16.00
Outstanding at September 30, 2006		15,085,549			12.93		5.46
Exercisable at September 30, 2006		9,021,699			10.24		3.98

     The total intrinsic value of options outstanding and exercisable at September 30, 2006 totaled $130.0 million and $101.7 million, respectively. The weighted average grant date fair value of options granted during the nine-months ended September 30, 2006 was $20.25. The total intrinsic value of options exercised during the year ended September 30, 2006 was $15.2 million. Sovereign recognized pre-tax compensation expense associated with stock options of $4.6 million and $3.4 million for the nine-month period ended September 30, 2006 and 2005, respectively.

     Cash received from option exercises for all share-based payment arrangements for the quarter ended September 30, 2006 was $3.3 million. At September 30, 2006, Sovereign had $19.4 million of unrecognized compensation cost related to employee stock option awards that will be recognized over a weighted average period of 3.2 years.

     Subsequent to September 2005, Sovereign issued approximately 1,503,000 of treasury shares at a weighted average cost of $21.04 to satisfy option exercises. Prior to September 2005, Sovereign had a practice of issuing new authorized shares to satisfy option exercises and, as such, did not repurchase shares on the open market to fund them.

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

	Shares (In thousands)			Weighted average grant date fair value
Total non-vested restricted stock at December 31, 2005		2,161,460		$	21.46
Restricted stock granted in 2006		1,167,342		$	20.14
Vested restricted stock in 2006		(405,779	)	$	18.77
Non-vested shares forfeited in 2006		(271,725	)	$	22.05
Total non-vested restricted stock at September 30, 2006		2,651,298		$	21.23

     Since 2001, Sovereign has issued shares of restricted stock to certain key officers and employees that vest over a three-year or five-year period. Pre-tax compensation expense associated with this plan of $10.1 million and $10.0 million was recorded during the nine-month period ended September 30, 2006 and 2005, respectively. As of September 30, 2006, there was $37.9 million of total unrecognized compensation cost related to restricted stock awards. This cost is expected to be recognized over a weighted average period of 3.1 years. The weighted average grant date fair value of restricted stock granted in 2006 and 2005 was $20.14 per share and $22.32 per share, respectively.

31

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

(17) STOCKHOLDERS’ EQUITY

     On May 31, 2006, Sovereign issued common stock to Santander and received net proceeds of $2.4 billion which was used to fund a portion of the Independence acquisition. For further discussion, see Note 18.

     On May 15, 2006, Sovereign issued 4,000,000 shares of Series C non-cumulative perpetual preferred stock and received net proceeds of $195.4 million. The perpetual preferred stock ranks senior to our common stock. Our perpetual preferred stockholders are entitled to receive dividends when and if declared by our board of directors at the rate of 7.30% per annum, payable quarterly, before we may declare or pay any dividend on our common stock. The dividends on the perpetual preferred stock are non-cumulative. The Series C preferred stock is not redeemable prior to May 15, 2011. On or after May 15, 2011, the Series C preferred stock is redeemable at par.

     The dividends on our preferred stock are recorded against retained earnings, however for earnings per share purposes they are deducted from net income available to common shareholders. See Note 2 for the calculation of earnings per share.

32

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

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

     Sovereign closed on its acquisition of Independence effective June 1, 2006 for $42 per share in cash, representing an aggregate transaction value of $3.6 billion. Sovereign funded this acquisition using the proceeds from the $2.4 billion equity offering to Santander, net proceeds from recent issuances of perpetual and trust preferred securities and cash on hand. Sovereign issued 88,705,123 shares to Banco Santander Central Hispano (“Santander”), which makes Santander its largest shareholder. Independence was headquartered in Brooklyn, New York, with 125 community banking offices in the five boroughs of New York City, Nassau and Suffolk Counties and New Jersey. Sovereign acquired Independence to connect their Mid-Atlantic geographic footprint to New England and create new markets in certain areas of New York.

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

Assets
Investments	$	3,126.7
Loans:
Multifamily		5,571.2
Commercial		5,313.3
Consumer		517.2
Residential		1,829.0
Total loans		13,230.7
Less allowance for loan losses		(97.8	)
Total loans, net		13,132.9
Cash acquired, net of cash paid		(2,713.2	)
Premises and equipment, net		167.9
Bank Owned Life Insurance		343.3
Other assets		365.0
Core deposit and other intangibles		394.2
Goodwill		2,271.1
Total assets	$	17,087.9
Liabilities
Deposits:
Core	$	6,960.8
Time		4,070.1
Total deposits		11,030.9
Borrowings and other debt obligations		5,470.4
Other liabilities (1)		586.6
Total liabilities	$	17,087.9

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

     In connection with the Independence acquisition, Sovereign recorded charges against its earnings for the three-month and nine-month period ended September 30, 2006 for merger related expenses of $25.9 million and $32.2 million pre-tax, respectively. Sovereign anticipates incurring additional merger related expenses in the fourth quarter of 2006.

33

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

(18) PURCHASE OF INDEPENDENCE COMMUNITY BANK CORP. (“INDEPENDENCE”) (continued)

     These merger-related expenses incurred during the nine-month period ending September 30, 2006 include the following (in thousands):

System conversions	$	8,782
Retail banking conversion costs		10,059
Marketing		3,802
Branch consolidations		2,330
Retention bonuses and other employee related costs		5,157
Other		2,063
Total	$	32,193

     The following unaudited pro forma condensed statements of income assume that Sovereign and Independence were combined January 1, 2006 and is presented for informational purposes only and is not necessarily indicative of the results of operations of the consolidated company that would have actually occurred had the acquisition of Independence been effective January 1, 2006. The unaudited pro forma condensed statements of income for the periods presented may have been different had the companies actually been consolidated as of January 1, 2006 due to, among other factors, possible revenue enhancements, expense efficiencies and integration costs. Additionally, the actual adjustments to yield and/or amortization of the acquired assets and liabilities may vary materially from the assumptions used in preparing the unaudited pro forma condensed statements of income.

	Pro Forma (1)		Pro Forma (1)
	Three Months Ended		Nine Months Ended
	September 30,		September 30,
	2006		2006
Net interest income	$	492,107	$	1,512,458
Non-interest income		201,005		206,084
Provision for credit losses		45,000		118,500
Non-interest expense		401,539		1,244,849
Income taxes	$	45,701	$	32,936
Net income		200,872		322,257
Less: Preferred dividend		1,825		10,950
Net income available for common stockholders	$	199,047	$	311,307
Contingently convertible trust expense, net of tax		6,344		19,007
Net income available for common stockholders for diluted EPS purposes	$	205,391	$	330,314
Weighted average basic shares outstanding		472,447		476,004
Weighted average diluted shares outstanding		506,135		509,596
Basic earnings per share	$	0.42	$	0.65
Diluted earnings per share	$	0.41	$	0.65

(1) Pro forma adjustments include the following adjustments: accretion for loan and investment security fair value discount, reduction of interest income for amounts used to fund the acquisition, amortization for certificates of deposits fair value premium, accretion for borrowing obligations fair value premium, amortization of fair value adjustments on acquired premises and equipment, mortgage servicing rights and related amortization for intangibles acquired, net of Independence’s historical intangible amortization expense. The pro forma income statement excluded $227.2 million of charges incurred by Sovereign and Independence directly related to the acquisition. These charges included $41.9 million of deal costs which were primarily investment banking and legal fees, $83.9 million related to compensation expense from the acceleration of stock options, restricted stock, and the employee stock ownership plan, $71.1 million of severance paid to terminated employees, and $32.2 million of merger related costs as detailed above.

34

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

(19) 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, 2005.

Related party loans at December 31, 2005	$	58,014
Loan fundings		45,836
Loan repayments		(29,264	)
Related party loan balance at September 30, 2006	$	74,586

     Related party loans at September 30, 2006 included commercial loans to affiliated businesses of directors of Sovereign Bank totaling $60.2 million compared with $42.1 million at December 31, 2005. Related party loans also included commercial loans to affiliated businesses of directors of Sovereign Bancorp totaling $10.0 million at September 30, 2006 compared with $11.8 million at December 31, 2005.

     Related party loans at September 30, 2006 and December 31, 2005 also included consumer loans secured by residential real estate of $4.4 million and $4.1 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 $51.5 million and $47.8 million at September 30, 2006 and December 31, 2005, respectively. The majority of these amounts ($46.7 million and $43.9 million at September 30, 2006 and December 31, 2005) are on undrawn commercial lines of credit for affiliated businesses of individuals who are solely Directors of Sovereign Bank.

     The Company is engaged in certain activities with Meridian Capital due to its acquisition of Independence. Meridian Capital is deemed to be a “related party” of the Company as such term in defined in SFAS No. 57 since Sovereign has a 35% minority equity investment in Meridian Capital, which is 65% owned by Meridian Funding, a New-York based mortgage firm. Meridian Capital refers borrowers seeking financing of their multi-family and/or commercial real estate loans to Sovereign as well as to numerous other financial institutions. Sovereign recognized $2.8 million and $3.7 million of income due to its investment in Meridian Capital for the three-month and nine-month periods ended September 30, 2006.

     In 2006, Santander’s capital markets group received approximately $800,000 in underwriting discounts in connection with Sovereign’s capital market initiatives to fund the Independence acquisition. In January 2006, Santander extended a total of $400 million in unsecured lines of credit to Sovereign Bank for federal funds and Eurodollar lines of credit, of which up to $150 million could be used for the confirmation of standby letters of credit issued by Sovereign Bank. This line is at market rate and in the ordinary course of business. This line of credit can be cancelled by either Sovereign or Santander at any time. Since its inception, the average balance outstanding under federal funds and Eurodollar lines is approximately $13 million. At September 30, 2006, there was no outstanding balance.

(20) SUBSEQUENT EVENT

     On October 10, 2006, the Company entered into a Retirement-Resignation and Transition Agreement with Jay S. Sidhu, the Chairman of the Board and Chief Executive Officer of the Company. Under the terms of this agreement Mr. Sidhu will receive a lump cash payment of $10.5 million, representing the present value of payments due under his 1997 Employment Agreement and a lump sum cash payment of $22.4 million, which represents the present value, computed using actuarial assumptions consistent with the Company’s supplemental retirement plans of amounts earned and due to Mr. Sidhu under the terms of the Company’s 1996 and 1997 supplemental retirement plans. Also the Company agreed to accelerate the vesting on certain unvested restricted stock and unvested stock option awards which would have otherwise been forfeited. A more detailed summary description of the Retirement-Resignation and Transition Agreement are set forth in Sovereign’s Current Report on Form 8-K filed with the SEC on October 13, 2006, which Form 8-K includes the full text of the Retirement-Resignation and Transition Agreement as Exhibit 10.1. The Company anticipates recording a pre-tax charge of approximately $29 million in connection with this agreement in the fourth quarter.

35

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 $90 billion financial institution with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, Maryland, and Delaware. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including: deposit and loan services, sales of residential, home equity, and multi-family loans and investment securities, capital markets products, cash management products, and bank owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by various factors including the economic environment, including interest rates, consumer and business confidence and spending, as well as competitive conditions.

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

     Management is in the process of implementing strategies to address these weaknesses. Now that Sovereign has successfully merged the operations and processes of Independence into Sovereign, management is completing a comprehensive review of Sovereign’s operating cost structure, and the results of that review will be presented to Sovereign’s Board of Directors in the fourth quarter of 2006. Management believes significant opportunities exist within the Company to lower costs and improve our financial performance. Management is evaluating a number of alternatives including, but not necessarily limited to, consolidating certain back office functions, eliminating underperforming business lines, and focusing on more profitable business opportunities. We believe these strategies will help to strengthen our capital position and related capital ratios which have decreased following the Independence acquisition. However, these actions will likely result in recording a material charge to earnings in the fourth quarter of 2006 and/or first quarter of 2007.

     Management is also in the process of enhancing the customer’s experience with Sovereign. Sovereign recently completed the branding of approximately 1,000 ATM machines in CVS Pharmacy locations in the Northeast. This more than doubled the number of branded ATM locations and provides greater convenience for our customers. We also announced an agreement with OPEN from American Express, the company’s small business unit, to offer co-branded American Express Cards to Sovereign’s small business customers. This relationship will generate an additional source of fee revenue for Sovereign and will enable us to leverage the American Express brand to help Sovereign generate core deposits and build and retain small-business relationships. We also entered into an alliance with ADP, the country’s leading payroll services provider. With this partnership, ADP will provide approximately 200 dedicated reps throughout our footprint to assist our commercial relationship managers in providing payroll solutions for our business customer.

     We are focused on our critical success factors including management of interest rate risk and credit risk, superior service delivery, and productivity and expense control.

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

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

36

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

CURRENT INTEREST RATE ENVIRONMENT

     Net interest income represents a substantial portion of the Company’s revenues. Accordingly, the interest rate environment has a significant impact on Sovereign’s earnings. Sovereign currently has a liability sensitive interest rate risk position. The impact of the flattening to inverted yield curve that has been experienced in 2005 and thus far in 2006 has negatively impacted our margin since the spread between our longer-term assets and our shorter-term liabilities has contracted. In the third quarter of 2005, the average interest rate spread between the 2-year Treasury note and the 10-year note was 26 basis points which compressed to negative 4 basis points in the third quarter of 2006 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities. The flat to inverted yield curve, coupled with low cost core deposit increases not meeting our targets, has resulted in net interest margin compression to 2.64% for the quarter ending September 30, 2006 compared to 2.86% in the prior quarter and 3.13% in the comparable quarter in 2005. We would expect to benefit from any substantial sustained expansion between long-term and short-term interest rates, and if we are able to grow low-cost core deposits. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

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

RESULTS OF OPERATIONS

General

     Net income was $184.0 million, or $0.37 per diluted share and $266.4 million, or $0.62 per diluted share for the three-month and nine-month periods ended September 30, 2006 as compared to $181.0 million, or $0.45 per diluted share and $510.7 million, or $1.27 per diluted share for the three-month and nine-month periods ended September 30, 2005.

     During the second quarter of 2006, following the Independence acquisition, Sovereign sold $3.5 billion of investment securities for asset/liability management purposes and to offset, in part, the negative effect of the current yield curve on net interest margin for future periods. In connection with the sale, Sovereign incurred a $238.3 million pretax loss ($154.9 million after-tax or $0.38 per diluted share). See Note 3 for additional details.

     Additionally, during the second quarter of 2006, Sovereign recorded an other-than-temporary charge on FNMA and FHLMC preferred stock of $67.5 million ($43.9 million after-tax or $0.11 per diluted share) to write down investments to their fair value as management concluded that a recovery to Sovereign’s cost basis on these securities was not probable within a reasonable period of time based on near-term prospects of the issuers and the anticipated interest rate and liquidity spreads expected in the near term. See Note 3 for further discussion and analysis of our determination that the remaining unrealized losses in the investment portfolio at June 30, 2006 were considered temporary.

     Sovereign closed the Independence acquisition during the second quarter of 2006, incurring net merger related charges of $32.2 million pretax for the second and third quarters of 2006 ($20.9 million net of tax, or $0.05 per diluted share). See Note 13 for further details on the components of these merger related charges.

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

37

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

	2006								2005
				Tax								Tax
	Average			Equivalent		Yield/			Average			Equivalent		Yield/
	Balance			Interest		Rate			Balance			Interest		Rate
EARNING ASSETS
INVESTMENTS	$	14,281,351		$	610,934		5.71	%	$	12,093,200		$	461,037		5.08	%
LOANS:
Commercial loans		19,699,524			1,051,982		7.14	%		15,698,330			705,536		6.01	%
Multi-Family		2,748,477			126,583		6.14	%		—			—		—	%
Consumer loans
Residential mortgages		15,053,802			636,131		5.63	%		10,160,711			404,143		5.30	%
Home equity loans and lines of credit		10,110,555			488,104		6.45	%		10,151,595			419,263		5.42	%
Total consumer loans secured by real estate		25,164,357			1,124,235		5.96	%		20,312,306			823,406		5.41	%
Auto loans		4,400,416			192,228		5.84	%		4,322,967			170,755		5.28	%
Other		460,455			27,826		8.08	%		550,965			31,073		7.54	%
Total consumer		30,025,228			1,344,289		5.98	%		25,186,238			1,025,234		5.43	%
Total loans (1)		52,473,229			2,522,854		6.42	%		40,884,568			1,730,770		5.65	%
Allowance for loan losses		(471,358	)		—		—			(422,569	)		—		—
NET LOANS		52,001,871			2,522,854		6.48	%		40,461,999			1,730,770		5.71	%
TOTAL EARNING ASSETS		66,283,222			3,133,788		6.31	%		52,555,199			2,191,807		5.57	%
Other assets		9,623,451			—		—			7,247,966			—		—
TOTAL ASSETS	$	75,906,673		$	3,133,788		5.51	%	$	59,803,165		$	2,191,807		4.89	%
FUNDING LIABILITIES
Deposits and other customer related accounts:
Core deposits and other related accounts	$	25,684,728		$	507,832		2.64	%	$	21,474,388		$	226,063		1.41	%
Time deposits		13,784,845			442,893		4.30	%		9,313,316			197,078		2.83	%
TOTAL DEPOSITS		39,469,573			950,725		3.22	%		30,787,704			423,141		1.84	%
BORROWED FUNDS:
FHLB advances		15,715,567			528,095		4.49	%		11,761,895			351,972		4.00	%
Fed funds and repurchase agreements		1,528,668			58,590		5.12	%		1,382,706			31,918		3.08	%
Other borrowings		4,942,265			200,476		5.41	%		4,190,575			115,674		3.69	%
TOTAL BORROWED FUNDS		22,186,500			787,161		4.74	%		17,335,176			499,564		3.85	%
TOTAL FUNDING LIABILITIES		61,656,073			1,737,886		3.77	%		48,122,880			922,705		2.56	%
Demand deposit accounts		5,826,134			—		—			5,278,467			—		—
Other liabilities		1,342,011			—		—			740,996			—		—
TOTAL LIABILITIES		68,824,218			1,737,886		3.37	%		54,142,343			922,705		2.28	%
STOCKHOLDERS’ EQUITY		7,082,455			—		—			5,660,822			—		—
TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	75,906,673			1,737,886		3.06	%	$	59,803,165			922,705		2.06	%
NET INTEREST INCOME				$	1,395,902							$	1,269,102
NET INTEREST SPREAD (1) (2)							2.55	%							3.01	%
NET INTEREST MARGIN (1) (3)							2.81	%							3.22	%

(1)	In accordance with banking regulatory reporting guidance issued in the first quarter of 2006, Sovereign reclassified prepayment fees and late fees on loans from non-interest income to interest income. Prior periods were reclassified to conform to the current period presentation.
(2)	Represents the difference between the yield on total earning assets and the cost of total funding liabilities.
(3)	Represents annualized, taxable equivalent net interest income divided by average interest-earning assets.

38

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Net Interest Income

     Net interest income for the three-month and nine-month periods ended September 30, 2006 was $491.8 million and $1.3 billion compared to $408.3 million and $1.2 billion for the same periods in 2005. Net interest margin was 2.64% and 2.81% for the three-month and nine-month periods ended September 30, 2006 compared to 3.13% and 3.22% for the same periods in 2005. The decrease in net interest margin for the three-month and nine-month periods ended September 30, 2006, compared to the corresponding periods in the prior year, resulted from the flattening yield curve, which became inverted during the first quarter of 2006 and whose spread has continued to remain under pressure in the second and third quarter. As previously discussed the spread between the 2-year Treasury note and the 10-year note was 26 basis points in the third quarter of 2005 and compressed to negative 4 basis points in the third quarter of 2006 illustrating the relative pressure between shorter term and longer term funding costs and loan asset and investment security reinvestment opportunities. Sovereign’s net interest margin has also been negatively impacted by a shift in liability mix as higher cost borrowing and higher cost deposit obligations have risen faster than our low cost core deposits.

     Interest on investment securities and interest earning deposits was $221.5 million and $556.0 for the three-month and nine-month periods ended September 30, 2006 compared to $140.5 million and $425.6 million for the same periods in 2005. The average balance of investment securities was $14.3 billion with an average tax equivalent yield of 5.71% for the nine-month period ended September 30, 2006 compared to an average balance of $12.1 billion with an average yield of 5.08% for the same period in 2005. The increase in yield is primarily due to a rise in market interest rates and due to the investment restructuring Sovereign executed in the second quarter of 2006. See Note 3 for additional details.

     Interest on loans was $1.0 billion and $2.5 billion for the three-month and nine-month periods ended September 30, 2006 compared to $620.7 million and $1.7 billion for the three-month and nine-month periods in 2005. The average balance of loans was $52.5 billion with an average yield of 6.42% for the nine-month period ended September 30, 2006 compared to an average balance of $40.9 billion with an average yield of 5.65% for the same period in 2005. Average balances of commercial loans in 2006 increased $4.0 billion, as compared to 2005 primarily due to strong demand in our commercial loan portfolio and the impact of loans acquired from Independence. Commercial loan yields have increased 113 basis points due to the rise in short-term interest rates which has particularly increased the yields on our variable rate loan products. Average residential mortgages increased $4.9 billion due to loan purchases and increased origination activity as well as loans acquired from Independence. Average home equity loans and lines of credit are consistent compared to the prior year due to loan sales of $503 million in September 2005 and $898 million of sales in December 2005. Additionally, Sovereign deemphasized its purchases of correspondent home equity loans in the latter half of 2005 and ceased its purchases in the first quarter of 2006 due to tightening spreads in this product and increased charge-offs on this loan product.

     Interest on deposits and related customer accounts was $412.9 million and $950.7 million for the three-month and nine-month periods ended September 30, 2006 compared to $169.1 million and $423.1 million for the same periods in 2005. The average balance of deposits was $39.5 billion with an average cost of 3.22% for the nine-month period ended September 30, 2006 compared to an average balance of $30.8 billion with an average cost of 1.84% for the same period in 2005. Additionally, the average balance of non-interest demand deposits has increased to $5.8 billion at September 30, 2006 from $5.3 billion for the same period in the prior year. The increase in the balance of deposits is primarily due to the addition of deposits in connection with the Independence acquisition. Also contributing to the increase is time deposit and money market growth which has become a more favorable funding alternative as costs on shorter term borrowing obligations continue to increase. The increase in average cost year to year is due primarily to the Federal Reserve’s increases to short term interest rates over the past year and resultant increases in customer deposit yields as well as changes in the mix of deposits to higher cost time deposits which have now become a more favorable funding alternative to shorter term borrowing obligations.

     Interest on borrowed funds was $336.2 million and $787.2 million for the three-month and nine-month periods ended September 30, 2006 compared to $183.8 million and $499.6 million for the same periods in 2005. The average balance of borrowings was $22.2 billion with an average cost of 4.74% for the nine-month period ended September 30, 2006 compared to an average balance of $17.3 billion with an average cost of 3.85% for the same period in 2005. The increase in the cost of funds on borrowings and other debt obligations resulted principally from the higher rates on short-term sources of funding including repurchase agreements and overnight FHLB advances due to an increase in short-term interest rates.

     Sovereign currently has a series of callable advances totaling $2.8 billion with the FHLB. These advances provide variable funding (currently at 3.15%) during the non-call period which ranges from 6 to 18 months. After the non-call period, the interest rates on these advances resets to a fixed rate of interest with certain caps (ranging from 4.90% to 5.50%) and floors of 0%. Based on the current interest rate environment, these instruments may be called by the FHLB upon the expiration of the non-call period.

39

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Provision for Credit Losses

     The provision for credit losses is based upon credit loss experience, growth or contraction of specific segments of the loan portfolio, and the estimate of losses inherent in the current loan portfolio. The provision for credit losses for the three-month and nine-month periods ended September 30, 2006 was $45.0 million and $118.5 million compared to $20.0 million and $64.0 million for the same periods in 2005. The provision for credit losses for the nine-months ended September 30, 2006 includes a higher level of provision versus 2005 due to higher charge-offs in our correspondent home equity loan portfolio in 2006 and loan growth. Additionally, since the addition of multifamily loans was largely a new asset class for Sovereign, the Company engaged an outside consultant to conduct an analysis of Independence’s multifamily loan portfolio. As a result of the analysis, Sovereign increased the loss percentage that Independence had historically maintained on pass rated multifamily loans which caused Sovereign to record an additional $12.5 million of provision for credit losses to cover the inherent losses in that portfolio in the second quarter of 2006.

     Net loan charge-offs for the nine-months ended September 30, 2006 were $93.1 million compared to $58.5 million for the comparable period in the prior year. This equates to an annualized net loan charge-off to average loan ratio of 0.24% for the nine-months ended September 30, 2006 compared to 0.20% for the comparable period in the prior year. Included in net charge-off for the nine months ending September 30, 2006, is a net charge-off of approximately $5 million related to the sale of approximately $21 million of non-performing loans out of the correspondent home equity portfolio. Non-performing assets were $273.1 million or 0.43% of total loans at September 30, 2006, compared to $205.6 million or 0.47% of total loans at December 31, 2005 and $181.1 million or 0.42% of total loans at September 30, 2005. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance as deemed necessary.

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

	Nine-month Period Ended
	September 30,
	2006			2005
Allowance for loan losses, beginning of period	$	419,599		$	391,003
Charge-offs:
Commercial		33,036			32,822
Consumer secured by real estate		53,979			14,777
Consumer not secured by real estate		53,891			51,361
Total Charge-offs		140,906			98,960
Recoveries:
Commercial		8,587			10,429
Consumer secured by real estate		7,646			5,287
Consumer not secured by real estate		31,623			24,780
Total Recoveries		47,856			40,496
Charge-offs, net of recoveries		93,050			58,464
Provision for loan losses (1)		123,109			63,238
Allowance released in connection with loan sales		(3,000	)		(6,202	)
Acquired allowance for loan losses from business acquisitions		97,824			28,778
Allowance for loan losses, end of period	$	544,482		$	418,353
Reserve for unfunded lending commitments, beginning of period		18,212			17,713
Provision/(benefit) for unfunded lending commitments (1)		(4,609	)		762
Reserve for unfunded lending commitments, end of period		13,603			18,475
Total Allowance for credit losses	$	558,085		$	436,828

(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.

40

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Non-Interest Income

     Total non-interest income was $201.0 million and $172.3 million for the three-month and nine-month periods ended September 30, 2006 compared to $159.9 million and $444.1 million for the same periods in 2005. The decrease for the nine months ended September 30, 2006 was driven by the previously mentioned $238.3 million loss on sale of investment securities and an other-than-temporary impairment charge of $67.5 million on FNMA/FMLMC preferred stock in the second quarter of 2006. Excluding securities gains/ (losses), total fees and other income for the three-month and nine-month periods ended September 30, 2006 were $171.9 million and $488.2 million as compared to $158.2 million and $431.1 million for the same periods in 2005.

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

	Three-months ended September 30,						Nine-months ended September 30,
	2006			2005			2006			2005
Recoveries of/ (Impairments to) mortgage servicing rights	$	(3,495	)	$	6,837		$	(3,495	)	$	2,026
Mortgage servicing fees		8,923			5,122			21,641			14,931
Amortization of mortgage servicing rights		(5,341	)		(5,279	)		(13,868	)		(13,048	)
Net gains/(loss) under SFAS 133		(423	)		717			4			1,685
Sales of mortgage, home equity and multifamily loans and mortgage backed securities		14,665			21,274			27,563			56,022
Total mortgage banking income	$	14,329		$	28,671		$	31,845		$	61,616

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

     Mortgage banking income is contingent upon loan growth and market conditions. In 2006, the Company originated more loans that were maintained on our balance sheet and not for sale as margins in the secondary markets were not as favorable in 2006 resulting in a decrease in revenues related to the sale of mortgage loans. In the third quarter of 2005, Sovereign sold $503 million of home equity loans and recorded a net gain of $13.1 million. In the third quarter of 2006, Sovereign sold $776 million of multi-family loans and recorded a gain of $6.5 million.

     At September 30, 2006, Sovereign serviced approximately $7.8 billion of mortgage loans for others and our net mortgage servicing asset was $100.5 million, compared to $7.2 billion of loans serviced for others and a net mortgage servicing asset of $91.1 million, at December 31, 2005. The most important assumptions in the valuation of mortgage servicing rights are anticipated loan prepayment rates (CPR speed) and the positive spread we receive on holding escrow related balances. Increases in prepayment speeds (which are generally driven by lower long term interest rates) result in lower valuations of mortgage servicing rights, while lower prepayment speeds result in higher valuations. The escrow related credit spread is the estimated reinvestment yield earned on the serviced loan escrow deposits. Increases in escrow related credit spreads result in higher valuations of mortgage servicing rights while lower spreads result in lower valuations. For each of these items, Sovereign must make assumptions based on future expectations. All of the assumptions are based on standards that we believe would be utilized by market participants in valuing mortgage servicing rights and are consistently derived and/or benchmarked against independent public sources. Additionally, an independent appraisal of the fair value of our mortgage servicing rights is obtained at least annually and is used by management to evaluate the reasonableness of our discounted cash flow model. Sovereign recorded a mortgage serving right impairment charge of $3.5 million due to an increase in prepayment speed assumptions at September 30, 2006 compared to June 30, 2006.

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

	September 30, 2006			December 31, 2005			September 30, 2005			December 31, 2004
CPR speed		12.50	%		12.42	%		15.80	%		16.53	%
Escrow credit spread		4.71	%		4.16	%		4.01	%		3.92	%

41

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

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

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

     Although all of the loans serviced for Fannie Mae (both loans originated for sale and loans sold from portfolio) are currently fully performing, the Company has established a liability related to the fair value of the retained credit exposure. This liability represents the amount that the Company estimates that it would have to pay a third party to assume the retained recourse obligation. The estimated liability represents the present value of the estimated losses that the portfolio is projected to incur based upon an industry-based default curve with a range of estimated losses. At September 30, 2006, Sovereign had a $15.0 million liability related to the fair value of the retained credit exposure for loans sold to Fannie Mae under this sales program.

     At September 30, 2006, Sovereign serviced $7.0 billion of loans for Fannie Mae sold to it pursuant to this program with a maximum potential loss exposure of $139.8 million. As a result of retaining servicing on $7.0 billion of multi-family loans sold to Fannie Mae, the Company had a $19.1 million loan servicing asset at September 30, 2006. Additionally, as a result of the acquisition of Independence, Sovereign acquired a servicing asset related to single-family residential loans that were sold in the secondary market with servicing retained. At September 30, 2006, the Company has recorded a servicing asset of $7.1 million related to $463.0 million of single family residential loans sold to others resulting from its acquisition of Independence.

     Sovereign recorded servicing asset amortization of $2.0 million and $0.7 million related to the two servicing assets that were acquired from Independence for the third and second quarter of 2006, respectively.

     Bank owned life insurance (BOLI) income represents the increase in the cash surrender value of life insurance policies for certain employees where the Bank is the beneficiary of the policies as well as the receipt of insurance proceeds. The increase in BOLI income is due to $300 million of purchases of BOLI which occurred in the second quarter of 2006 and $343.3 million of BOLI acquired as a result of the Independence transaction.

42

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

     We recorded a net gain/ (loss) on investment securities of $29.2 million and $(275.9) million for the three-month and nine-month periods ended September 30, 2006 compared to net gains of $1.7 million and $13.0 million for the same periods in 2005. The loss incurred for the nine-months ended September 30, 2006 was a result of the previously mentioned $238.3 million restructuring charge and an other-than-temporary impairment charge of $67.5 million on FNMA and FMLMC preferred stock in the second quarter.

General and Administrative Expenses

     General and administrative expenses for the three-month and nine-month periods ended September 30, 2006 were $351.8 million and $935.1 million compared to $276.9 million and $807.4 million for the same periods in 2005. General and administrative expenses increased in 2006 primarily due to increased compensation and benefit costs associated with the hiring of additional team members and four months of operating expenses associated with the Independence acquisition. Average full time equivalents during the third quarter of 2006 rose to 10,621 from 9,616 for the comparable prior year period.

Other Expenses

     Other expenses consist primarily of amortization of intangibles, minority interest expense, merger related and integration charges, equity method investment expense and proxy and related professional fees. Other expenses were $75.3 million and $179.0 million for the three-month and nine-month periods ended September 30, 2006, compared to $32.6 million and $123.4 million for the same periods in 2005. The reasons for the variances are discussed below.

     Total merger-related and integration costs for the nine months ended September 30, 2006 consisted primarily of $32.2 million of charges related to Independence. Net merger-related and integration charges of $12.7 million were recorded in the nine-month period ended September 30, 2005 which were primarily related to the Waypoint acquisition closed in the first quarter of 2005. See Note 13 for additional details.

     Sovereign has an investment in a synthetic fuel partnership that generates IRC Section 29 tax credits for the production of fuel from a non-conventional source (“the Synthetic Fuel Partnership”). Our investment balance totaled $20.3 million at September 30, 2006. Sovereign is amortizing this investment through December 31, 2007, which is the period through which we expect to receive alternative energy tax credits. Reductions in the investment value and our allocation of the partnership’s earnings or losses totaled $6.9 million and $20.7 million for the three-month and nine-month periods ended September 30, 2006, respectively and are included as expense in the line “Equity method investments” in our consolidated statement of operations, while the alternative energy tax credits we receive are included as a reduction of income tax expense. We anticipate receiving tax credits in excess of our recorded investment over the remaining life of the partnership. The alternative energy tax credit is reduced and ultimately eliminated based on a formula tied to the annual average wellhead price per barrel of domestic crude oil which is not subject to regulation by the United States. To the extent that the average price of crude oil exceeds certain levels resulting in a phase out and/or an elimination of the alternative energy tax credits, Sovereign’s investment in the synthetic fuel partnership could become impaired. The alternative energy tax credit has never been phased out. However, volatility in oil prices has raised the possibility of a phase out in 2006 and 2007. Sovereign will continue to monitor oil price increases in the future and their related impact on our investment and recognition of alternative energy tax credits.

     Sovereign recorded intangible amortization expense of $34.1 million and $75.5 million for the three-month and nine-month periods ended September 30, 2006 compared to $18.3 million and $56.1 million for the corresponding periods in the prior year. The reason for the increase is due primarily to the amortization expense of $17.9 million related to the intangible assets recorded during the Independence acquisition.

     As discussed in Note 8, Sovereign recorded a pretax charge of $11.4 million recorded in the three-month period ended June 30, 2006, related to notification by the SEC that certain of our fair value hedges failed to meet the criteria for hedge accounting under SFAS No. 133. This was recorded within other expenses as losses from economic hedges on Sovereign’s consolidated statement of operations.

     Also impacting other expenses were proxy and related professional fees of $14.3 million recorded in the three-month period ended March 31, 2006. Due to the settlement with Relational we do not anticipate any additional significant costs related to this matter. See Note 15 for further discussion related to this settlement.

43

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Income Tax Provision

     The income tax provision was $36.6 million and $7.8 million for the three-month and nine-month periods ended September 30, 2006, compared to a provision of $57.7 million and $167.4 million for the same periods in 2005. The effective tax rates for the three-month and nine-month periods ended September 30, 2006 were 16.6% and 2.9% compared to 24.2% and 24.7% for the same periods in 2005. The effective tax rate differs from the statutory rate of 35% primarily due to income from tax-exempt investments, income related to bank-owned life insurance, tax credits associated with low income housing investment partnerships and the Synthetic Fuel Partnership. The lower effective tax rate for the three and nine-month periods ended September 30, 2006 results from reduced profitability of the Company due to the previously discussed investment restructuring charge and the other-than-temporary charge recorded on FNMA and FHLMC preferred stock recorded in the second quarter of 2006.

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

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

Line of Business Results

     Segment results are derived from the Company’s business unit profitability reporting system by specifically attributing managed balance sheet assets, deposits and other liabilities and their related interest income or expense. Funds transfer pricing methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The provision for credit losses recorded by each segment is based on the net charge-offs of each line of business. Effective in the first quarter of 2006, the difference between the provision for credit losses recognized by the Company on a consolidated basis and the provision recorded by the business lines at the time of charge-off is allocated to each business line based on a risk profile of their loan portfolio. Previously, this amount was recorded in the Other segment. Prior periods have been reclassified to conform to the current period presentation. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. 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. As a result of the Independence acquisition, the Company included Independence’s results in Other. Beginning in the third quarter of 2006, the business unit profitability reporting unit system was reorganized to include a Metro New York segment. This new segment is primarily comprised of the net assets of Independence and substantially all of Sovereign’s New Jersey banking offices, which were moved from the Mid-Atlantic segment.

     The Mid-Atlantic Banking Division’s net interest income decreased $5.1 million and $6.7 million to $80.7 million and $243.1 million for the three-month and nine-month periods ended September 30, 2006 compared to the corresponding period in the preceding year. The average balance of loans was $4.7 billion with an average yield of 7.04% for the nine-months ended September 30, 2006 compared to an average balance of $4.7 billion with an average yield of 5.89% for the corresponding period in the preceding year. The average balance of deposits was $8.3 billion at a cost of 2.47% for the nine-months ended September 30, 2006, compared to $8.3 billion at a cost of 1.62% for the same period a year ago. The increase in yields is due to the increase in market rates between these two time periods. The provision for credit losses increased $2.4 million and decreased $5.2 million for the three-months and nine-months ended September 30, 2006 and is driven by the charge-offs in the division’s loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $66.8 million and $195.5 million for the three-months and nine-months ended September 30, 2005, to $72.6 million and $212.1 million for the corresponding periods in 2006 or 8.7% and 8.5%, respectively. As previously discussed, Sovereign’s management team is currently working on a cost saving initiative

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

to eliminate or reduce certain redundant expenses.

     The New England Banking Division’s net interest income decreased $5.6 million and $0.2 million to $164.8 million and $493.5 million for the three-month and nine-month periods ended September 30, 2006 compared to the corresponding period in the preceding year. The decrease in net interest income was principally due to margin compression on a matched fund basis. The average balance of loans was $5.5 billion with an average yield of 6.90% for the nine-months ended September 30, 2006 compared to an average balance of $5.4 billion with an average yield of 5.84% for the corresponding period in the preceding year. The average balance of deposits was $17.7 billion at a cost of 2.20% for the nine-months ended September 30, 2006, compared to $17.6 billion at a cost of 1.32% for the same period a year ago. The increase in rates is primarily driven by the increase in market interest rates between these two time periods. The provision for credit losses increased $1.8 million and $5.1 million to $3.1 million and $10.8 million for the three-month and nine-month periods ended September 30, 2006 due to increased charge-offs. General and administrative expenses (including allocated corporate and direct support costs) increased from $117.4 million and $349.4 million for the three-months and nine-months ended September 30, 2005, to $124.5 million and $369.8 million for the three-months and nine-months ended September 30, 2006 or increases of 6.0% and 5.8%, respectively. As previously discussed, Sovereign’s management team is currently working on a cost saving initiative to eliminate or reduce certain redundant expenses.

     The Metro New York Banking Division’s net interest income increased $90.0 million and $111.4 million to $154.2 million and $299.6 million for the three-month and nine-month periods ended September 30, 2006 compared to the corresponding period in the preceding year. The increase in net interest income was principally due to the acquisition of Independence on June 1, 2006. The average balance of loans was $7.4 billion with an average yield of 6.36% for the nine-months ended September 30, 2006 compared to an average balance of $1.7 billion with an average yield of 5.85% for the corresponding period in the preceding year. The average balance of deposits was $11.9 billion at a cost of 2.59% for the nine-months ended September 30, 2006, compared to $6.6 billion at a cost of 1.33% for the same period a year ago. The increase in rates is primarily driven by the increase in market interest rates between these two time periods. The increase in fees and other income of $26.7 million and $34.4 million was due primarily due to the acquisition of Independence on June 1, 2006. The provision for credit losses increased $0.1 million and $16.6 million to $2.3 million and $19.7 million for the three-month and nine-month periods ended September 30, 2006. Included in the provision for the nine-months ended September 30,2006, is the previously discussed $12.5 million charge recorded at June 30, 2006 to increase reserves on Independence’s multifamily loan portfolio. General and administrative expenses (including allocated corporate and direct support costs) increased from $36.4 million and $107.8 million for the three-months and nine-months ended September 30, 2005, to $104.8 million and $202.9 million for the three-months and nine-months ended September 30, 2006. The increase in general and administrative expenses is principally due to the acquisition of Independence on June 1, 2006.

     The Shared Services Consumer segment net interest income decreased $1.2 million and $1.8 million to $82.0 million and $248.4 million for the three-month and nine-month periods ended September 30, 2006 compared to the corresponding period in the preceding year. The reason for the decline in net interest income for the three-month and nine-month periods ended September 30, 2006 was due to the margin compression experienced on our consumer loans compared with margins from a year earlier on a matched funded basis. The average balance and yield earned on loans by this segment for the nine-month period ended September 30, 2006 was $24.8 billion and 5.79%, respectively, compared with $20.6 billion and 5.23% for the corresponding period in the prior year. The increase in loan balances was driven by strong residential loan originations. The provision for credit losses increased $17.4 million and $34.3 million to $29.6 million and $69.3 million at September 30, 2006 due primarily to higher charge-offs on our correspondent home equity loan business. Sovereign deemphasized these loan purchases in the latter half of 2005 and in the first quarter of 2006 decided to cease purchasing loans from this channel. General and administrative expenses totaled $29.5 million and $92.3 million for the three-months and nine-months ended September 30, 2005, compared to $26.5 million and $91.9 million for the three-months and nine-months ended September 30, 2006. This decline in expenses is a result of the aforementioned closure of the correspondent home equity business.

     The Shared Services Commercial segment net interest income increased $0.2 million and decreased $1.8 million to $60.3 million and $170.0 million for the three-month and nine-month periods ended September 30, 2006 compared to the corresponding period in the preceding year. The decrease in net interest income was principally due to margin compression on a matched funded basis. The average balance and yield earned on loans by this segment for the nine-months ended September 30, 2006 was $10.1 billion and 7.30%, respectively, compared with $8.6 billion and 5.88% for the corresponding period in the prior year. The increase in fees and other income of $1.6 million and $10.8 million was due to increases in precious metals revenues. The provision for credit losses increased $2.6 million and $3.6 million to $3.9 million and $8.5 million for the three-months and nine-months ended September 30, 2006. General and administrative expenses (including allocated corporate and direct support costs) were $37.2 million and $100.4 million for the three-months and nine-months ended September 30, 2006 compared with $36.0 million and $101.9 for the corresponding periods in the prior year.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

     The net loss before income taxes for Other increased $321.2 million to a loss of $468.0 million for the nine-months ended September 30, 2006 compared to the corresponding period in the preceding year. This was primarily related to the previously mentioned investment restructuring loss and other than temporary impairment charge on FNMA and FHLMC preferred stock. Net interest (expense) increased $5.1 million and $4.8 million to a net interest expense of $(50.1) million and $(120.1) million for the three-months and nine-months ended September 30, 2006 compared to the corresponding periods in the preceding year due primarily to a $2.2 billion increase in average investments offset by a $4.9 billion increase in average borrowings. Average borrowings for the nine-month period ended September 30, 2006 and 2005 was $22.2 billion and $17.3 billion, respectively, with an average cost of 4.74% and 3.85%. Average investments for the nine-month period ended September 30, 2006 and 2005 was $14.3 billion and $12.1 billion respectively, at an average yield of 5.71% and 5.08%. The increase in cost is due to the rise in market interest rates between periods.

     The Other segment includes merger-related and integration charges of $28.4 million and $31.9 million for the three-months and nine-months ended September 30, 2006 as compared to a reversal of $2.0 million for the three-month period ended September 30, 2005 and charges of $12.7 million for the nine-month period ended September 30, 2005. The nine-month period ended September 30, 2006 also includes the previously mentioned pre-tax charges associated with the investment restructuring of $238.3 million, the other-than-temporary impairment charge on FNMA and FHLMC preferred stock of $67.5 million and the loss on economic hedges of $11.4 million.

Critical Accounting Policies

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

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

FINANCIAL CONDITION

Loan Portfolio

     At September 30, 2006, commercial loans totaled $24.0 billion representing 38.0% of Sovereign’s loan portfolio, compared to $16.6 billion or 38.0% of the loan portfolio at December 31, 2005 and $16.2 billion or 38.0% of the loan portfolio at September 30, 2005. At September 30, 2006 and December 31, 2005, only 6% and 7%, respectively, of our total commercial portfolio was unsecured. The increase in commercial loans since December 31, 2005 has primarily been driven by the acquisition of Independence and their related loan portfolio of $13.2 billion and organic loan growth.

     As part of the acquisition of Independence, Sovereign acquired a multifamily loan portfolio. At September 30, 2006, this portfolio totaled $6.0 billion, representing 9.5% of Sovereign’s loan portfolio.

     The consumer loan portfolio secured by real estate (consisting of home equity loans and lines of credit of $10.5 billion and residential loans of $17.8 billion) totaled $28.3 billion at September 30, 2006, representing 44.8% of Sovereign’s loan portfolio, compared to $22.3 billion, or 50.8%, of the loan portfolio at December 31, 2005 and $21.5 billion or 50.0% of the loan portfolio at September 30, 2005. The increase in the consumer loan portfolio secured by real estate was driven by the acquisition of Independence which increased consumer loans by $2.3 billion along with continued growth in our residential mortgage loan portfolio as a result of a decrease in the amount of residential mortgage loans sold in the secondary market in the second and third quarters of 2006.

     The consumer loan portfolio not secured by real estate (consisting of automobile loans of $4.4 billion and other consumer loans of $0.4 million) totaled $4.8 billion at September 30, 2006, representing 7.7% of Sovereign’s loan portfolio, compared to $4.9 billion, or 11.2%, of the loan portfolio at December 31, 2005 and $5.0 billion or 12.0% of the loan portfolio at September 30, 2005.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Non-Performing Assets

     At September 30, 2006, Sovereign’s non-performing assets increased by $67.5 million to $273.1 million compared to $205.6 million at December 31, 2005. This increase is due primarily to the addition of Independence loans in the second quarter of 2006, as well as a repossessed asset of approximately $21 million which was subsequently recovered in full on October 10, 2006. Non-performing assets as a percentage of total loans, real estate owned and repossessed assets improved to 0.43% at September 30, 2006 from 0.47% at December 31, 2005. Sovereign generally places all commercial loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer and residential loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved for. Loans secured by residential real estate with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved for or charged off.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

	September 30,			December 31,
	2006			2005
Non-accrual loans:
Consumer:
Residential mortgages	$	35,365		$	30,393
Home equity loans and lines of credit		62,002			55,543
Auto loans and other consumer loans		1,711			2,389
Total consumer loans		99,078			88,325
Commercial		68,995			68,572
Commercial real estate		62,208			31,800
Multifamily		1,930			—
Total non-accrual loans		232,211			188,697
Restructured loans		570			777
Total non-performing loans		232,781			189,474
Other real estate owned		34,775			11,411
Other repossessed assets		5,500			4,678
Total other real estate owned and other repossessed assets		40,275			16,089
Total non-performing assets	$	273,056		$	205,563
Past due 90 days or more as to interest or principal and accruing interest	$	65,314		$	54,794
Annualized net loan charge-offs to average loans		0.23	%		0.20	%
Non-performing assets as a percentage of total assets		0.30	%		0.32	%
Non-performing loans as a percentage of total loans		0.37	%		0.43	%
Non-performing assets as a percentage of total loans and real estate owned		0.43	%		0.47	%
Allowance for credit losses as a percentage of total non-performing assets(1)		204.4	%		213.0	%
Allowance for credit losses as a percentage of total non-performing loans(1)		239.7	%		231.1	%

(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.

     Loans ninety (90) days or more past due and still accruing interest increased by $10.5 million from December 31, 2005 to September 30, 2006, attributable to increases of $6.2 million in the home equity loans and lines of credit portfolio and $5.5 million in the auto loans and other consumer loans portfolios and a decrease of $1.2 million in the residential portfolio.

     Potential problem loans (commercial loans delinquent more than 30 days but less than 90 days, although not currently classified as non-performing loans) amounted to approximately $191.6 million and $57.2 million at September 30, 2006 and December 31, 2005, respectively. This increase in potential problem loans relates primarily to processing delays from the Independence system conversion that occurred in September. As a percentage of total loans, potential problem loans were 0.30% and 0.13% at September 30, 2006 and December 31, 2005.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Allowance for Credit Losses

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

	September 30, 2006					December 31, 2005
			% of					% of
			Loans					Loans
			to					to
			Total					Total
	Amount		Loans			Amount		Loans
Allocated allowance:
Commercial loans	$	362,460		47	%	$	220,314		38	%
Consumer loans secured by real estate		134,770		45			142,728		51
Consumer loans not secured by real estate		45,758		8			50,557		11
Unallocated allowance		1,494		n/a			6,000		n/a
Total allowance for loan losses	$	544,482		100	%	$	419,599		100	%
Reserve for unfunded lending commitments		13,603					18,212
Total allowance for credit losses		558,085				$	437,811

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

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

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

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

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

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

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

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

     The factors supporting the allowance for loan losses and 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 $220.3 million at December 31, 2005 to $362.5 million at September 30, 2006. This is a result of loans acquired from the Independence acquisition as well as organic growth of loans which required additional reserves. As a percentage of commercial loans the allowance decreased from 1.32% to 1.21% at September 30, 2006 which reflects the lower reserve requirements needed on certain Independence commercial loans compared to Sovereign’s reserves on its historical commercial portfolio.

     Consumer Secured by Real Estate Portfolio. The allowance for the consumer loans secured by real estate portfolio decreased from $142.7 million at December 31, 2005, to $134.8 million at September 30, 2006 due primarily to continued favorable credit quality which reduced the loss factors for this portfolio and an increase in the proportion of residential mortgages in the consumer secured by real estate portfolio which carry lower reserve requirements than our home equity loan portfolios.

     During the second quarter of 2006, Sovereign entered into a credit default swap on $5.2 billion of its residential real estate loan portfolio through a synthetic securitization structure. Under the terms of the credit default swap, Sovereign is responsible for the first ten basis points of losses on the $5.2 billion residential real estate loan portfolio. Sovereign is reimbursed for losses above ten basis points up to aggregate losses of 120 basis points under the terms of the credit default swap. This credit default swap term is equal to the term of the loan portfolio. The structure resulted in fewer reserves being allocated to the residential loan portfolio as a portion of the losses are reimbursed through the credit default swap.

     The Consumer Secured by Real Estate Portfolio includes the correspondent home equity portfolio. We ceased to add loans to this business in early 2006. Although the portfolio approximates for just over 7% of our loans outstanding it accounted for more than 50% of our net charge-offs for the quarter ending September 30, 2006 and has shown increasing charge-offs throughout 2006. The portfolio ran-off by $322 million this quarter, and is now at $4.6 billion. We believe that we have adequately reserved for the inherent losses on this portfolio but will continue to closely monitor future loss levels and adjust reserves for this portfolio if loss experience continues to deteriorate.

     Consumer Not Secured by Real Estate Portfolio. The allowance for the consumer not secured by real estate portfolio decreased slightly from $50.6 million at December 31, 2005 to $45.8 million at September 30, 2006 due primarily to continued favorable credit quality which reduced the loss factors for this portfolio.

     Unallocated Allowance. The unallocated allowance for loan losses decreased to $1.5 million at September 30, 2006 from $6.0 million at December 31, 2005. Management continuously evaluates its class allowance reserving methodology, however the

50

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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 declined from $18.2 million at December 31, 2005 to $13.6 million at September 30, 2006 due to a reduction in reserve factors on this category reflecting low loss exposure on these commitments.

Investment Securities

     Investment securities consist primarily of mortgage-backed securities, tax-free municipal securities, U.S. Treasury and government agency securities, corporate debt securities and stock in the Federal Home Loan Bank of Pittsburgh (“FHLB”), Freddie Mac and Fannie Mae. Mortgage-backed securities consist of pass-throughs and collateralized mortgage obligations issued by federal agencies or private label issuers. Sovereign’s mortgage-backed securities are generally either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by Standard and Poor’s and Moody’s at the date of issuance. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. The effective duration of the available for sale investment portfolio at September 30, 2006 was 4.4 years.

     Total investment securities available-for-sale were $12.8 billion at September 30, 2006 and $7.3 billion at December 31, 2005. The reason for the increase is due to the reclassification of our held-to-maturity securities to available for sale during the second quarter. Our held-to-maturity securities totaled $4.6 billion at December 31, 2005. For additional information with respect to Sovereign’s investment securities (including the reclassification of our held-to-maturity securities to available for sale), see Note 3 in the Notes to Consolidated Financial Statements.

Goodwill and Core Deposit Intangible Assets

     Goodwill increased by $2.3 billion since December 31, 2005 due primarily to the Independence acquisition and core deposit intangibles increased by $294.9 million since December 31, 2005 due to a core deposit intangible asset of $369.1 million recorded in connection with the Independence acquisition, offset by year-to-date amortization expense of $74.2 million. See Note 10 for the anticipated amortization expense for each of the five succeeding calendar years ending December 31^st. There were no goodwill or core deposit intangible asset impairment charges recorded in 2005 and through September 30, 2006.

Deposits and Other Customer Accounts

     Sovereign attracts deposits within its primary market area with an offering of deposit instruments including demand accounts, NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits and other customer accounts at September 30, 2006 were $52.8 billion compared to $38.0 billion at December 31, 2005.

Borrowings and Other Debt Obligations

     Sovereign utilizes borrowings and other debt obligations as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the FHLB provided certain standards related to creditworthiness have been met. Sovereign also utilizes reverse repurchase agreements, which are short-term obligations collateralized by securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof, and federal funds lines with other financial institutions. Total borrowings at September 30, 2006 and December 31, 2005 were $27.1 billion and $18.7 billion, respectively.

Off Balance Sheet Arrangements

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

     In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has retained interests in the QSPEs. Off-balance sheet QSPEs had $1.1 billion of assets that Sovereign sold to the QSPEs which are not included in Sovereign’s Consolidated Balance Sheet at September 30, 2006. Sovereign’s retained interests and servicing assets in such QSPEs was $86.3 million at September 30, 2006 and this amount represents Sovereign’s maximum exposure to credit losses related to these unconsolidated securitizations. Sovereign does not provide contractual legal recourse to third party investors that purchase debt or equity securities issued by the QSPEs beyond

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

the credit enhancement inherent in Sovereign’s subordinated interests in the QSPEs. At September 30, 2006, there are no known events or uncertainties that would result in or are reasonably likely to result in the termination or material reduction in availability to Sovereign’s access to off-balance sheet markets. See Note 14 for a description of Sovereign’s retained interests in its off-balance sheet asset securitizations.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Bank Regulatory Capital

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

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

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

							TIER 1			TOTAL
				TIER 1			RISK-BASED			RISK-BASED
	TANGIBLE			LEVERAGE			CAPITAL TO			CAPITAL TO
	CAPITAL TO			CAPITAL TO			RISK			RISK
	TANGIBLE			TANGIBLE			ADJUSTED			ADJUSTED
REGULATORY CAPITAL	ASSETS			ASSETS			ASSETS			ASSETS
Sovereign Bank at September 30, 2006:
Regulatory capital	$	5,264,849		$	5,264,849		$	5,073,352		$	6,834,079
Minimum capital requirement (1)		1,695,129			3,390,259			2,644,652			5,289,305
Excess	$	3,569,720		$	1,874,590		$	2,428,700		$	1,544,774
Sovereign Bank capital ratio		6.21	%		6.21	%		7.67	%		10.34	%
Sovereign Bank at December 31, 2005:
Regulatory capital	$	4,167,306		$	4,167,306		$	4,090,381		$	5,313,535
Minimum capital requirement (1)		1,219,112			2,438,224			1,993,145			3,986,289
Excess	$	2,948,194		$	1,729,082		$	2,097,236		$	1,327,246
Sovereign Bank capital ratio		6.84	%		6.84	%		8.21	%		10.66	%

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

     Listed below are capital ratios for Sovereign Bancorp.

	TANGIBLE	TANGIBLE
	EQUITY TO	EQUITY TO
	TANGIBLE	TANGIBLE	TIER 1
	ASSETS,	ASSETS,	LEVERAGE
	EXCLUDING	INCLUDING	CAPITAL
REGULATORY CAPITAL	OCI	OCI	RATIO
Capital ratio at September 30, 2006 (1)	3.89 %	3.78 %	5.82 %
Capital ratio at December 31, 2005 (1)	5.05 %	4.73 %	6.68 %

(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.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

     The Sovereign Bancorp capital ratios at September 30, 2006 have declined from December 31, 2005 levels due to the loss on sale of securities, the other-than-temporary impairment, and the purchase accounting adjustments and related goodwill recorded in connection with the Independence acquisition.

Liquidity and Capital Resources

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

     Factors which impact the liquidity position of Sovereign Bank include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, general market conditions, investment portfolio cash flows and maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of September 30, 2006, Sovereign had $11.2 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investments to be pledged as collateral for additional borrowings. Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times.

     Sovereign Bancorp has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, a revolving credit agreement and access to the capital markets. Sovereign Bank may pay dividends to its parent subject to approval of the OTS, as discussed above. Sovereign also has approximately $2.1 billion of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets.

     Cash and cash equivalents increased $800.7 million from December 31, 2005. Net cash used by operating activities was $1.4 billion for 2006. Net cash used by investing activities for 2006 was $7.0 billion and consisted primarily of the purchase of loans and investment securities of $6.5 billion and $11.0 billion, respectively, a net increase in loans of $3.4 billion and the purchase of Independence for $2.7 billion, offset by proceeds from loan and investment sales of $4.0 billion and $11.4 billion, respectively. Net cash provided by financing activities for 2006 was $9.1 billion, which was primarily due to an increase in net deposits of $3.8 billion, proceeds from the issuance of common stock of $2.0 billion and a net increase in borrowings of $2.5 billion.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Contractual Obligations and Commercial Commitments

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

Contractual Obligations
(in thousands of dollars)

	Payments Due by Period
			Less than		Over 1 yr		Over 3 yrs		Over
	Total		1 year		to 3 yrs		to 5 yrs		5 yrs
FHLB advances (1)	$	22,617,455	$	12,999,916	$	2,123,728	$	1,546,548	$	5,947,263
Securities sold under repurchase agreements (1)		296,896		134,668		85,303		5,083		71,842
Fed Funds (1)		1,605,234		1,605,234		—		—		—
Other debt obligations (1)		4,789,320		88,051		1,494,375		627,900		2,578,994
Junior subordinated debentures due to Capital Trust entities (1)(2)		5,116,930		115,523		235,292		236,252		4,529,863
Certificates of deposit (1)		17,591,424		14,192,366		2,293,031		580,594		525,433
Investment partnership commitments (3)		55,113		29,348		22,160		3,531		74
Operating leases		705,333		97,683		153,735		116,559		337,356
Total contractual cash obligations	$	52,777,705	$	29,262,789	$	6,407,624	$	3,116,467	$	13,990,825

(1)	Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon interest rates in effect at September 30, 2006. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in market interest rates could materially affect the contractual amounts to be paid.
(2)	Excludes unamortized premiums or discounts.
(3)	The commitments to fund investment partnerships represent future cash outlays for the construction and development of properties for low-income housing, and historic tax credit projects. The timing and amounts of these commitments are projected based upon the financing arrangements provided in each project’s partnership or operating agreement, and could change due to variances in the construction schedule, project revisions, or the cancellation of the project.

     Excluded from the above table are deposits of $36.0 billion that are due on demand by customers.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

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

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

Amount of Commitment Expiration Per Period

	Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs
(in thousands of dollars)
Commitments to extend credit	$	17,449,232	$	8,304,807	$	2,983,834	$	3,067,605	$	3,092,986
Standby letters of credit		3,343,669		815,109		909,274		1,411,768		207,518
Loans sold with recourse		211,642		211,642		—		—		—
Forward buy commitments		613,493		613,493		—		—		—
Total commercial commitments	$	21,618,036	$	9,945,051	$	3,893,108	$	4,479,373	$	3,300,504

     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 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 September 30, 2006 was $3.3 billion, and the approximate value of the underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $2.7 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 September 30, 2006. 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.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Asset and Liability Management

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

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

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

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

	The following estimated percentage
If interest rates changed in parallel by the	increase/(decrease) to net interest
amounts below at September 30, 2006	income would result
Up 100 basis points		(0.51	)%
Up 200 basis points		(2.38	)%
Down 100 basis points		2.08	%

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

     As of September 30, 2006, the one year cumulative gap was (2.81)%, compared to (3.87)% at December 31, 2005. As we approach the end of the Federal Reserve interest rate tightening cycle, management has adjusted its target for managing its interest rate position from asset sensitive to slightly liability sensitive.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

If interest rates changed in parallel by the	Estimated NPV Ratio
amounts below at September 30, 2006	September 30, 2006			December 31, 2005
Base		11.68	%		12.38	%
Up 200 basis points		11.12	%		11.82	%
Up 100 basis points		11.46	%		12.16	%
Down 100 basis points		11.57	%		12.37	%
Down 200 basis points		11.08	%		12.00	%

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

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

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

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

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

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

58

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, 2006. 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 September 30, 2006.

     On June 1, 2006, Sovereign completed its acquisition of independence. However, none of Independence’s operating systems were integrated with Sovereign’s at the acquisition date. On September 8, 2006, Independence’s operating systems were integrated with Sovereign’s.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

Item 1 is not applicable.

Item 1A – Risk Factors

     There has been no material change in the Corporation’s risk factors as previously disclosed in our Form 10-K for the fiscal year ended December 31, 2005 in response to Item 1A to Part I of such Form 10-K. Such risk factors are incorporated herein by reference.

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

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

					Total Number of		Maximum Number
			Average		Shares Purchased		of Shares
	Total		Price		as Part of		that may be
	Number of		Paid		Publicly		Purchased Under
	Shares		Per		Announced Plans		the Plans or
Period	Purchased		Share		or Programs (1)		Programs (1)
7/1/06 through 7/31/06		3,108	$	20.40		N/A		19,500,000
8/1/06 through 8/31/06		3,248		20.93		N/A		19,500,000
9/1/06 through 9/30/06		561		21.16		N/A		19,500,000

(1) Sovereign has three stock repurchase programs in effect that would allow the Company to repurchase up to 40.5 million shares of common stock as of September 30, 2006. Twenty one million shares have been purchased under these repurchase programs as of September 30, 2006. All of Sovereign’s stock repurchase programs have no prescribed time limit in which to fill the authorized repurchase amount.

Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated minimum income tax liabilities. Sovereign repurchased 6,917 shares outside of publicly announced repurchase programs during the third quarter of 2006.

Item 3 is not applicable or the response is negative.

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

     The 2006 annual meeting of the shareholders of Sovereign Bancorp, Inc. was held on September 20, 2006. The following is a brief description of each matter voted on at the meeting.

	SHARES
									BROKER
PROPOSAL	FOR		AGAINST		WITHHELD		ABSTENTIONS		NON-VOTES
1. To elect four (4) Class I directors of Sovereign, each to serve for a term of three years and until their successors shall have been elected and qualified:
Brian Hard		345,529,634		N/A		84,163,614		—		—
Marian L. Heard		345,387,584		N/A		84,305,664		—		—
Cameron C Troilo, Sr		344,776,124		N/A		84,917,124		—		—
Ralph V Whitworth		415,856,362		N/A		13,836,886		—		—
2. To approve the Company’s 2006 Non-Employee Director Compensation Plan		297,557,585		30,792,338		—		4,154,276		97,189,046
3. 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, 2006		422,835,212		4,362,889		—		2,495,144		—
4. To approve the shareholder proposal from the California Public Retirement System regarding classification of Sovereign’s Board		145,163,801		181,358,646		—		5,981,752		97,189,046

Item 5 is not applicable or the response is negative.

60

Item 6 – Exhibits

     (a) Exhibits

(3.1)	Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign Bancorp’s Registration on Form S-8, SEC File No. 333-134976, filed June 13, 2006)
(3.2)	Bylaws, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.2 to Sovereign Bancorp’s Registration on Form S-3, SEC File No. 333-133514, filed April 25, 2006)
(10.1)	Retirement-Resignation and Transition Agreement, effective October 10, 2006, Sovereign Bancorp, Inc., Sovereign Bank and Jay S. Sidhu (Incorporated by reference to Exhibit 10.1 to Sovereign Bancorp’s Current Report on Form 8-K filed on October 13, 2006)
(31.1)	Chief Executive Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2)	Chief Financial Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1)	Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(32.2)	Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

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SIGNATURES

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

	SOVEREIGN BANCORP, INC.
	(Registrant)
Date: November 9, 2006	/s/ Joseph P. Campanelli
	Joseph P. Campanelli,
	Chief Executive Officer and President
	(Authorized Officer)
Date: November 9, 2006	/s/ Mark R. McCollom
	Mark R. McCollom
	Chief Financial Officer
	(Principal Financial Officer)

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

EXHIBITS INDEX
(3.1)	Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.1 to Sovereign Bancorp’s Registration on Form S-8, SEC File No. 333-134976, filed June 13, 2006)
(3.2)	Bylaws, as amended and restated, of Sovereign Bancorp, Inc. (Incorporated by reference to Exhibit 3.2 to Sovereign Bancorp’s Registration on Form S-3, SEC File No. 333-133514, filed April 25, 2006)
(10.1)	Retirement-Resignation and Transition Agreement, effective October 10, 2006, Sovereign Bancorp, Inc., Sovereign Bank and Jay S. Sidhu (Incorporated by reference to Exhibit 10.1 to Sovereign Bancorp’s Current Report on Form 8-K filed on October 13, 2006)
(31.1)	Chief Executive Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(31.2)	Chief Financial Officer certification pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
(32.1)	Chief Executive Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(32.2)	Chief Financial Officer certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

63