EXHIBIT 99.1

Report of Independent Auditors

Board of Directors
Sovereign Bancorp, Inc.

We have audited the supplemental consolidated balance sheets of Sovereign
Bancorp Inc. (Sovereign) (formed as a result of the consolidation of Sovereign
and First State Financial Services, Inc. (First State)) as of December 31, 1996
and 1995, and the related supplemental consolidated statements of operations,
stockholders' equity, and cash flows for each of the three years in the period
ended December 31, 1996. The supplemental consolidated financial statements give
retroactive effect to the merger of Sovereign and First State on February 18,
1997, which has been accounted for using the pooling of interests method as
described in the notes to the supplemental consolidated financial statements.
These supplemental financial statements are the responsibility of the management
of Sovereign. Our responsibility is to express an opinion on these supplemental
financial statements based on our audits. We did not audit the financial
statements of First State, which statements reflect total assets constituting 6%
for 1996 and 8% for 1995 of the related supplemental consolidated financial
statement totals, and which reflect net (loss) income constituting approximately
(11%) in 1996, and 7% in 1995 and 1994 of the related supplemental consolidated
financial statement totals for the three year period ended December 31, 1996.
Those statements were audited by other auditors whose report has been furnished
to us, and our opinion, insofar as it relates to data included for First State,
is based solely on the report of the other auditors.

We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a
reasonable basis for our opinion.

In our opinion, based on our audits and the report of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the consolidated financial position of Sovereign at
December 31, 1996 and 1995, and the consolidated results of its operations and
its cash flows for each of the three years in the period ended December 31,
1996, after giving retroactive effect to the merger of First State as described
in the notes to the supplemental consolidated financial statements, in
conformity with generally accepted accounting principles.

In 1995, Sovereign changed its method of accounting for mortgage servicing
rights, as discussed in Note 1 to the supplemental consolidated financial
statements. In 1994, Sovereign changed its method of accounting for investment
and mortgage-backed securities, as discussed in Note 1 to the supplemental
consolidated financial statements.

/s/ ERNST & YOUNG LLP
May 27, 1997
Reading, Pennsylvania.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)

AT DECEMBER 31,
-----------------------------
1996 1995
-------------- -------------

ASSETS
Cash and amounts due from depository institutions............................... $ 111,296 $ 142,039
Interest-earning deposits....................................................... 6,273 17,524
Loans held for resale (approximate fair value of $33,162 and $138,939 at
December 31, 1996 and 1995, respectively).................................... 32,955 137,731
Investment and mortgage-backed securities available-for-sale.................... 494,997 905,023
Investment and mortgage-backed securities held-to-maturity (approximate fair
value of $2,464,844 and $2,127,015 at December 31, 1996 and 1995,
respectively)................................................................ 2,487,615 2,117,062
Loans........................................................................... 6,649,537 5,142,094
Allowance for possible loan losses.............................................. (46,093) (40,938)
Premises and equipment.......................................................... 63,763 67,474
Real estate owned............................................................... 10,634 13,078
Accrued interest receivable..................................................... 56,848 46,831
Goodwill and other intangible assets............................................ 113,606 125,592
Other assets.................................................................... 59,928 41,797
-------------- -------------
TOTAL ASSETS.............................................................. $ 10,041,359 $ 8,715,307
-------------- -------------
-------------- -------------
LIABILITIES
Deposits........................................................................ $ 5,606,333 $ 5,606,469
Borrowings
Short-term................................................................... 2,765,118 1,530,495
Long-term.................................................................... 1,097,076 1,023,266
Advance payments by borrowers for taxes and insurance........................... 25,949 25,370
Other liabilities............................................................... 38,044 61,090
-------------- -------------
Total Liabilities......................................................... 9,532,520 8,246,690
-------------- -------------
STOCKHOLDERS' EQUITY
Preferred stock; no par value; $50 liquidation preference; 7,500,000 shares
authorized; 2,000,000 shares issued and outstanding at December 31, 1996 and
December 31, 1995............................................................ 96,446 96,446
Common stock; no par value; 100,000,000 shares authorized; 69,492,593 shares
issued at December 31, 1996 and 63,822,108 shares issued at December 31,
1995......................................................................... 299,357 269,863
Unallocated common stock held by the Employee Stock Ownership Plan at cost;
4,067,047 shares at December 31, 1996 and 3,569,215 shares at December 31,
1995......................................................................... (33,015) (28,772)
Treasury stock; at cost; 229,168 shares........................................... (2,300) --
Unrecognized gain on investment and mortgage-backed securities
available-for-sale, net of tax............................................... 2,362 3,899
Retained earnings............................................................... 145,989 127,181
-------------- -------------
Total Stockholders' Equity................................................... 508,839 468,617
-------------- -------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY................................ $ 10,041,359 $ 8,715,307
-------------- -------------
-------------- -------------

See accompanying notes to supplemental consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER SHARE DATA)

YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------

INTEREST INCOME:
Interest on interest-earning deposits.................................... $ 3,406 $ 3,995 $ 2,637
Interest and dividends on investment and mortgage-backed securities
available-for-sale.................................................... 34,561 10,643 7,292
Interest and dividends on investment and mortgage-backed securities
held-to-maturity...................................................... 176,501 154,416 99,329
Interest and fees on loans............................................... 451,021 368,326 279,818
----------- ----------- -----------
Total interest income........................................... 665,489 537,380 389,076
----------- ----------- -----------
INTEREST EXPENSE:
Interest on deposits..................................................... 224,448 230,921 134,899
Interest on borrowings................................................... 199,146 109,649 77,290
----------- ----------- -----------
Total interest expense.......................................... 423,594 340,570 212,189
----------- ----------- -----------
NET INTEREST INCOME........................................................ 241,895 196,810 176,887
Provision for possible loan losses......................................... 11,416 2,650 5,992
----------- ----------- -----------
Net interest income after provision for possible loan losses............... 230,479 194,160 170,895
----------- ----------- -----------
OTHER INCOME:
Other loan fees and service charges...................................... 18,692 8,170 6,607
Deposit fees............................................................. 13,858 11,211 7,341
Gain on sale of loans and investment and mortgage-backed securities
available-for-sale.................................................... 5,456 294 576
Gain on sale of loans held for resale.................................... 1,622 6,167 1,960
Miscellaneous income..................................................... 4,535 6,355 2,220
----------- ----------- -----------
Total other income.............................................. 44,163 32,197 18,704
----------- ----------- -----------
GENERAL AND ADMINISTRATIVE EXPENSES:
Salaries and employee benefits........................................... 59,937 48,520 41,544
Occupancy and equipment expenses......................................... 24,495 21,293 17,954
Outside services......................................................... 33,595 16,720 10,135
Deposit insurance premiums............................................... 10,258 11,657 8,724
Advertising.............................................................. 4,218 5,414 4,737
Other administrative expenses............................................ 19,743 16,793 18,185
----------- ----------- -----------
Total general and administrative expenses....................... 152,246 120,397 101,279
----------- ----------- -----------
OTHER OPERATING EXPENSES:
Non-recurring SAIF assessment............................................ 30,914 -- --
Amortization of goodwill and other intangible assets..................... 11,963 12,611 7,044
Real estate owned losses................................................. 3,770 2,272 1,547
----------- ----------- -----------
Total other operating expenses.................................. 46,647 14,883 8,591
----------- ----------- -----------
Income before income taxes................................................. 75,749 91,077 79,729
Income tax provision....................................................... 29,935 30,671 29,830
----------- ----------- -----------
NET INCOME................................................................. $ 45,814 $ 60,406 $ 49,899
----------- ----------- -----------
----------- ----------- -----------
NET INCOME APPLICABLE TO COMMON STOCK...................................... $ 39,564 $ 55,717 $ 49,899
----------- ----------- -----------
----------- ----------- -----------
EARNINGS PER COMMON AND COMMON EQUIVALENT SHARE(1) $ .59 $ .82 $ .74
----------- ----------- -----------
----------- ----------- -----------
DIVIDENDS PER COMMON SHARE(1).............................................. $ .077 $ .078 $ .095
----------- ----------- -----------
----------- ----------- -----------

- ------------------
(1) All per share data have been adjusted to reflect all stock dividends and
stock splits declared through January 1997.

See accompanying notes to supplemental consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

SUPPLEMENTAL CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
(IN THOUSANDS)

COMMON PREFERRED UNALLOCATED
SHARES SHARES COMMON PREFERRED RETAINED TREASURY COMMON STOCK
COMBINED OUTSTANDING OUTSTANDING STOCK STOCK EARNINGS STOCK HELD BY ESOP
- --------------------------------- --------------- ----------- ----------- ----------- ----------- ----------- -------------

BALANCE, DECEMBER 31, 1993....... 55,296 -- $ 205,793 $ -- $ 90,624 $ (1,958) $ (1,159)
Net income....................... -- -- -- -- 49,899 -- --
Exercise of stock options........ 662 -- 1,318 -- -- -- --
Cash in lieu of fractional
shares.......................... (1) -- (14) -- -- -- --
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... 229 -- 2,580 -- -- -- --
Stock dividends.................. 4,162 -- 38,135 -- (38,135) -- --
Dividends paid on common stock,
$.0000 per share................ -- -- -- -- (5,728) -- --
Treasury stock retired........... -- -- (1,958) -- -- 1,958 --
Unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. -- -- -- -- -- -- --
Allocation of shares under
Employee Stock Ownership Plan... -- -- -- -- -- -- 1,159
Other............................ (26) -- (98) -- 622 -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1994....... 60,322 -- 245,756 -- 97,282 -- --
--------- --------- --------- --------- --------- --------- ---------
Net Income....................... -- -- -- -- 60,406 -- --
Exercise of stock options........ 481 -- 945 -- -- -- --
Cash in lieu of fractional
shares.......................... -- -- (2) -- -- -- --
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... 251 -- 1,963 -- -- -- --
Stock dividends.................. 2,743 -- 20,571 -- (20,571) -- --
Dividends paid on common stock,
$.0000 per share................ -- -- -- -- (4,703) -- --
Preferred stock offering......... -- 2,000 -- 96,446 -- -- --
Dividends paid on preferred
stock, $0.00 per share.......... -- -- -- -- (4,688) -- --
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan............ (3,757) -- -- -- -- -- (30,286)
Allocation of shares under
Employee Stock Ownership Plan... 188 -- -- -- -- -- 1,514
Other............................ 25 -- 630 -- (545) -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1995....... 60,253 2,000 269,863 96,446 127,181 -- (28,772)
--------- --------- --------- --------- --------- --------- ---------
Net Income....................... -- -- -- -- 45,814 -- --
Exercise of stock options........ 544 -- 1,550 -- -- -- --
Cash in lieu of fractional
shares.......................... -- -- (2) -- (9) -- --
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... 201 -- 1,699 -- -- -- --
Stock dividends.................. 2,905 -- 24,509 -- (24,509) -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares.......................... (179) -- -- -- 1,506 -- (1,506)
Dividends paid on common stock,
$.000 per share................. -- -- -- -- (4,999) -- --
Dividends paid on preferred
stock, $0.00 per share.......... -- -- -- -- (6,250) -- --
Treasury stock repurchase........ (229) -- -- -- -- (2,300) --
Unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. -- -- -- -- -- -- --
Purchase of shares under Employee
Stock Ownership Plan............ (544) -- -- -- -- -- (4,559)
Allocation of shares under
Employee Stock Ownership Plan... 224 -- 643 -- -- -- 1,822
Issuance of stock for West
Jersey.......................... 1,996 -- 1,030 -- 7,255 -- --
Other............................ 25 -- 65 -- -- -- --
--------- --------- --------- --------- --------- --------- ---------
BALANCE, DECEMBER 31, 1996....... 65,196 2,000 $ 299,357 $ 96,446 $ 145,989 $ (2,300) $ (33,015)
--------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- ---------

UNRECOGNIZED TOTAL
LOSS ON STOCKHOLDERS'
COMBINED AFS EQUITY
- --------------------------------- ------------- -------------

BALANCE, DECEMBER 31, 1993....... $ -- $ 293,300
Net income....................... -- 49,899
Exercise of stock options........ -- 1,318
Cash in lieu of fractional
shares.......................... -- (14)
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... -- 2,580
Stock dividends.................. -- --
Dividends paid on common stock,
$.0000 per share................ -- (5,728)
Treasury stock retired........... -- --
Unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. (1,165) (1,165)
Allocation of shares under
Employee Stock Ownership Plan... -- 1,159
Other............................ -- 524
--------- ---------
BALANCE, DECEMBER 31, 1994....... (1,165) 341,873
--------- ---------
Net Income....................... -- 60,406
Exercise of stock options........ -- 945
Cash in lieu of fractional
shares.......................... -- (2)
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... -- 1,963
Stock dividends.................. -- --
Dividends paid on common stock,
$.0000 per share................ -- (4,703)
Preferred stock offering......... -- 96,446
Dividends paid on preferred
stock, $0.00 per share.......... -- (4,688)
Unrecognized gain on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. 5,064 5,064
Purchase of shares under Employee
Stock Ownership Plan............ -- (30,286)
Allocation of shares under
Employee Stock Ownership Plan... -- 1,514
Other............................ -- 85
--------- ---------
BALANCE, DECEMBER 31, 1995....... 3,899 468,617
--------- ---------
Net Income....................... -- 45,814
Exercise of stock options........ -- 1,550
Cash in lieu of fractional
shares.......................... -- (11)
Sale of stock under Dividend
Reinvestment and Employee Stock
Purchase Plan................... -- 1,699
Stock dividends.................. -- --
Stock dividends on unallocated
Employee Stock Ownership Plan
shares.......................... -- --
Dividends paid on common stock,
$.000 per share................. -- (4,999)
Dividends paid on preferred
stock, $0.00 per share.......... -- (6,250)
Treasury stock repurchase........ -- (2,300)
Unrecognized loss on investment
and mortgage-backed securities
available-for-sale, net of
tax............................. (1,537) (1,537)
Purchase of shares under Employee
Stock Ownership Plan............ -- (4,559)
Allocation of shares under
Employee Stock Ownership Plan... -- 2,465
Issuance of stock for West
Jersey.......................... -- 8,285
Other............................ -- 65
--------- ---------
BALANCE, DECEMBER 31, 1996....... $ 2,362 $ 508,839
--------- ---------
--------- ---------

See accompanying notes to supplemental consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)

YEAR ENDED DECEMBER 31,
----------------------------------
1996 1995 1994
---------- ---------- ----------

CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................................... $ 45,814 $ 60,406 $ 49,899
Adjustments to reconcile net income to net cash provided by operating
activities:
Provision for possible loan losses and deferred taxes...................... 18,840 6,552 12,429
Depreciation............................................................... 7,292 6,116 5,960
Amortization............................................................... 8,713 5,235 (1,216)
Gain on sale of loans, investment and mortgage-backed securities and real
estate owned............................................................. (4,692) (2,483) (2,060)
Allocation of Employee Stock Ownership Plan................................ 2,465 1,514 --
Net change in:
Loans held for resale.................................................... 104,776 (66,200) 63,803
Accrued interest receivable.............................................. (9,463) (13,351) (11,207)
Prepaid expenses and other assets........................................ (30,336) (1,740) (80,291)
Other liabilities........................................................ (24,084) 14,614 (3,918)
---------- ---------- ----------
Net cash provided by operating activities.................................... 119,325 10,663 33,399
---------- ---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment and mortgage-backed securities:
Available-for-sale......................................................... 696,199 55,973 760,352
Proceeds from repayments and maturities of investment and mortgage-backed
securities:
Available-for-sale......................................................... 113,394 -- 3,961
Held-to-maturity........................................................... 471,623 348,461 340,855
Purchases of investment and mortgage-backed securities:
Available-for-sale......................................................... (388,939) (98,795) (338,473)
Held-to-maturity........................................................... (830,844) (1,335,525) (675,613)
Proceeds from sales of loans................................................. 67,982 7,307 6,515
Purchase of loans............................................................ (885,033) (306,086) (72,808)
Net change in loans other than purchases and sales........................... (622,621) (86,241) (1,104,124)
Proceeds from sales of premises and equipment................................ 2,970 10,729 2,060
Purchases of premises and equipment.......................................... (6,063) (19,718) (5,489)
Proceeds from sales of real estate owned..................................... 10,189 9,758 19,491
Net cash received from business combinations................................. 4,983 5,569 46,659
Other, net................................................................... -- -- (4,568)
---------- ---------- ----------
Net cash used by investing activities........................................ (1,366,160) (1,408,568) (1,021,182)
---------- ---------- ----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Assumption of deposits....................................................... -- 818,913 13,687
Net (decrease) increase in deposits.......................................... (86,497) 176,204 148,887
Net increase (decrease) in short-term borrowings............................. 305,297 (549,300) 757,290
Proceeds from long-term borrowings........................................... 1,005,001 910,499 75,000
Repayments of long-term borrowings........................................... (2) (716) (3,020)
Net increase (decrease) in advance payments by borrowers for taxes and
insurance.................................................................. 464 (3,311) 4,152
Cash dividends paid to stockholders.......................................... (11,249) (9,391) (5,728)
Proceeds from issuance of common stock....................................... 4,333 2,991 3,884
Proceeds from issuance of preferred stock.................................... -- 96,446 --
Advance to the Employee Stock Ownership Plan................................. (10,206) (30,286) --
Purchase of Treasury Stock................................................... (2,300) -- --
---------- ---------- ----------
Net cash provided by financing activities.................................... 1,204,841 1,412,049 994,152
---------- ---------- ----------
Net change in cash and cash equivalents...................................... (41,994) 14,144 6,369
Cash and cash equivalents at beginning of period............................. 159,563 145,419 139,050
---------- ---------- ----------
Cash and cash equivalents at end of period................................... $ 117,569 $ 159,563 $ 145,419
---------- ---------- ----------
---------- ---------- ----------
RECONCILIATION OF CASH AND CASH EQUIVALENTS TO SUPPLEMENTAL CONSOLIDATED
BALANCE SHEETS:
Cash and amounts due from depository institutions............................ $ 111,296 $ 142,039 $ 114,832
Interest-earning deposits.................................................... 6,273 17,524 30,587
---------- ---------- ----------
Cash and cash equivalents at end of period................................... $ 117,569 $ 159,563 $ 145,419
---------- ---------- ----------
---------- ---------- ----------

SUPPLEMENTAL DISCLOSURES:

Income tax payments totaled $40.0 million in 1996, $22.8 million in 1995
and $24.9 million in 1994. Interest payments totaled $477.5 million in 1996,
$325.1 million in 1995 and $209.3 million in 1994. Noncash activity consisted of
mortgage loan securitization of $372.1 million in 1996, $200.9 million in 1995
and $159.5 million in 1994; reclassification of long-term borrowings to
short-term borrowings of $931.7 million in 1996, $315.8 million in 1995 and
$159.5 million in 1994; and reclassification of mortgage loans to real estate
owned of $11.9 million in 1996, $6.7 million in 1995 and $9.5 million in 1994.

See accompanying notes to supplemental consolidated financial statements.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS

These supplemental financial statements have been prepared to comply with
the Securities & Exchange Commission's filing requirements for a Registration
Statement on Form S-4. These supplemental financial statements together with the
complete footnote disclosures will become the historical financial statements of
the Registrant once financial results for the fiscal year ended December 31,
1997 are issued.

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The following is a description of the significant accounting policies of
Sovereign Bancorp, Inc. and subsidiaries ("Sovereign"). Such accounting policies
are in accordance with generally accepted accounting principles and have been
followed on a consistent basis, except as separately noted herein.

a. Principles of Consolidation -- The accompanying financial statements
include the accounts of the parent company, Sovereign Bancorp, Inc. and its
wholly-owned subsidiaries: Sovereign Bank and Sovereign Community Bank. All
material intercompany balances and transactions have been eliminated in
consolidation.

b. Use of Estimates -- The preparation of financial statements in
conformity with 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.

c. Per Share Information -- Earnings per share have been calculated based
on the average common shares outstanding (including assumed conversion of
preferred shares and excluding unallocated shares in Sovereign's Employee Stock
Ownership Plan ("ESOP")) for the respective periods. Stock options are
considered common stock equivalents and are included in the computation of the
number of outstanding shares using the treasury stock method, unless
anti-dilutive. The number of shares used in the computation of fully diluted
earnings per share for the years ended December 31, 1996, 1995, and 1994 were
77.9 million, 74.1 million and 67.8 million, respectively. All per share data
has been restated to reflect the effect of the 20% stock split which was
authorized on January 16, 1997, with a record date of March 3, 1997, the 5%
stock dividends which were authorized on December 20, 1995 and February 22,
1995, with record dates of February 1, 1996 and March 31, 1995, respectively,
the 10% stock dividend which was authorized on April 19, 1994, with a record
date of April 29, 1994 and all prior stock dividends and stock splits.

In February 1997, the FASB issued SFAS No. 128, Earnings Per Share. This
statement supersedes APB Opinion No. 15, "Earnings per Share" and FASB
Statement No. 85, "Yield Test for Determining whether a Convertible Security Is
a Common Stock Equivalent". The overall objective of SFAS No. 128 is to simplify
the calculation of earnings per share and achieve comparability with the
recently issued International Accounting Standard No. 33, "Earnings Per Share".
SFAS No. 128 is effective for all periods ending after December 15, 1997.
Subsequent to the effective date, all prior-period earnings per share amounts
are required to be restated to conform to the provisions of SFAS No. 128.

Under SFAS No. 128, primary earnings per share will be replaced with basic
earnings per share. Basic earnings per share will be calculated by dividing
income available to common stockholders by the weighted average common shares
outstanding, excluding options, warrants, and convertible securities from the
calculation.

Fully diluted earnings per share has been renamed diluted earnings per
share. Income available to common stockholders will be adjusted for the assumed
conversion of all potentially dilutive securities. In calculating diluted
earnings per share, the dilutive effect of options and warrants will continue to
be calculated using the treasury stock method. However, unlike the existing
calculation of fully diluted earnings per share, the treasury stock method will
be applied using the average market price for the period rather than the higher
of the average market price or the ending market price. The dilutive effect of
convertible debt or preferred stock will continue to be calculated using the
if-converted method.

d. Interest-Earning Deposits -- Interest-earning deposits consist of
deposit accounts with the Federal Home Loan Bank of Pittsburgh ("FHLB") and
deposits with other financial institutions generally having maturities of three
months or less.

e. Investment and Mortgage-backed Securities -- Effective January 1, 1994,
Sovereign adopted Statement of Financial Accounting Standard ("SFAS") No. 115,
"Accounting for Certain Investments in Debt and Equity Securities." Under SFAS
No. 115, debt securities that the company has the intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized cost.
Securities expected to be held for an indefinite period of time are classified
as available-for-sale and are carried at fair value with unrealized gains and
losses reported as a separate component of stockholders' equity, net of
estimated income taxes. Securities that are bought and held principally for the
purpose of selling are classified as trading and reported at fair value, with
unrealized gains and losses included in earnings. Sovereign has no securities
held for trading. Gains or losses on the sales of securities are recognized at
trade date utilizing the specific identification method. In 1993 and prior
periods, investment and mortgage-backed securities were intended to be
held-to-maturity and were generally carried at cost, adjusted for amortization
of premiums and accretion of discounts, because Sovereign had both the intent
and ability to hold these securities to maturity or on a long-term basis.
Marketable equity securities were carried at the lower of cost or estimated fair
value on an aggregate basis. Trading securities were carried at fair value.

f. Forward Commitments and Options -- Sovereign utilizes forward
commitments and/or options to hedge interest rate risk associated with loans
held for resale and/or commitments to fund loans. Gains and losses on these
transactions are included in the net gain or loss when the asset is sold.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

g. Mortgage Banking Activity -- Loans held for resale consist of
residential mortgage loans and mortgage-backed securities originated or
purchased by Sovereign. They are recorded at the lower of cost or estimated fair
value on an aggregate basis. Gains and losses are included in the consolidated
statements of operations. The fair value calculation includes consideration of
all open positions, outstanding commitments and related fees paid. Excess
servicing fees are computed as the present value of the difference between the
estimated future net revenues and normal servicing net revenues as established
by the federally sponsored secondary market makers. Resultant premiums are
deferred and amortized over the estimated life of the related mortgages using
the constant yield method.

Effective July 1, 1995, Sovereign prospectively adopted SFAS No. 122,
"Accounting for Mortgage Servicing Rights." SFAS No. 122 requires that
management recognize as separate assets, rights to service mortgage loans for
others, however these servicing rights are acquired. Management should allocate
the total cost of mortgage loans, either purchased or originated, to the loans
and the mortgage servicing rights based on their relative fair value. The
Statement also requires that management assess its capitalized mortgage
servicing rights for impairment based on the fair value of those rights, and
that this impairment be recognized through a valuation allowance.

For purposes of measuring impairment of capitalized mortgage servicing
rights and minimizing the impact of risk, Sovereign conservatively evaluates the
loans underlying these rights by stratifying them into certain homogeneous
categories which include, but are not limited to, residential real estate
30-year and 15-year fixed rate mortgage loans, adjustable rate mortgage loans
and balloon loans. Sovereign also takes into consideration any inherent risks,
which historically have been minimal on these loan types, as well as other
relevant factors associated with each portfolio. Prices are obtained in the
secondary market and are based upon current market prices of similarly traded
loans and/or comparable secondary market instruments.

h. Allowance for Possible Loan Losses -- An allowance for possible loan
losses is maintained at a level that management considers adequate to provide
for potential 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 which
have 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 may be necessary if conditions differ substantially
from the assumptions used in making the evaluations.

i. Loans -- Interest on loans is credited to income as it is earned.
Interest income is not recognized on loans when the loan payment is 90 days or
more delinquent (unless government-guaranteed or secured by deposit accounts) or
sooner if management believes the loan has become impaired. Sovereign defines
impairment as the existence of one or a combination of any of the following loan
weaknesses:

o the primary source of repayment is gone or severely impaired and
Sovereign may have to rely on the secondary source

o loss does not seem likely, but sufficient problems have arisen to
cause Sovereign to go to abnormal lengths to protect its position in
order to maintain a high probability of repayment

o Obligors are unable to generate enough cash flow to reduce their
debts

o Deterioration in collateral value or inadequate inspection or
verification of value (if the collateral is expected to be a source
of repayment)

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

o Flaws in documentation leave Sovereign in a subordinated or
unsecured position when the collateral is needed for repayment of
the loan

When a loan is placed on non-accrual status, all accrued yet uncollected
interest is reversed from income. In order for a non-accrual loan to revert to
accruing status, all delinquent interest must be paid and Sovereign must approve
a repayment plan.

Loans delinquent 180 days or more are considered for charge-off unless it
can be clearly demonstrated that repayment will occur regardless of the
delinquency status. Examples of this would include: a loan which is secured by
collateral and is in the process of collection; a loan supported by a valid
guarantee or insurance; or a loan supported by a valid claim against a solvent
estate. A decision to charge-off a loan does not necessarily mean that the asset
has no recovery or salvage value, but rather it is not practical to defer
writing off the balance, even though partial or full recovery may be realized in
the future.

j. Loan Fees, Discounts and Premiums -- Loan origination fees and certain
direct loan origination costs are deferred and recognized as interest income in
the consolidated statement of operations over the contractual life of the loan
utilizing the level yield method, except in the case of certain discounted loans
in which a portion of the net deferred fee may be amortized over the discount
period. Discounts and premiums on loans purchased are amortized into income
utilizing methods which approximate the level yield method.

k. Premises and Equipment -- Premises and equipment are carried at cost,
less accumulated depreciation. Depreciation is calculated utilizing both
accelerated and straight-line methods. Estimated useful lives are as follows:

Office buildings............................... 15 to 50 years
Leasehold improvements......................... 5 to 10 years
Furniture, fixtures and equipment.............. 3 to 10 years
Automobiles.................................... 3 years

Expenditures for maintenance and repairs are charged to expense as
incurred.

l. Real Estate Owned -- Real estate owned consists of properties acquired
by or in lieu of foreclosure and properties that qualify for in-substance
foreclosure. Real estate owned is stated at the lower of cost or estimated fair
value minus estimated costs to sell. Write-downs of real estate owned which
occur after the initial transfer from the loan portfolio are recorded as other
operating expenses. Costs of holding foreclosed property are charged to expense
in the current period, except for significant property improvements which are
capitalized to the extent that carrying value does not exceed estimated fair
value.

m. Income Taxes -- Deferred income taxes are provided on temporary
differences between amounts reported for financial statement and tax purposes in
accordance with SFAS No. 109, "Accounting for Income Taxes."

n. Interest Rate Exchange Agreements (Including Swaps, Caps, and Floors) --
Sovereign has entered into certain interest rate exchange agreements in
connection with its asset/liability management program as hedges. Related fees
are deferred and amortized on a straight line basis over the life of the
interest rate exchange agreement. Net interest payments/receipts are accrued as
an adjustment of interest expense/income on the hedged assets or liabilities.
Gains or losses resulting from early termination of interest rate exchange
agreements are deferred and amortized over the remaining term of the original
exchange agreements. In the event the related asset/liability is disposed of,
such deferred

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES -- (CONTINUED)

gains or losses are recognized as an adjustment to the respective gain or loss
on disposition. Changes in the value of interest rate exchange agreements are
not recorded in the financial statements because the interest rate exchange
agreements are designated as hedges.

o. General and Administrative Expenses -- General and administrative
expenses are classified on a functional basis, except for salaries and employee
benefits. Certain direct loan origination costs are deferred and are being
amortized as a yield adjustment through net interest income (see note 1-j).

p. Consolidated Statement of Cash Flows -- For purposes of reporting cash
flows, cash and cash equivalents include cash and amounts due from depository
institutions, interest-earning deposits and securities purchased under resale
agreements with an original maturity of three months or less.

q. Reclassifications -- Certain amounts in the financial statements of
prior periods have been reclassified to conform with the presentation used in
these financial statements. These reclassifications have no effect on net
income.

r. Long-Lived Assets -- In March 1995, the Financial Accounting Standards
Board ("FASB") issued SFAS No. 121, "Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to Be Disposed of," which requires impairment
losses to be recorded on long-lived assets used in operations when indicators of
impairment are present and the undiscounted cash flows estimated to be generated
by those assets are less than the assets' carrying amount. SFAS No. 121 also
addresses the accounting for long-lived assets that are expected to be disposed
of. Sovereign adopted SFAS No. 121 in 1996 and the effect of adoption was not
material.

s. Intangibles -- Core deposit intangibles are a measure of the value of
consumer demand and savings deposits acquired in business combinations accounted
for as purchases. Core deposit intangibles are being amortized on accelerated
bases pursuant to core deposit studies and in accordance with SFAS No. 72,
"Accounting for Certain Acquisitions of Banking or Thrift Institutions," over
the estimated lives of the existing deposit relationships acquired, but not
exceeding 15 years. Goodwill is the excess of the purchase price over the fair
value of net assets of companies acquired through business combinations
accounted for as purchases. Goodwill is being amortized using the straight line
method over various periods not exceeding 20 years. The carrying amount of the
goodwill is reviewed if facts and circumstances suggest that it may be impaired.
If this review indicates that goodwill will not be recoverable, as determined
based on the loss of economic value, the carrying amount of the goodwill is
reduced by the estimated loss of value. In addition, goodwill associated with
impaired long-lived assets is included in the impairment evaluation which
Sovereign assesses under the rules of SFAS No. 121.

(2) BUSINESS COMBINATIONS

On May 31, 1996, Sovereign acquired West Jersey Bancshares, Inc. ("West
Jersey") in a transaction accounted for as a pooling-of-interests; however, the
consolidated financial statements have not been restated due to immateriality.
Sovereign acquired approximately $100.0 million in assets consisting principally
of investment securities and loans and assumed approximately $73.0 million of
deposit liabilities. West Jersey shareholders received .8335 shares of Sovereign
common stock in exchange for each share of West Jersey common stock, or $8.91
per share. Sovereign issued 1.7 million new shares (2.0 million shares as
adjusted for all subsequent stock dividends and stock splits) of Sovereign
common stock in connection with the transaction, which was tax-free to West
Jersey and West Jersey shareholders.

On November 17, 1995, Sovereign acquired two branch offices and related
deposits of Berkeley Federal Bank & Trust, FSB ("Berkeley"). Sovereign assumed
approximately $111.7 million of deposits for a premium of $5.5 million. Of this
premium, $604,000 was recorded as a core deposit

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(2) BUSINESS COMBINATIONS -- (CONTINUED)

intangible and $4.9 million was recorded as goodwill. The balances of this core
deposit intangible and goodwill at December 31, 1996 were $441,000 and $4.6
million, respectively.

On November 15, 1995, Sovereign acquired Colonial State Bank in a
transaction accounted for as a purchase. Sovereign acquired $46.5 million of
assets consisting principally of loans and investment securities. Sovereign also
assumed approximately $42.0 million of deposit liabilities. Sovereign acquired
Colonial State Bank in exchange for $6.3 million in cash. This transaction added
goodwill of $3.3 million to Sovereign's balance sheet. The balance of the
goodwill at December 31, 1996 was $3.1 million. After receipt of regulatory
approvals and pursuant to the terms of the agreement entered into by Sovereign
and Colonial State Bank, upon acquisition, Colonial State Bank became a
wholly-owned, BIF-insured subsidiary of Sovereign and converted to a federal
savings bank under the name Colonial Bank for Savings, a Federal Savings Bank.
On April 1, 1996, Colonial Bank for Savings, FSB was renamed Sovereign Community
Bank. It is management's intention to merge Sovereign Community Bank into
Sovereign Bank in 1997.

On November 10, 1995, Sovereign completed the sale of its Pottsville,
Pennsylvania branch office with related deposits totaling $23.9 million to
Northwest Savings Bank ("Northwest") and the sale of its English Village branch
office in North Wales, Pennsylvania with related deposits of $12.4 million to
Union National Bank & Trust Company ("Union National"). As a result of these
transactions, Sovereign recognized a pre-tax gain of $1.1 million and reduced
goodwill by $568,000, respectively.

On April 21, 1995, Sovereign completed its sale of seven southern New
Jersey offices with related deposits totaling $106.7 million to Collective
Bancorp, Inc. ("Collective"). Six of these offices had previously been purchased
from Berkeley as part of a transaction which occurred on January 1, 1995. In
addition, Sovereign acquired $7.0 million of deposits from Collective's
Wilmington, Delaware branch office. As a result of this transaction, Sovereign
recognized a pre-tax gain of $1.5 million and reduced its existing core deposit
intangible by approximately $6.0 million.

On January 1, 1995, Sovereign acquired 23 branch offices located in New
Jersey and Delaware with $909.3 million of deposit liabilities from Berkeley. In
exchange for assuming the deposits of the Berkeley offices, Sovereign acquired
principally cash and fixed assets, net of a deposit premium of $66.6 million
which was recorded as $7.6 million of core deposit intangible and $59.0 million
of goodwill. The balances of this core deposit intangible and goodwill at
December 31, 1996 were $3.4 million and $49.4 million, respectively.

On November 1, 1994, Sovereign acquired Charter FSB Bancorp, Inc.
("Charter"). Sovereign exchanged a total of 7.0 million new shares (9.3 million
shares as adjusted for all subsequent stock dividends and stock splits) of
Sovereign common stock for all of the outstanding shares of Charter common
stock. The acquisition of Charter was accounted for as a pooling-of-interests
and accordingly, the consolidated financial statements have been restated to
include the accounts of Charter for all periods presented. Sovereign's
consolidated results of operations for the year ended December 31, 1994 include
Charter's results of operations for the twelve-month period ended December 31,
1994.

On September 16, 1994, Sovereign acquired the Chadds Ford, Pennsylvania
office and related deposits of Second National Federal Savings Association
("Second National") from the Resolution Trust Corporation ("RTC"), receiver for
Second National. Sovereign assumed approximately $14.4 million of deposits from
the Chadds Ford office for a premium of $675,000, which was recorded as a core
deposit intangible. The balance of this core deposit intangible was $337,000 at
December 31, 1996.

On August 5, 1994, Sovereign acquired Shadow Lawn Savings Bank ("Shadow
Lawn") in a transaction accounted for as a purchase. Sovereign acquired $787.5
million of assets consisting principally of investment and mortgage-backed
securities and loans. Sovereign also assumed approximately $730.6 million of
deposit liabilities. Sovereign acquired Shadow Lawn in exchange for an estimated
purchase price of $78.4 million of cash. This transaction added a core deposit
intangible

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(2) BUSINESS COMBINATIONS -- (CONTINUED)

of $13.0 million and goodwill of $26.7 million to Sovereign's balance sheet. The
balances of this core deposit intangible and goodwill at December 31, 1996 were
$7.4 million and $24.3 million, respectively.

Following are selected unaudited pro forma results of operations for 1996,
1995 and 1994 as if the Colonial and Shadow Lawn acquisitions (which were
accounted for as purchases) had occurred at the beginning of 1994 (in thousands,
except per share data):

YEAR ENDED DECEMBER 31,
----------------------------
1996 1995 1994
-------- -------- --------
Total interest and non-interest income........... $709,652 $572,877 $442,857
Net interest income.............................. 241,895 198,600 193,018
Net income....................................... 45,814 60,600 50,814
Earnings per common and common equivalent share.. .59 .82 .75

On February 18, 1997, Sovereign acquired First State FinanciaL Services,
Inc. ("First State"), a $603 million savings institution headquartered in West
Caldwell, New Jersey with 14 branch offices located throughout central and
northern New Jersey. In accordance with the merger agreement, First State
shareholders received 1.47 shares of Sovereign common stock in exchange for each
share of First State common stock. Sovereign issued approximately 5.9 million
new shares of Sovereign common stock in connection with the transaction, which
was tax-free to First State and First State shareholders. This transaction was
accounted for as a pooling-of-interests and accordingly, the consolidated
financiaL statements have been restated to include the accounts of First State
for all periods presented.

The results of operations previously reported by the separated enterprises
and the combined amounts presented in the accompanying supplemental consolidated
financial statements are summarized below:

Years Ended December 31,
1996 1995
------------------------
Net interest income
Sovereign $216,710 $174,226
First State 25,185 22,584
-------- --------

Combined $241,895 $196,810
======== ========

Net income (loss):
Sovereign $ 51,463 $ 56,408
First State (5,649) 3,998
-------- --------

Combined $ 45,814 $ 60,406
======== ========

Prior to the combination, First State's fiscal year end was September 30,
and accordingly, Sovereign's consolidated results of operations for the years
ended December 31, 1996, 1995, and 1994 include First State's results of
operations for the twelve-month periods ended September 30, 1996, 1995 and 1994,
respectively. In 1997, a net decrease to Sovereign's stockholders' equity of
$5.2 million will be made to reflect First State's activity for the three-month
period ended December 31, 1996. That activity will consist of proceeds from the
exercise of stock options of $1.0 million, net loss of $6.4 million and net
change in unrecognized loss on available-for-sale securities of $228,000.

On February 5, 1997, Sovereign executed a Definitive Agreement to acquire
Bankers Corp., Inc. ("Banker's"), a $2.5 billion financial services holding
company headquartered in Perth Amboy, New Jersey. Bankers' sole banking
subsidiary, Bankers Savings, operates 15 branch offices located in Middlesex,
Monmouth, and Ocean counties, New Jersey. The transaction will add loans,
deposits, and shareholders' equity to Sovereign of $1.7 billion, $1.6 billion,
and $193.0 million, respectively. The terms of the Agreement call for Sovereign
to exchange $25.50 in Sovereign common stock for each outstanding common share
of Bankers. The transaction will be tax-free to Bankers and Bankers'
shareholders, and will be accounted for as a pooling-of-interests. Sovereign
anticipates that the transaction will close during the third quarter of 1997.

(3) RESTRICTIONS ON CASH AND AMOUNTS DUE FROM DEPOSITORY INSTITUTIONS

Sovereign Bank and Sovereign Community Bank are required to maintain
certain average reserve balances as established by the Federal Reserve Board.
The amounts of those reserve balances for the reserve computation periods which
included December 31, 1996 and 1995 were $43.7 million and $50.8 million,
respectively.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES

The amortized cost and estimated fair value of investment and
mortgage-backed securities are as follows (in thousands):

AT DECEMBER 31,
------------------------------------------------------------------------------------------------------
1996 1995
-------------------------------------------------- --------------------------------------------------
AMORTIZED UNREALIZED UNREALIZED FAIR AMORTIZED UNREALIZED UNREALIZED FAIR
COST APPRECIATION DEPRECIATION VALUE COST APPRECIATION DEPRECIATION VALUE
--------- ------------ ------------ --------- --------- ------------ ------------ ---------

Investment and Mortgage-
backed Securities
Available-for-Sale:

Investment Securities:

U.S. Treasury and
government agency
securities.............. $ 5,728 $ 43 $ 7 $ 5,764 $ 151,249 $ 131 $ 1,270 $ 150,110
Equity securities......... 286,773 3,525 -- 290,298 139,237 1,172 89 140,320
Other securities.......... 7,720 -- 248 7,472 2,728 6 17 2,717

Mortgage-backed Securities:

FHLMC..................... 25,288 -- 287 25,001 156,123 763 1,357 155,529
FNMA...................... -- -- -- -- 136,861 2,241 657 138,445
GNMA...................... -- -- -- -- 59,215 2,697 -- 61,912
Collateralized mortgage
obligations............. 164,459 895 129 165,225 245,037 3,568 662 247,943
Other securities.......... 1,259 -- 22 1,237 8,130 -- 83 8,047
--------- --------- --------- --------- --------- --------- --------- ---------
Total investment and
mortgage-backed securities
available-for-sale........ $ 491,227 $ 4,463 $ 693 $ 494,997 $ 898,580 $ 10,578 $ 4,135 $ 905,023
--------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- ---------

Investment and Mortgage-
backed Securities Held-to-
Maturity:

Investment Securities:

U.S. Treasury and
government agency
securities.............. $ 13,426 $ 60 $ 171 $ 13,315 $ 15,896 $ 59 $ 171 $ 15,784
Corporate securities...... 1,006 32 -- 1,038 1,010 60 -- 1,070
Other securities.......... 65,086 86 242 64,930 10,468 75 158 10,385

Mortgage-backed Securities:

FHLMC..................... 145,075 900 3,425 142,550 173,439 1,808 1,307 173,940
FNMA...................... 193,607 374 5,102 188,879 223,754 1,262 2,071 222,945
GNMA...................... 194,782 3,590 370 198,002 173,937 6,587 86 180,438
RTC....................... -- -- -- -- 28,954 -- 4,456 24,498
Private issues............ 272,778 87 9,529 263,336 284,640 622 2,626 282,636
Collateralized mortgage
obligations............. 1,599,769 4,589 13,614 1,590,744 1,204,964 10,664 309 1,215,319
Other securities.......... 2,086 -- 36 2,050 -- -- -- --
---------- --------- --------- --------- ---------- --------- --------- ----------
Total investment and
mortgage-backed securities
held-to-maturity.......... $2,487,615 $ 9,718 $ 32,489 $2,464,844 $2,117,062 $ 21,137 $ 11,184 $2,127,015
---------- --------- --------- ---------- ---------- --------- --------- ----------
---------- --------- --------- ---------- ---------- --------- --------- ----------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES

The amortized cost and estimated fair value of investment and
mortgage-backed securities at December 31, 1996 by contractual maturity are
shown below. Expected maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or prepayment penalties (in thousands):

AMORTIZED FAIR
COST VALUE
--------- -----------

Investment and Mortgage-backed Securities Available-for-Sale:
Due in one year or less....................................................... $ -- $ --
Due after one year through five years......................................... 12,552 12,558
Due after five years through ten years........................................ 15,964 15,832
Due after ten years........................................................... 174,682 175,086
No stated maturity............................................................ 288,029 291,521
--------- ---------
Total investment and mortgage-backed securities available-for-sale.......... $ 491,227 $ 494,997
--------- ---------
--------- ---------

AMORTIZED FAIR
COST VALUE
----------- ----------

Investment and Mortgage-backed Securities Held-to-Maturity:
Due in one year or less...................................................... $ 60,526 $ 60,557
Due after one year through five years........................................ 59,557 59,739
Due after five years through ten years....................................... 52,246 52,429
Due after ten years.......................................................... 2,315,286 2,292,119
----------- ----------
Total investment and mortgage-backed securities held-to-maturity........... $ 2,487,615 $2,464,844
----------- ----------
----------- ----------

There were no sales of investment and mortgage-backed securities
held-to-maturity in 1996, 1995 and 1994. Proceeds from sales of investment and
mortgage-backed securities available-for-sale and the realized gross gains and
losses from those sales are as follows (in thousands):

AVAILABLE-FOR-SALE
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Proceeds from sales..................................................... $ 696,199 $ 55,973 $ 760,352
--------- --------- ---------
--------- --------- ---------
Gross realized gains.................................................... $ 9,034 $ 358 $ 2,514
Gross realized losses................................................... 4,543 164 895
--------- --------- ---------
Net realized gains...................................................... $ 4,491 $ 194 $ 1,619
--------- --------- ---------
--------- --------- ---------

Investment and mortgage-backed securities with an estimated fair value of
$129.0 million and $608.9 million were pledged as collateral for borrowings,
interest rate agreements and public deposits at December 31, 1996 and 1995,
respectively.

In May 1993, the FASB issued SFAS No. 115, "Accounting for Certain
Investments in Debt and Equity Securities." SFAS No. 115 requires management to
classify investments in equity securities that have readily determinable fair
values and all investments in debt securities as either held-to-maturity and
reported at amortized cost, available-for-sale and reported at fair value with
unrealized gains and losses reported in a separate component of stockholders'
equity, or trading securities and reported at fair value with unrealized gains
and losses included in earnings. Effective January 1, 1994, Sovereign adopted
SFAS No. 115 and classified $1.29 billion of securities as held-to-maturity,
$391.0 million of securities as available-for-sale and $6.5 million of
securities as trading securities. The adoption of SFAS No. 115 resulted in an
$836,000 increase to stockholders' equity accounted for as the cumulative effect
of a change in accounting principle in 1994.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(4) INVESTMENT AND MORTGAGE-BACKED SECURITIES -- (CONTINUED)

On November 15, 1995, the FASB issued a Special Report, "A Guide to
Implementation of Statement 115 on Accounting for Certain Investments in Debt
and Equity Securities." In accordance with provisions in that Special Report,
Sovereign reclassified $759.3 million of securities from held-to-maturity to
available-for-sale. This reclassification resulted in a $1.8 million unrealized
gain, net of tax, which is included in Sovereign's stockholders' equity at
December 31, 1995.

(5) LOANS

A summary of loans included in the consolidated balance sheets follows (in
thousands):

AT DECEMBER 31,
----------------------------
1996 1995
------------- -------------
BALANCE BALANCE
------------- -------------

Residential real estate loans......................................... $ 5,286,017 $ 4,282,209
Residential construction loans (net of loans in process of $45,088 and
$37,683, respectively).............................................. 82,579 43,485
------------- -------------
Total Residential Loans.......................................... 5,368,596 4,325,694
------------- -------------
Multi-family loans.................................................... 71,815 98,839
Commercial real estate loans.......................................... 140,973 114,607
Commercial loans...................................................... 125,706 51,178
------------- -------------
Total Commercial Loans........................................... 338,494 264,624
------------- -------------
Consumer loans(1)..................................................... 942,447 551,776
------------- -------------
Total Loans...................................................... $ 6,649,537 $ 5,142,094
------------- -------------
------------- -------------
Total Loans with:
Fixed rate.......................................................... $ 1,503,497 $ 1,323,411
Adjustable rate..................................................... 5,146,040 3,818,683
------------- -------------
Total Loans...................................................... $ 6,649,537 $ 5,142,094
------------- -------------
------------- -------------

- ------------------
(1) Consumer loan balances at December 31, 1996 and 1995 include home equity
loans of $583.3 million and $484.5 million, respectively.

As a result of Sovereign's use of interest rate swaps, $561.2 million of
variable rate mortgage loans have been effectively converted to fixed rate
mortgage loans. Also, $248.6 million of intermediate variable rate mortgage
loans (loans with a five-year fixed rate period) and $150.0 million of
short-term variable rate mortgage loans (loans with less than a five year fixed
rate period) have effectively been converted to a variable rate over the fixed
rate period.

The majority of all loans are located in Sovereign's marketplace (eastern
Pennsylvania, New Jersey and northern Delaware). This is Sovereign's only
significant geographic concentration.

The total amount of loans being serviced for the benefit of others was
$1.31 billion and $1.06 billion at December 31, 1996 and 1995, respectively.
During 1995, Sovereign recognized a gain of $3.6 million on the sale of
servicing rights related to $238.5 million of residential mortgage loans. At
December 31, 1996 and 1995, Sovereign had capitalized excess servicing assets of
$815,000 and $2.3 million and originated mortgage servicing rights of $6.0
million and $1.9 million, respectively and no purchased servicing assets.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(5) LOANS -- (CONTINUED)

mortgage servicing rights based on their relative fair value. The Statement also
requires that management assess its capitalized mortgage servicing rights for
impairment based on the fair value of those rights, and that this impairment be
recognized through a valuation allowance.

The activity in the allowance for possible loan losses is as follows (in
thousands):

YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Balance, beginning of period................................... $ 40,938 $ 42,640 $ 41,210
Acquired reserves and other additions.......................... 716 485 4,542
Provision for possible loan losses............................. 11,416 2,650 5,992
Charge-offs.................................................... 8,415 5,571 10,319
Recoveries..................................................... 1,438 734 1,215
--------- --------- ---------
Balance, end of period......................................... $ 46,093 $ 40,938 $ 42,640
--------- --------- ---------
--------- --------- ---------

In May 1993, the FASB issued SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan." SFAS No. 114 requires that certain impaired loans be
measured based on the present value of expected future cash flows discounted at
the loan's effective interest rate or, as a practical expedient, at the loan's
observable market price or the fair value of the collateral if the loan is
collateral dependent. In October 1994, the FASB issued SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan -- Income Recognition and Disclosures,"
that amends SFAS No. 114 and eliminates its provisions regarding how a creditor
should report income on an impaired loan. Originally, SFAS No. 114 would have
required creditors to apply one of two allowable methods. As a result of the
amendment, creditors may now continue to use existing methods for recognizing
income on impaired loans, including methods that are required by certain
industry regulators. SFAS No. 118 also clarified SFAS No. 114's disclosure
requirements. Consistent with SFAS No. 114, Sovereign excludes all residential
and consumer loans from the requirements of this Statement, as these
smaller-balance, homogeneous loans are collectively evaluated for impairment.
SFAS No. 114 and SFAS No. 118 were adopted by Sovereign beginning January 1,
1995. The effect of SFAS No. 114 and SFAS No. 118 on Sovereign was not
significant.

(6) PREMISES AND EQUIPMENT

A summary of premises and equipment, less accumulated depreciation and
amortization, follows (in thousands):

AT DECEMBER 31,
------------------------
1996 1995
----------- -----------

Land...................................................................... $ 11,479 $ 11,630
Office buildings.......................................................... 46,190 46,933
Furniture, fixtures, and equipment........................................ 57,686 52,719
Leasehold improvements.................................................... 6,881 6,213
Automobiles............................................................... 973 987
----------- -----------
123,209 118,482
Less accumulated depreciation............................................. (59,446) (51,008)
----------- -----------
Total premises and equipment......................................... $ 63,763 $ 67,474
----------- -----------
----------- -----------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(6) PREMISES AND EQUIPMENT -- (CONTINUED)

Sovereign is committed under various non-cancelable operating leases
relating to branch facilities having initial or remaining terms in excess of one
year. The minimum annual rental commitments under these leases at December 31,
1996, are summarized as follows (in thousands):

1997................................................................ $ 3,239
1998................................................................ 2,712
1999................................................................ 2,201
2000................................................................ 1,789
2001................................................................ 1,501
Thereafter.......................................................... 4,697
---------
$ 16,139
---------
---------

Total rental expense for all leases for the years ended December 31, 1996,
1995 and 1994 was $3.4 million, $2.8 million and $2.2 million, respectively.

(7) ACCRUED INTEREST RECEIVABLE

Accrued interest receivable is summarized as follows (in thousands):

AT DECEMBER 31,
--------------------
1996 1995
--------- ---------

Accrued interest receivable on:
Investment and mortgage-backed securities.................................... $ 18,190 $ 17,723
Loans........................................................................ 38,658 29,108
--------- ---------
Total interest receivable............................................... $ 56,848 $ 46,831
--------- ---------
--------- ---------

Accrued interest receivable is stated net of an allowance for potentially
uncollected interest (for loans on non-accrual and for loans that have been
restructured). If these non-accruing and restructured loans had been current in
accordance with their original terms and had been outstanding throughout the
period, gross interest income for the years ended December 31, 1996 and 1995
would have increased by approximately $5.0 million and $4.0 million,
respectively. Interest income, which was recorded on these loans for the years
ended December 31, 1996 and 1995 was $2.2 million and $1.4 million,
respectively.

(8) DEPOSITS

Deposits are summarized as follows (in thousands):

AT DECEMBER 31,
------------------------------------------------------------------------------
1996 1995
------------------------------------- -------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
TYPE OF ACCOUNT BALANCE PERCENT RATE BALANCE PERCENT RATE
- --------------- ----------- ---------- ----------- ----------- ---------- -----------

Demand deposit accounts............... $ 272,445 5% -- % $ 193,843 3% -- %
NOW accounts.......................... 469,810 8 1.40 424,872 8 1.39
Savings accounts...................... 1,091,556 19 2.38 1,036,298 19 2.32
Money market accounts................. 661,987 12 3.96 774,165 14 4.28
Retail certificates of deposit........ 2,951,917 53 5.31 2,997,764 53 5.49
Jumbo certificates of deposit......... 158,618 3 5.56 179,527 3 5.70
----------- --------- --------- ----------- --------- ---------
Total deposits.................... $ 5,606,333 100% 4.00% $ 5,606,469 100% 4.24%
----------- --------- --------- ----------- --------- ---------
----------- --------- --------- ----------- --------- ---------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(8) DEPOSITS -- (CONTINUED)

Certificate accounts are frequently renewed at maturity rather than paid
out. The following table sets forth the maturity of Sovereign's certificates of
deposit as scheduled to mature contractually at December 31, 1996 (in
thousands):

SIX MOS.
WITHIN - ONE - THREE - FIVE - OVER
SIX MOS. ONE YR. THREE YRS. FIVE YRS. TEN YRS. TEN YRS. TOTAL
--------- ---------- ---------- ---------- ---------- ---------- ----------

Certificate accounts by rate:
2.001 -- 4.000%........................ $ 27,726 $ 166 $ 478 $ 284 $ 25 $ 32 $ 28,711
4.001 -- 6.000%........................ 169,211 2,050,254 640,377 18,372 7,507 52 2,885,773
6.001 -- 8.000%........................ 34,383 20,808 58,540 27,643 38,261 3,347 182,982
8.001 -- 10.000%....................... 1,083 1,063 5,607 727 883 461 9,824
Above 10.000%.......................... 198 167 344 843 1,693 -- 3,245
--------- ---------- --------- --------- --------- --------- ----------
Total certificate accounts............. $ 232,601 $2,072,458 $ 705,346 $ 47,869 $ 48,369 $ 3,892 $3,110,535
--------- ---------- --------- --------- --------- --------- ----------
--------- ---------- --------- --------- --------- --------- ----------

The following table sets forth the maturity of Sovereign's certificates of
deposit of $100,000 or more as scheduled to mature contractually at December 31,
1996:

AT DECEMBER 31,
1996
---------------
(IN THOUSANDS)
Three months or less.................................... $ 87,468
Over three through six months........................... 60,670
Over six through twelve months.......................... 57,021
Over twelve months...................................... 62,967
-----------
Total.............................................. $ 268,126
-----------
-----------

Interest expense on deposits is summarized as follows (in thousands):

YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------

Demand deposit and NOW accounts.................... $ 6,042 $ 6,204 $ 5,323
Savings accounts................................... 26,293 25,809 27,015
Money market accounts.............................. 27,558 26,515 10,187
Certificates of deposit............................ 164,555 172,393 92,374
----------- ----------- -----------
Total interest expense on deposits............... $ 224,448 $ 230,921 $ 134,899
----------- ----------- -----------
----------- ----------- -----------

The majority of Sovereign's deposits are insured by the Savings Association
Insurance Fund ("SAIF") of the Federal Deposit Insurance Corporation ("FDIC").
As a result, for 1996, Sovereign paid insurance fees equal to $.23 per $100.00
(23 basis points) of insured deposits annually, the lowest rate permitted. Banks
which are insured by the Bank Insurance Fund ("BIF") of the FDIC have been
required to pay rates as low as 4.4 basis points since September 30, 1995, and
most BIF-insured institutions have been required to pay only $2,000 in annual
insurance premiums since January 2, 1996.

On September 30, 1996, legislation was signed into law which effectively
ends the BIF/SAIF disparity by the year 2000. As part of the new law,
SAIF-insured institutions were required to make a one-time payment of 65.7 basis
points for all SAIF-insured deposits held as of March 31, 1995. At Sovereign,
this amounted to an after-tax charge of $19.2 million.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(9) SHORT-TERM AND LONG-TERM BORROWINGS

Short-term Borrowings. Short-term borrowings included in the consolidated
balance sheets are as follows (in thousands):

AT DECEMBER 31,
----------------------------
1996 1995
------------- -------------

Securities sold under repurchase agreements........................... $ -- $ 382,279
Federal Home Loan Bank advances....................................... 2,765,118 1,146,661
Other borrowings...................................................... -- 1,555
------------- -------------
Total borrowings................................................. $ 2,765,118 $ 1,530,495
------------- -------------
------------- -------------

Included in short-term borrowings are sales of securities under repurchase
agreements. Securities underlying these repurchase agreements consisted of
mortgage-backed securities which had a book value of $387.2 million and a market
value of $392.6 million at December 31, 1995.

At December 31, 1995, short-term borrowings include an 11.60% amortizing
loan with principal of $714,000 which is collateralized by 15% of the
outstanding shares of common stock of Sovereign Bank (all of the outstanding
shares of Sovereign Bank are owned by Sovereign Bancorp).

Qualifying repurchase agreements are treated as financings and the
obligations to repurchase securities sold are reflected as a liability in the
balance sheet. The dollar amount of securities underlying the agreements remains
in the asset accounts, although the securities underlying the agreements are
delivered to the brokers who arranged the transactions. In certain instances,
the broker may have sold, loaned, or disposed of the securities to other parties
in the normal course of their operations, and have agreed to resell to Sovereign
substantially similar securities at the maturity of the agreements. The
broker/dealers who participate with Sovereign in these agreements are primary
broker/dealers reporting to the Federal Reserve Bank of New York. The following
table summarizes information regarding securities sold under repurchase
agreements (in thousands):

SECURITIES SOLD UNDER REPURCHASE AGREEMENTS

DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------

Balance.................................................... $ -- $ 382,279 $ 608,810
Weighted average interest rate............................. --% 6.38% 5.72%
Maximum amount outstanding at any month-end during the
period................................................... $ 288,155 $ 630,077 $ 608,810
Average amount outstanding during the period............... $ 181,526 $ 477,195 $ 427,509
Weighted average interest rate during the period........... 6.57% 6.01% 4.49%

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(9) SHORT-TERM AND LONG-TERM BORROWINGS -- (CONTINUED)

The following table summarizes information regarding short-term FHLB
advances (in thousands):

FEDERAL HOME LOAN BANK ADVANCES

DECEMBER 31,
-------------------------------------------
1996 1995 1994
------------- ------------- -------------

Balance.............................................. $ 2,765,118 $ 1,146,661 $ 1,142,116
Weighted average interest rate....................... 5.79% 5.67% 5.34%
Maximum amount outstanding at any month-end during
the period......................................... $ 3,323,966 $ 1,151,286 $ 1,142,116
Average amount outstanding during the period......... $ 2,009,989 $ 807,794 $ 623,814
Weighted average interest rate during the period..... 5.88% 5.55% 4.58%

Long-term Borrowings. Long-term FHLB advances had weighted average
interest rates of 6.04% and 5.89% at December 31, 1996 and 1995, respectively.
Long-term borrowings are as follows (in thousands):

AT DECEMBER 31,
----------------------------
1996 1995
------------- -------------

FHLB advances, maturing January 1998 to September 2006................... $ 929,328 $ 855,995
6.75% senior notes, due July 1, 2000..................................... 49,517 49,379
6.75% subordinated debentures, due 2000.................................. 49,585 49,472
8.50% subordinated debentures, due 2002.................................. 19,550 19,471
8.00% subordinated debentures, due 2003.................................. 49,096 48,949
------------- -------------
Total long-term borrowings.......................................... $ 1,097,076 $ 1,023,266
------------- -------------
------------- -------------

The 6.75% notes are non-amortizing and are not redeemable prior to
maturity. The 6.75% debentures are non-amortizing and are not redeemable prior
to maturity. The 6.75% debentures have, through the use of an interest rate
swap, been effectively converted from a fixed rate obligation to a variable rate
obligation tied to the 3-month LIBOR plus 140.5 basis points. The 8.50%
debentures are non-amortizing and are redeemable at the option of Sovereign in
whole or in part at any time on or after September 15, 1999. The 8.00%
debentures are non-amortizing and are not redeemable prior to maturity.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(10) STOCKHOLDERS' EQUITY

The Financial Institutions Reform, Recovery and Enforcement Act ("FIRREA")
requires institutions regulated by the OTS to have minimum regulatory tangible
capital equal to 1.5% of total tangible assets, 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%. Sovereign Bank and Sovereign Community Bank were in
compliance with all of these capital requirements as of December 31, 1996. The
following schedule summarizes the actual capital balances of Sovereign Bank and
Sovereign Community Bank at December 31, 1996 (in thousands):

TANGIBLE LEVERAGE LEVERAGE RISK-BASED
CAPITAL TO CAPITAL TO CAPITAL TO CAPITAL TO
TANGIBLE TANGIBLE RISK-ADJUSTED RISK-ADJUSTED
ASSETS ASSETS ASSETS ASSETS
----------- ----------- ------------- -------------

Sovereign Bank:
- --------------
Regulatory capital....................................... $ 521,370 $ 521,370 $ 521,370 $ 557,622
Minimum capital requirement.............................. 146,871 293,740 185,757 371,513
----------- ----------- ----------- -----------
Excess................................................. $ 374,499 $ 227,630 $ 335,613 $ 186,109
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Capital ratio............................................ 5.32% 5.32% 11.23% 12.01%

Sovereign Community Bank:
- ------------------------
Regulatory capital....................................... $ 12,246 $ 12,246 $ 12,246 $ 13,495
Minimum capital requirement.............................. 3,444 6,888 5,367 10,734
----------- ----------- ----------- -----------
Excess................................................. $ 8,802 $ 5,358 $ 6,879 $ 2,761
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Capital ratio............................................ 5.33% 5.33% 9.13% 10.06%

OTS capital regulations do not apply to holding companies. The following
schedule summarizes actual capital balances of Sovereign Bancorp at December 31,
1996 as if those regulations did apply to Sovereign Bancorp (in thousands):

Sovereign Bancorp:
- ------------------
Regulatory capital....................................... $ 401,615 $ 401,615 $ 401,615 $ 609,116
Minimum capital requirement.............................. 148,097 296,194 191,745 383,488
----------- ----------- ----------- -----------
Excess................................................. $ 253,518 $ 105,421 $ 209,870 $ 225,628
----------- ----------- ----------- -----------
----------- ----------- ----------- -----------
Capital ratio............................................ 4.07% 4.07% 8.38% 12.70%

The Federal Deposit Insurance Corporation Improvement Act ("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 December 31, 1996, Sovereign Bank and Sovereign
Community Bank were both classified as well-capitalized and were in compliance
with all capital requirements. Management anticipates that Sovereign Bank and

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(10) STOCKHOLDERS' EQUITY -- (CONTINUED)

Sovereign Community Bank will each continue to be classified as well-capitalized
and will be in compliance with all regulatory capital requirements.

As a result of provisions of the Small Business Jobs Protection Act of 1996
(the "Jobs Protection Act"), which repealed the tax reserve method for bad debts
for thrift institutions and the circumstances requiring bad debt recapture for
large institutions, Sovereign must determine the tax deduction for bad debt
based on actual charge-offs. The Jobs Protection Act retained the existing base
year bad debt reserve and requires recapture into taxable income in certain
circumstances such as in the case of certain excess distributions or complete
redemptions. None of the limited circumstances requiring recapture are
anticipated by Sovereign. Retained earnings at December 31, 1996 includes $58.9
million in bad debt reserves, for which no deferred taxes have been provided due
to the indefinite nature of the recapture provisions.

Sovereign maintains a Dividend Reinvestment and Stock Purchase Plan which
permits holders of record of Sovereign common stock to purchase additional
shares of common stock directly from Sovereign via reinvestment of cash
dividends and optional cash purchases. At December 31, 1996, purchases of common
stock with reinvested dividends are made at a 5% discount from the current
market price as defined and optional cash purchases are limited to a maximum of
$5,000 per quarter.

Sovereign maintains a Stockholder Rights Plan (the "Rights Plan"). The
Rights Plan is designed to protect stockholders from attempts to acquire control
of Sovereign at an inadequate price. Under the Rights Plan, Sovereign
distributed a dividend of one right to purchase a unit of preferred stock on
each outstanding share of Sovereign's common stock. The rights are not currently
exercisable or transferable and no separate certificates evidencing such rights
will be distributed, unless certain events occur. The rights attach to shares of
common stock outstanding on October 2, 1989 and will expire on September 27,
2004 as stated in the amendment to the Rights Plan dated September 27, 1995. The
rights will entitle the holders to purchase either Sovereign's common stock or
the common stock of the potential acquirer at a substantially reduced price.

On May 17, 1995, Sovereign completed the sale of 2.0 million shares of
Convertible Preferred Stock, raising $96.7 million in capital. The 6 1/4%
non-voting, Cumulative Convertible Preferred Stock is convertible at the option
of the holder at any time, unless previously redeemed, at a conversion rate
(adjusted to reflect all stock dividends and stock splits declared through
January 1997) of 5.987 shares of common stock for each share of preferred stock;
equivalent to a conversion price of $8.352 per share of common stock. The
preferred stock may not be redeemed prior to May 15, 1998. Thereafter, the
preferred stock is redeemable at the option of Sovereign, in whole or in part,
at $52.188 per share during the twelve months beginning May 15, 1998, and
thereafter at prices declining ratably to par on and after May 15, 2005.

(11) STOCK OPTION PLANS

Sovereign grants stock options for a fixed number of shares to key officers
and directors with an exercise price equal to the fair value of the shares at
the date of grant. Sovereign accounts for stock option grants in accordance with
APB Opinion No. 25, "Accounting for Stock Issued to Employees," and accordingly,
recognizes no compensation expense for the stock option grants. There are 10.8
million shares of common stock reserved for issuance under the plans. These
shares, along with the per share data in the following summary of option
transactions, have been adjusted to reflect all stock dividends and stock splits
declared through January 1997.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(11) STOCK OPTION PLANS -- (CONTINUED)

OPTIONS OPTIONS OPTIONS
OUTSTANDING OUTSTANDING OUTSTANDING
OPTION DEC. 31, DEC. 31, DEC. 31,
PLAN PRICE 1994 GRANTED EXERCISED FORFEITED 1995 GRANTED EXERCISED FORFEITED 1996
- ---- --------- ----------- ----------- --------- --------- ----------- --------- --------- --------- -----------

1986........ $1.15-$8.33 1,184,952 8,820 (176,264) -- 1,017,508 71,820 (114,254) (1,260) 973,814
1987........ $3.74 345,377 -- (27,930) -- 317,447 -- (37,118) -- 280,329
1988........ $1.52 103,554 -- (103,554) -- -- -- -- -- --
1989........ $5.00 -- -- -- -- -- 134,937 (126,935) 8,002
1990........ $1.56 434,978 -- (161,784) -- 273,194 -- (205,141) -- 68,053
1993........ $4.54-$4.76 74,676 9,335 -- -- 84,011 9,335 (18,669) -- 74,677
1993........ $4.84 137,645 -- (41,158) (1,799) 94,688 -- (42,284) -- 52,404
1993........ $4.93-$9.01 -- 76,146 -- -- 76,146 114,513 -- (7,938) 182,721
1993........ $5.25 720,894 -- -- (115,260) 605,634 -- -- (46,104) 559,530
1994........ $6.75 22,701 -- -- -- 22,701 -- -- -- 22,701
1996........ $8.33 -- -- -- -- -- 9,600 -- -- 9,600
--------- --------- --------- --------- --------- --------- --------- --------- ---------
Total...... 3,024,777 94,301 (510,690) (117,059) 2,491,328 340,205 (544,401) (55,302) 2,231,831
--------- --------- --------- --------- --------- --------- --------- --------- ---------
--------- --------- --------- --------- --------- --------- --------- --------- ---------

OPTIONS
EXERCISABLE
DEC. 31,
PLAN 1996
- ---- -----------

1986........ 901,994
1987........ 280,329
1988........ --
1989........ 8,002
1990........ 68,053
1993........ 74,677
1993........ 52,404
1993........ 182,721
1993........ --
1994........ 22,701
1996........ --
---------
Total...... 1,590,881
---------
---------

In October 1995, the FASB issued SFAS No. 123, "Accounting for Stock-Based
Compensation," which provides companies with a choice either to expense the fair
value of employee stock options over the vesting period (recognition method) or
to continue the previous practice but disclose the pro forma effects on net
income and earnings per share had the fair value method been used (disclosure
only method). Companies electing the disclosure only method will be required to
include the pro forma effects of all awards granted in fiscal years beginning
after December 15, 1994. Sovereign adopted the disclosure only method during
1996.

Pro forma information regarding net income and earnings per share is
required by SFAS No. 123 and has been determined as if Sovereign had accounted
for its employee stock options under the fair value method of that statement.
The fair value for these options was estimated at the date of grant using a
Black-Scholes option pricing model with the following assumptions:

1986 PLAN 1993 PLAN 1996 PLAN
-------------------- -------------------- -----------

Grant date....................................................... 12/6/95 1/24/96 11/15/95 4/10/96 6/26/96
Options granted.................................................. 8,820 71,820 114,513 9,335 9,600
Options forfeited................................................ -- 1,260 3,381 -- --
Expected volatility.............................................. .292 .292 .292 .292 .292
Expected life in years........................................... 6 6 4 6 6
Stock price on date of grant..................................... $ 8.33 $ 7.84 $ 9.01 $ 4.54 $ 8.33
Exercise price................................................... $ 8.33 $ 7.84 $ 9.01 $ 4.54 $ 8.33
Expected dividend yield.......................................... .21% .22% .21% .21% .21%
Risk-free interest rate.......................................... 5.55% 6.30% 5.70% 6.42% 6.86%
Vesting period in years.......................................... 1 1 1 1 1

The Black-Scholes option valuation model was developed for use in
estimating the fair market value of traded options which have no vesting
restrictions and are fully transferable. In addition, option valuation models
require the input of highly subjective assumptions, including the expected stock
price volatility. Because Sovereign's employee stock options have
characteristics significantly different from those traded options and because
changes in the subjective input assumptions can materially affect the fair value
estimate, in management's opinion, the existing models do not necessarily
provide reliable single measure of fair value of its employee stock options.

Pro forma disclosures of the impact on net income and earnings per share
are not shown as the impact of applying SFAS No. 123's fair value method to
Sovereign's stock-based awards is immaterial.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(12) EMPLOYEE BENEFIT PLANS

Sovereign sponsors a non-contributory defined benefit pension plan which
covers substantially all employees who have attained the age of 21 and completed
one year of service. Benefits under the plan are based upon years of service and
the employees' average compensation computed based upon the five consecutive
plan years of highest pay during the ten years preceding retirement or
termination.

It is Sovereign's policy to fund the minimum contribution as determined by
an actuarial valuation. The net periodic pension costs for this plan are
comprised of the following components (in thousands):

1996 1995 1994
----------- --------- ---------

Service cost benefits earned during the period................................ $ 1,194 $ 1,124 $ 1,347
Interest cost on projected benefit obligation................................. 1,714 1,604 1,535
Actual return on plan assets.................................................. (3,532) (4,768) 138
Amortization of unrecognized net assets and other deferred amounts, net....... 1,163 2,963 (1,739)
Curtailment loss.............................................................. 542 -- --
----------- --------- ---------
Net periodic pension expense................................................ $ 1,081 $ 923 $ 1,281
----------- --------- ---------
----------- --------- ---------

The following table sets forth the pension plan's funded status at December
31, 1996 and 1995 (in thousands):

1996 1995
--------- ---------

Fair value of plan assets....................................................... $ 29,198 $ 25,562
--------- ---------
--------- ---------
Projected benefit obligation:
Vested benefits............................................................... $ 23,067 $ 22,660
Non-vested benefits........................................................... 724 581
Effect of projected future salary increases................................... 2,411 2,002
--------- ---------
Projected benefit obligation............................................... $ 26,202 $ 25,243
--------- ---------
--------- ---------
Plan assets in excess of the projected benefit obligation....................... $ 2,997 $ 319
Unrecognized net asset existing at transition date.............................. (173) (214)
Unrecognized net loss........................................................... 100 1,683
Unrecognized prior service cost................................................. (102) 731
Additional minimum balance sheet liability...................................... -- (496)
--------- ---------
Net pension asset included in balance sheet................................... $ 2,822 $ 2,023
--------- ---------
--------- ---------

In determining the projected benefit obligation, the assumed discount rates
at December 31, 1996, 1995 and 1994 were 7.06%, 7.07% and 7.93%, respectively.
The weighted average rate of salary increase was 5.06% for 1996, 5.07% for 1995
and 4.85% for 1994. The expected long-term rate of return on assets used in
determining net periodic pension expense was 9.00% for all three years.

The pension plan's assets consist primarily of common stock, fixed income
securities such as corporate bonds and U.S. Treasury securities and units of
certain common trust funds.

Sovereign also maintains a 401(k) savings plan. Substantially all employees
of Sovereign are eligible to participate in the 401(k) savings plan on the
January 1 and July 1 following their completion of one year of service and
attaining age 21. Sovereign's contributions to this plan were $211,000, $191,000
and $186,000 during 1996, 1995 and 1994, respectively. Pursuant to this plan,
employees can contribute up to 10% of their compensation to the plan. Sovereign
contributes 50% of the employee contribution up to 6% of compensation in the
form of Sovereign common stock.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(12) EMPLOYEE BENEFIT PLANS -- (CONTINUED)

Sovereign maintains an ESOP. Substantially all employees of Sovereign are
eligible to participate in the ESOP on the January 1 or July 1 following their
completion of one year of service and attaining age 21. The ESOP is a deferred
contribution plan which provides retirement benefits for participants and
beneficiaries by purchasing Sovereign common stock in the open market. The
amount of annual contributions to the ESOP by Sovereign is determined by the
Board of Directors based upon the financial performance of Sovereign each year.
Sovereign recognized as expense $2.5 million, $1.6 million and $1.5 million to
the ESOP during 1996, 1995 and 1994, respectively.

On November 21, 1994, Sovereign's Board of Directors authorized an
amendment to Sovereign's ESOP to add a leverage feature to purchase up to 4.2
million shares of Sovereign's outstanding common stock in the open market or in
negotiated transactions. The ESOP is funded through direct loans from Sovereign
totaling $40.0 million in 1996. The proceeds from these loans were used to
purchase outstanding shares of Sovereign's common stock. As the debt on these
loans is repaid, shares of Sovereign common stock are released and become
eligible for allocation to employee accounts. In addition, dividends are paid on
all shares of Sovereign common stock, including unallocated shares held by the
ESOP. Dividends on the unallocated shares are allocated on a pro-rata basis when
purchased shares are released. Compensation expense is recognized based on the
fair value of the shares committed to be released to employees and the shares
then become outstanding for earnings per share computations. Sovereign has
committed to make contributions sufficient to provide for the ESOP debt
requirements. At December 31, 1996, the ESOP held 4.7 million shares of which
583,000 shares were allocated to employee accounts. The unallocated ESOP shares
are presented as a reduction of stockholders' equity in the consolidated
financial statements. At December 31, 1996, the fair value of the unallocated
shares held by the ESOP was $44.5 million.

Sovereign's Compensation Committee administers the ESOP. Under the ESOP,
the trustees are directed to vote all allocated shares held in the ESOP in
accordance with the instructions of the participants to whom the shares have
been allocated. In addition, the trustees shall vote in their sole discretion
any shares in the unallocated suspense account.

In 1992, Sovereign implemented the Employee Stock Purchase Plan which
permits eligible employees to purchase Sovereign common stock directly from
Sovereign. Purchases of common stock are limited to 15% of a participant's
compensation. During 1996, 1995 and 1994, participants purchased Sovereign
common stock at a price equal to 92.5% of the fair value of Sovereign common
stock on the offering date. Compensation expense for this plan for the year
ended December 31, 1996, 1995 and 1994 was $41,000, $31,000 and $31,000,
respectively.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(13) INCOME TAXES

The provision for income taxes in the consolidated statement of operations
is comprised of the following components (in thousands):

YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Current:
Federal...................................................................... $ 23,662 $ 24,826 $ 14,536
State........................................................................ 2,401 3,078 3,297
--------- --------- ---------
26,063 27,904 17,833
Deferred....................................................................... 3,872 2,767 11,997
--------- --------- ---------
Total income tax expense..................................................... $ 29,935 $ 30,671 $ 29,830
--------- --------- ---------
--------- --------- ---------

The following is a reconciliation of the actual tax provisions with taxes
computed at the federal statutory rate of 35% for 1996, 1995 and 1994:

YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Federal income tax at statutory rate................................................. 35.0% 35.0% 35.0%
Increase (decrease) in taxes resulting from:
Tax-exempt interest................................................................ (1.9) (.5) (.3)
State income taxes, net of federal tax benefit..................................... 2.0 2.1 2.7
Amortization of intangible assets and other purchase accounting adjustments........ 2.3 2.4 2.7
Other................................................................................ 2.1 (5.3) (2.5)
--------- --------- ---------
39.5% 33.7% 37.6%
--------- --------- ---------
--------- --------- ---------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(13) INCOME TAXES -- (CONTINUED)

The tax effects of temporary differences that give rise to significant
portions of the deferred tax assets and deferred tax liabilities are presented
below (in thousands):

YEAR ENDED DECEMBER 31,
-------------------------------------
1996 1995 1994
----------- ----------- -----------

Deferred tax assets:
Allowance for possible loan losses....................................... $ 15,669 $ 15,787 $ 15,690
Merger related liabilities............................................... 1,006 785 392
Purchase accounting adjustments.......................................... 2,329 3,538 7,846
Unrealized loss on available-for-sale portfolio.......................... 89 30 567
Net operating loss carryforwards......................................... 417 -- --
Other.................................................................... 5,146 2,102 2,549
----------- ----------- -----------
Total gross deferred tax assets.......................................... 24,656 22,242 27,044
Less valuation allowance................................................. (2,006) (1,181) (1,583)
----------- ----------- -----------
Net deferred tax assets.................................................. $ 22,650 $ 21,061 $ 25,461
----------- ----------- -----------
Deferred tax liabilities:
Purchase accounting adjustments.......................................... $ (7,188) $ (8,559) $ (9,038)
Deferred loan fees....................................................... (5,353) (2,826) (1,826)
Unrealized gain on available-for-sale portfolio.......................... (1,815) (2,708) --
Other.................................................................... (9,867) (6,546) (1,179)
----------- ----------- -----------
Total gross deferred tax liabilities..................................... $ (24,223) $ (20,639) $ (12,043)
----------- ----------- -----------
Net deferred tax (liability) asset....................................... $ (1,573) $ 422 $ 13,418
----------- ----------- -----------
----------- ----------- -----------

The valuation allowance for deferred tax assets is unchanged from the
balance at January 1, 1994, and is primarily related to state deductible
temporary differences resulting from the Harmonia acquisition.

Sovereign has determined that it is not required to establish any
additional valuation reserve for deferred tax assets since it is more likely
than not that deferred tax assets (other than those for which a valuation
allowance has been established) will be principally realized through carry back
to taxable income in prior years. Sovereign's conclusion that it is "more likely
than not" that the deferred tax assets will be realized is based on a history of
growth in earnings and the prospects for continued growth including an analysis
of potential uncertainties that may affect future operating results. Sovereign
will continue to review the criteria related to the recognition of deferred tax
assets on a quarterly basis.

(14) COMMITMENTS AND CONTINGENCIES

Financial Instruments

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.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)

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. Unless noted otherwise, Sovereign does not require and is not
required to pledge collateral or other security to support financial instruments
with credit risk.

The following schedule summarizes Sovereign's off-balance sheet financial
instruments (in thousands):

CONTRACT OR
NOTIONAL AMOUNT
AT DECEMBER 31,
----------------------------
1996 1995
------------- -------------

Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit.................................................... $ 538,035 $ 472,663
Standby letters of credit....................................................... 2,763 2,763
Loans sold with recourse........................................................ 60,113 60,113
Financial instruments whose notional or contract amounts exceed the amount of
credit risk:
Forward contracts............................................................... 32,500 77,250
Interest rate swaps............................................................. 2,517,013 1,211,130
Interest rate caps.............................................................. 500,000 1,446,000

Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments are expected to
expire without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Sovereign evaluates each customer's
creditworthiness on a case-by-case basis. The amount of collateral obtained upon
extension of credit is based on management's credit evaluation of the
counterparty. Collateral held usually consists of real estate but may include
securities, accounts receivable, inventory and property, plant and equipment.

Standby letters of credit 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. Most
guarantees expire in 1997, one guarantee expires in September 2000 and one
guarantee for $1.4 million expires in January 2011. The credit risk involved in
issuing letters of credit is essentially the same as that involved in extending
loan facilities to customers. Sovereign holds various collateral to support the
commitments.

Loans sold with recourse primarily represent residential loans.

The forward contracts used by Sovereign in its mortgage banking activities
are contracts for delayed delivery of securities in which Sovereign agrees to
make delivery of a specified instrument, at a specified future date, at a
specified price or yield. Risks arise from the possible inability of
counterparties to meet the terms of their contracts and from movements in
securities' values and interest rates.

Interest rate swaps, caps and floors enable Sovereign to transfer, modify
or reduce its interest rate risk and are used as part of asset and liability
management. Sovereign may become a principal in the exchange of interest
payments with another party and therefore, is exposed to loss should one of the
other parties default. Sovereign minimizes this risk by performing credit
reviews on counterparties.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(14) COMMITMENTS AND CONTINGENCIES -- (CONTINUED)

Notional principal amounts often are used to express the volume of these
transactions, but the amounts potentially subject to credit risk are much
smaller.

Litigation

At December 31, 1996, Sovereign was party to a number of lawsuits. While any
litigation has an element of uncertainty, management, after reviewing these
actions with legal counsel, is of the opinion that the liability, if any,
resulting from these actions will not have a material effect on the financial
condition or results of operations of Sovereign.

(15) FAIR VALUE OF FINANCIAL INSTRUMENTS

The following table presents disclosures about the fair value of financial
instruments as defined by SFAS No. 107, "Fair Value of Financial Instruments."
These fair values are presented based upon subjective estimates of relevant
market conditions at a specific point in time and information about each
financial instrument. In cases where quoted market prices are not available,
fair values are based on estimates using present value or other valuation
techniques. These techniques involve uncertainties resulting in variability in
estimates affected by changes in assumptions and risks of the financial
instruments at a certain point in time. Therefore, the derived fair value
estimates presented below cannot be substantiated by comparison to independent
markets. In addition, the fair values do not reflect any premium or discount
that could result from offering for sale at one time an entity's entire holdings
of a particular financial instrument nor does it reflect potential taxes and the
expenses that would be incurred in an actual sale or settlement. Accordingly,
the aggregate fair value amounts presented do not represent the underlying value
of Sovereign (in thousands):

AT DECEMBER 31,
----------------------------------------------------------
1996 1995
---------------------------- ----------------------------
CARRYING FAIR CARRYING FAIR
VALUE VALUE VALUE VALUE
------------- ------------- ------------- -------------

Financial Assets:
Cash and amounts due from depository
institutions.................................... $ 111,296 $ 111,296 $ 142,039 $ 142,039
Interest-earning deposits.......................... 6,273 6,273 17,524 17,524
Loans held for resale.............................. 32,955 33,162 137,731 138,939
Investment and mortgage-backed securities
available-for-sale.............................. 494,997 494,997 905,023 905,023
Investment and mortgage-backed securities
held-to-maturity................................ 2,487,615 2,464,844 2,117,062 2,127,015
Loans, net......................................... 6,603,444 6,600,072 5,101,156 5,134,975
Excess servicing................................... 815 4,187 2,328 7,330
Originated mortgage servicing rights............... 5,954 7,428 1,894 2,840
Cash surrender value of life insurance............. 11,978 11,978 11,582 11,582
Financial Liabilities:
Deposits........................................... 5,606,333 5,602,633 5,606,469 5,617,265
Borrowings(1)...................................... 3,876,341 3,880,372 2,565,570 2,581,149
Unrecognized Financial Instruments:(2)
Commitments to extend credit....................... 1,315 1,239 930 869
Standby letters of credit.......................... 7 12 4 6
Loans sold with recourse........................... 301 120 391 156
Interest rate swaps, caps and floors............... 9,283 3,755 12,777 (9,873)

- ------------------
(1) Borrowings are shown without unamortized cap premiums, as cap premiums are
reflected separately below in "Interest rate swaps, caps and floors."

(2) The amounts shown under "carrying value" represent accruals or deferred
income (cost) arising from those unrecognized financial instruments.

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

Cash and amounts due from depository institutions and interest-earning
deposits. For these short-term instruments, the carrying amount is a reasonable
estimate of fair value.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(15) FAIR VALUE OF FINANCIAL INSTRUMENTS -- (CONTINUED)

Loans held for resale. Fair values are estimated using quoted rates based
upon secondary market sources for securities backed by similar loans. Fair value
estimates include consideration of all open positions (including forward
contracts), outstanding commitments and related fees paid.

Investment and mortgage-backed securities available-for-sale. The fair
value of investment and mortgage-backed securities available-for-sale are based
on quoted market prices as of the balance sheet date.

Investment and mortgage-backed securities held-to-maturity. The carrying
amounts for short-term investment and mortgage-backed securities
held-to-maturity approximate fair value because of the short maturity of these
instruments and they do not present unanticipated credit concerns. The fair
value of long-term investments and mortgage-backed securities held-to-maturity
is estimated based upon bid quotations received from securities dealers and an
independent pricing servicing bureau.

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

Excess servicing and originated mortgage servicing rights. The fair value
of excess servicing and originated mortgage servicing rights is estimated using
quoted rates based upon secondary market sources. The estimated fair value
approximates the amount for which the servicing could currently be sold.

Deposits. The fair value of deposits with no stated maturity, such as
non-interest bearing demand deposits, NOW accounts, savings accounts and certain
money market accounts, is equal to the amount payable on demand as of the
balance sheet date. The fair value of fixed-maturity certificates of deposit is
estimated by discounting cash flows using currently offered rates for deposits
of similar remaining maturities.

Borrowings. Fair value is estimated by discounting cash flows using rates
currently available to Sovereign for other borrowings with similar terms and
remaining maturities.

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

Standby letters of credit. The fair value of letters of credit is based on
fees currently charged for similar agreements or on the estimated cost to
terminate them or otherwise settle the obligations with the counterparties.

Loans sold with recourse. The fair value of loans sold with recourse is
estimated based upon the cost to terminate Sovereign's obligations under the
recourse provisions.

Interest rate swaps, caps and floors. The fair value of interest rate
swaps, caps and floors which represent the estimated amount Sovereign would
receive or pay to terminate the contracts or agreements, taking into account
current interest rates and when appropriate, the current creditworthiness of the
counterparties are obtained from dealer quotes.

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(16) INTEREST RATE EXCHANGE AGREEMENTS

Amortizing and non-amortizing interest rate swaps are generally used to
convert fixed rate assets and liabilities to variable rate assets and
liabilities and vice versa. Interest rate caps are generally used to limit the
exposure from the repricing and maturity of liabilities. Interest rate floors
are generally used to limit the exposure from repricing and maturity of assets.
Interest rate caps and floors are also used to limit the exposure created by
other interest rate swaps. In certain cases, interest rate caps or floors are
simultaneously bought and sold to create a range of protection against changing
interest rates while limiting the cost of that protection. The following table
presents information regarding interest rate exchange agreements at the dates
indicated (in thousands):

AT DECEMBER 31, 1996 AT DECEMBER 31, 1995
------------------------------------------------ ------------------------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
NOTIONAL BOOK ESTIMATED MATURITY NOTIONAL BOOK ESTIMATED MATURITY
AMOUNT VALUE FAIR VALUE IN YEARS AMOUNT VALUE FAIR VALUE IN YEARS
--------- --------- --------- --------- --------- --------- --------- ---------

Amortizing interest rate
swaps:
Pay variable-receive
fixed(1).................. $ 713,448 $ -- $ (10,459) 3.6 $ 585,429 $ -- $ (4,066) 4.2
Pay fixed-receive
variable(2)............... 398,565 -- (464) 2.3 295,701 -- (3,653) 3.3
Non-amortizing interest rate
swaps:
Pay variable-receive
fixed(3).................. 50,000 -- (1,738) 3.7 50,000 -- (837) 4.6
Pay fixed-receive
variable(4)............... 1,355,000 -- 9,152 2.2 280,000 -- (2,780) 1.8
Interest rate caps(5)......... 500,000 9,283 7,264 4.5 1,446,000 12,777 1,463 1.6
---------- --------- --------- ---------- --------- ---------
$3,017,013 $ 9,283 $ 3,755 $2,657,130 $ 12,777 $ (9,873)
---------- --------- --------- ---------- --------- ---------
---------- --------- --------- ---------- --------- ---------

- ------------------
(1) The weighted average pay rate was 5.50% and 5.56% and the weighted average
receive rate was 5.93% and 5.61% at December 31, 1996 and 1995,
respectively.

(2) The weighted average pay rate was 6.76% and 6.87% and the weighted average
receive rate was 6.18% and 6.92% at December 31, 1996 and 1995,
respectively.

(3) The weighted average pay rate was 6.91% and 7.28% and the weighted average
receive rate was 6.75% and 6.75% at December 31, 1996 and 1995,
respectively.

(4) The weighted average pay rate was 5.28% and 5.91% and the weighted average
receive rate was 5.53% and 5.89% at December 31, 1996 and 1995,
respectively.

(5) The weighted average contract rate was 6.00% and 6.36% at December 31, 1996
and 1995, respectively.

The following table summarizes by notional amounts the activity of
Sovereign's interest rate exchange agreements (in thousands):

AMORTIZING NON-AMORTIZING
INTEREST INTEREST INTEREST RATE
RATE SWAPS RATE SWAPS CAPS
------------------ ---------------------- -------------

Balance, December 31, 1993............................. $ 620,934 $ 50,000 $ 300,000
-------------- -------------- -------------
Additions............................................ 591,800 200,000 980,000
Maturities/Amortization.............................. 127,089 -- 50,000
Terminations......................................... -- -- 780,000
-------------- -------------- -------------
Balance, December 31, 1994............................. 1,085,645 250,000 450,000
-------------- -------------- -------------
Additions............................................ 300,000 280,000 996,000
Maturities/Amortization.............................. 326,795 200,000 --
Terminations......................................... 177,720 -- --
-------------- -------------- -------------
Balance, December 31, 1995............................. 881,130 330,000 1,446,000
-------------- -------------- -------------
Additions............................................ 300,000 1,125,000 500,000
Maturities/Amortization.............................. 69,117 -- 450,000
Terminations......................................... -- 50,000 996,000
-------------- -------------- -------------
Balance, December 31, 1996............................. $ 1,112,013 $ 1,405,000 $ 500,000
-------------- -------------- -------------
-------------- -------------- -------------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(16) INTEREST RATE EXCHANGE AGREEMENTS -- (CONTINUED)

At December 31, 1996, Sovereign's balance sheet included a net deferred
loss of $4.9 million related to interest rate exchange agreements terminated in
December 1995 and June 1996 which were originally accounted for as hedges. Of
this net deferred loss, $4.4 million will amortize into interest expense in 1997
and $465,000 will amortize into interest expense in 1998.

Net interest income resulting from interest rate exchange agreements
includes $5.1 million of income and $7.4 million of expense for 1996, $1.7
million of income and $3.6 million of expense for 1995 and $10.0 million of
income and $2.0 million of expense for 1994.

(17) PARENT COMPANY FINANCIAL INFORMATION

Condensed financial information for Sovereign Bancorp, Inc. is as follows
(in thousands):

BALANCE SHEETS
------------------------
AT DECEMBER 31,
------------------------
1996 1995
----------- -----------

Assets
Interest-earning deposits.......................................................... $ 120 $ 500
Investment securities.............................................................. 15,805 10,503
Investment in subsidiaries......................................................... 649,010 582,648
Other assets....................................................................... 16,559 46,561
----------- -----------
Total Assets......................................................................... $ 681,494 $ 640,212
----------- -----------
----------- -----------
Liabilities and Stockholders' Equity
Short-term borrowings.............................................................. $ -- $ 714
Long-term borrowings............................................................... 167,748 167,271
Other liabilities.................................................................. 4,907 3,610
Stockholders' equity............................................................... 508,839 468,617
----------- -----------
Total Liabilities and Stockholders' Equity........................................... $ 681,494 $ 640,212
----------- -----------
----------- -----------

STATEMENTS OF OPERATIONS
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Interest income................................................................ $ 2,752 $ 4,384 $ 223
Other income................................................................... 3 2,791 13,008
--------- --------- ---------
Total income................................................................... 2,755 7,175 13,231
--------- --------- ---------
Interest expense............................................................... 13,117 11,758 9,341
Other expense.................................................................. 5,474 4,808 4,132
--------- --------- ---------
Total expense.................................................................. 18,591 16,566 13,473
--------- --------- ---------
Income before taxes, dividends and undistributed earnings of subsidiaries...... (15,836) (9,391) 242
Income taxes................................................................... (5,431) (4,565) --
--------- --------- ---------
Income before earnings of subsidiaries......................................... (10,405) (4,826) (242)
Distributed earnings from subsidiaries......................................... -- 20,544 19,496
Undistributed earnings of subsidiaries......................................... 56,219 44,688 30,645
--------- --------- ---------
Net Income..................................................................... $ 45,814 $ 60,406 $ 49,899
--------- --------- ---------
--------- --------- ---------

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)

(17) PARENT COMPANY FINANCIAL INFORMATION -- (CONTINUED)

STATEMENTS OF CASH FLOWS
-------------------------------
YEAR ENDED DECEMBER 31,
-------------------------------
1996 1995 1994
--------- --------- ---------

Cash Flows from Operating Activities:
Net income................................................................... $ 45,814 $ 60,406 $ 49,899
Adjustments to reconcile net income to net cash provided by operating
activities:
Dividends received from subsidiaries(1)................................... -- 20,544 19,496
Earnings from subsidiaries................................................ (56,219) (65,232) (50,141)
Allocation of Employee Stock Ownership Plan shares........................ 2,465 1,514 --
Change in other assets.................................................... 29,992 (45,038) 10,539
Change in other liabilities............................................... 1,297 2,608 (3,168)
--------- --------- ---------
Net cash provided (used) by operating activities............................... 23,349 (25,198) 26,625
--------- --------- ---------

Cash Flows from Investing Activities:
Investment in subsidiaries................................................... (10,282) (88,168) (17,063)
Maturity and repayments of investment securities............................. 1,259 1,221 5,319
Net change in investment securities(1)....................................... (6,561) (1,551) (10,606)
Other, net................................................................... 5,867 4,839 (385)
--------- --------- ---------
Net cash used by investing activities.......................................... (9,717) (83,659) (22,735)
--------- --------- ---------

Cash Flows from Financing Activities:
Net change in short-term borrowings.......................................... (714) (714) --
Net change in long-term borrowings........................................... 477 (376) (1,092)
Cash dividends paid to stockholders.......................................... (11,249) (9,391) (5,728)
Net cash received from debt offering......................................... -- 49,379 --
Net proceeds from issuance of common stock................................... 4,333 2,991 3,884
Net proceeds from issuance of preferred stock................................ -- 96,446 --
Purchase of Employee Stock Ownership Plan shares............................. (4,559) (30,286) --
Purchase of treasury stock................................................... (2,300) -- --
--------- --------- ---------
Net cash provided (used) by financing activities............................... (14,012) 108,049 (2,936)
--------- --------- ---------
Increase (decrease) in cash and cash equivalents............................... (380) (808) 954
Cash and cash equivalents at beginning of period............................... 500 1,308 354
--------- --------- ---------
Cash and cash equivalents at end of period..................................... $ 120 $ 500 $ 1,308
--------- --------- ---------
--------- --------- ---------

- ------------------
(1) The 1996 results reflect the dissolution and subsequent merger of Sovereign
Investment Corporation into Sovereign Bancorp during 1996.

(18) SUBSEQUENT EVENTS

During March 1997, Sovereign issued $100 million of preferred capital
securities ("Trust Preferred") through Sovereign Capital Trust I ("Trust"), a
special-purpose statutory trust created expressly for the issuance of these
securities. Distributions on the Trust Preferred will be payable at an annual
rate of 9% of the stated liquidation amount of $1,000 per capital security,
payable semi-annually. After issuance costs, proceeds of $97.6 million were
invested in Junior Subordinated Debentures of Sovereign, at terms identical to
the Trust Preferred offering. Cash distributions on the Trust Preferred are
made to the extent interest on the debentures is received by the Trust. In the
event of certain changes or amendments to regulatory requirements or federal
tax rules, the Trust Preferred securities are redeemable in whole. Otherwise,
the Trust Preferred securities are generally redeemable in whole or in part on
or after April 1, 2007, at a declining redemption price ranging from 103.875%
to 100% of the liquidation amount. On or after April 1, 2017, the Trust
Preferred securities may be redeemed at 100% of the liquidation amount.

The Trust Preferred offering is classified as and is similar to minority
interests and is presented as "Corporation-obligated mandatorily redeemable
capital securities of subsidiary trust holding solely subordinated debentures
of Sovereign Bancorp, Inc." The Trust Preferred offering qualifies for Tier I
capital treatement for Sovereign and the loan payments from Sovereign to the
Trust are fully tax deductible. Sovereign intends to use the proceeds of the
transaction for general corporate purposes.