SOVEREIGN BANCORP INC - 10-Q Quarterly Report

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)


[X]		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the quarter ended March 31, 2004


[ ]		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 for the transition period from _________ to _________.

Commission File Number: 001-16581

SOVEREIGN BANCORP, INC.

(Exact name of Registrant as specified in its charter)


Pennsylvania		23-2453088

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

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

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

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

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Act) Yes [X]. No [ ].

APPLICABLE ONLY TO CORPORATE ISSUERS:

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


Class		Outstanding at April 30, 2004

Common Stock (no par value)		306,473,139 shares

FORWARD LOOKING STATEMENTS

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

The Private Securities Litigation Reform Act of 1995 provides a “safe harbor” for forward-looking statements made by or on behalf of Sovereign Bancorp, Inc. (“Sovereign”). Sovereign may from time to time make forward-looking statements in Sovereign’s filings with the Securities and Exchange Commission (including this Quarterly Report on Form 10-Q and the Exhibits hereto), in its reports to shareholders (including its 2003 Annual Report) and in other communications by Sovereign, which are made in good faith by Sovereign, pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Some of the disclosure communications by Sovereign, including any statements preceded by, followed by or which include the words “may,” “could,” “should,” “pro forma,” “looking forward,” “will,” “would,” “believe,” “expect,” “anticipate,” “estimate,” “intend,” “plan,” “strive,” “hopefully,” “try,” “assume” or similar expressions constitute forward-looking statements.

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

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

• growth in earnings per share;

• return on equity;

• return on assets;

• efficiency ratio;

• Tier 1 leverage ratio;

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

• fee income as a percentage of total revenue;

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

• book value and tangible book value per share; and

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

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

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

FORWARD LOOKING STATEMENTS
(continued)

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

• inflation, interest rate, market and monetary fluctuations;

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

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

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

• anticipated acquisitions may not close on the expected closing date or it may not close;

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

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

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

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

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

• technological changes;

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

• changes in consumer spending and savings habits;

• terrorist attacks in the United States or upon United States interests abroad, or armed conflicts relating to these attacks;

FORWARD LOOKING STATEMENTS
(continued)

• armed conflicts involving the United States military;

• regulatory or judicial proceedings;

• changes in asset quality; and

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

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

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

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Unaudited)


	March 31,			December 31,
	2004			2003
	(in thousands, except share data)
ASSETS
Cash and amounts due from depository institutions	$	893,193		$	950,302
Investment securities:
Available-for-sale		11,912,292			10,102,619
Held-to-maturity		2,489,030			2,516,352
Loans (including loans held for sale of $152,833 and $137,154 at March 31, 2004 and December 31, 2003, respectively)		27,738,572			26,148,659
Allowance for loan losses		(351,007	)		(327,894	)

Net loans		27,387,565			25,820,765

Premises and equipment		289,517			273,278
Accrued interest receivable		188,002			190,714
Goodwill		1,292,809			1,027,292
Core deposit intangibles, net		261,582			268,759
Bank owned life insurance		841,568			801,535
Other assets		1,487,657			1,553,713

TOTAL ASSETS	$	47,043,215		$	43,505,329

LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits and other customer accounts	$	28,118,306		$	27,344,008
Borrowings and other debt obligations		14,261,686			12,197,603
Advance payments by borrowers for taxes and insurance		21,265			17,966
Other liabilities		523,819			483,210

TOTAL LIABILITIES		42,925,076			40,042,787

Minority interests		202,513			202,136

STOCKHOLDERS’ EQUITY
Common stock; no par value; 400,000,000 shares authorized; 311,322,257 shares issued at March 31, 2004 and 298,111,799 shares issued at December 31, 2003		2,102,183			1,892,126
Warrants and employee stock options issued		305,297			13,944
Unallocated common stock held by the Employee Stock Ownership Plan at cost; 3,550,268 shares at March 31, 2004 and 3,550,268 shares at December 31, 2003		(26,078	)		(26,078	)
Treasury stock at cost; 1,360,010 shares at March 31, 2004 and 1,450,668 shares at December 31, 2003		(22,190	)		(21,927	)
Accumulated other comprehensive income/(loss)		6,349			(52,924	)
Retained earnings		1,550,065			1,455,265

TOTAL STOCKHOLDERS’ EQUITY		3,915,626			3,260,406

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	47,043,215		$	43,505,329

See accompanying notes to consolidated financial statements.

-5-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)


	Three-Month Period
	Ended March 31,
	2004		2003
	(in thousands, except
	per share data)
INTEREST INCOME:
Interest-earning deposits	$	528	$	675
Investment securities:
Available-for-sale		137,226		158,231
Held-to-maturity		28,819		8,443
Interest on loans		333,190		333,615

TOTAL INTEREST INCOME		499,763		500,964

INTEREST EXPENSE:
Deposits and customer accounts		65,012		93,651
Borrowings and other debt obligations		111,935		104,273

TOTAL INTEREST EXPENSE		176,947		197,924

NET INTEREST INCOME		322,816		303,040
Provision for loan losses		43,000		43,357

NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES		279,816		259,683

NON-INTEREST INCOME:
Consumer banking fees		53,985		48,225
Commercial banking fees		28,685		25,223
Mortgage banking revenues		5,427		8,008
Capital markets revenue		4,887		7,749
Bank owned life insurance		9,626		10,332
Miscellaneous income		7,320		3,522

TOTAL FEES AND OTHER INCOME		109,930		103,059
Gain on investment securities, net		17,881		17,531

TOTAL NON-INTEREST INCOME		127,811		120,590

GENERAL AND ADMINISTRATIVE EXPENSES:
Compensation and benefits		104,080		93,182
Occupancy and equipment expenses		54,379		53,342
Technology expense		17,605		17,939
Outside services		12,336		13,473
Marketing expense		10,700		10,326
Other administrative expenses		26,934		22,826

TOTAL GENERAL AND ADMINISTRATIVE EXPENSES		226,034		211,088

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY
FOR THE THREE MONTH PERIOD ENDED MARCH 31, 2004
(unaudited)
(in thousands)


									Unallocated
									Common
	Common					Warrants			Stock
	Shares Out-			Common		& Stock			Held by
	standing			Stock		Options			ESOP
Balance, December 31, 2003		293,111		$	1,892,126	$	13,944		$	(26,078	)
Comprehensive income:
Net income		—			—		—			—
Change in unrealized gain/loss, net of tax:
Investments securities available for sale		—			—		—			—
Cash flow hedge derivative financial instruments		—			—		—			—
Total comprehensive income
Stock issued in connection with the First Essex Acquisition		12,688			204,916		4,936			—
Issuance of warrants in connection with PIERS offering		—			—		285,435			—
Purchase payout Network Capital		85			820		—			—
Stock issued in connection with employee benefit and incentive compensation plans		769			4,321		(219	)		—
Employee stock options issued		—			—		1,201			—
Dividends paid on common stock		—			—		—			—
Stock repurchased		(241	)		—		—			—

Balance, March 31, 2004		306,412		$	2,102,183	$	305,297		$	(26,078	)

[Additional columns below]

[Continued from above table, first column(s) repeated]


				Accumulated						Total
				Other						Stock-
	Treasury			Comprehensive			Retained			holders’
	Stock			Income/(Loss)			Earnings			Equity
Balance, December 31, 2003	$	(21,927	)	$	(52,924	)	$	1,455,265		$	3,260,406
Comprehensive income:
Net income		—			—			102,227			102,227
Change in unrealized gain/loss, net of tax:
Investments securities available for sale		—			56,942			—			56,942
Cash flow hedge derivative financial instruments		—			2,331			—			2,331

Total comprehensive income											161,500
Stock issued in connection with the First Essex Acquisition		—			—			—			209,852
Issuance of warrants in connection with PIERS offering		—			—			—			285,435
Purchase payout Network Capital		1,180			—			—			2,000
Stock issued in connection with employee benefit and incentive compensation plans		3,782			—			—			7,884
Employee stock options issued		—			—			—			1,201
Dividends paid on common stock		—			—			(7,427	)		(7,427	)
Stock repurchased		(5,225	)		—			—			(5,225	)

Balance, March 31, 2004	$	(22,190	)	$	6,349		$	1,550,065		$	3,915,626

See accompanying notes to consolidated financial statements.

-8-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

(unaudited)


	Three-month Period
	Ended March 31,
	2004			2003
	(in thousands)
CASH FLOWS FROM OPERATING ACTIVITES:
Net income	$	102,227		$	75,856
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		43,000			43,357
Deferred taxes		(8,076	)		(7,711	)
Depreciation and amortization		38,117			38,916
Net amortization of premium/discount on investment securities and loan premiums		11,439			2,028
Gain on sale of investment securities and related derivatives		(17,881	)		(17,531	)
Net loss on real estate owned and fixed assets		19			344
Loss on debt extinguishments		—			28,981
Stock-based compensation		5,335			3,965
Net change in:
Loans held for sale		(15,679	)		(3,083	)
Accrued interest receivable		8,894			7,554
Other assets and bank owned life insurance		(98,277	)		38,746
Other liabilities		41,030			79,382

Net cash provided by operating activities		110,148			290,804

CASH FLOWS FROM INVESTING ACTIVITIES:
Proceeds from sales of investment securities:
Available-for-sale		877,779			655,669
Proceeds from repayments and maturities of investment securities:
Available-for-sale		443,866			1,146,358
Held-to-maturity		60,824			63,447
Net change in FHLB stock		(48,818	)		(34,164	)
Purchases of available-for-sale investment securities		(2,599,740	)		(2,166,728	)
Purchases of held-to-maturity investment securities		(7,989	)		(34	)
Proceeds from sales of loans		692,164			938,202
Purchase of loans		(564,649	)		(1,509,892	)
Net change in loans other than purchases and sales		(279,497	)		(297,197	)
Proceeds from sales of premises and equipment		2,520			257
Purchases of premises and equipment		(23,122	)		(6,109	)
Proceeds from sales of real estate owned		3,264			3,125
Cash used for acquisitions, net of cash acquired		(199,012	)		—

Net cash used in investing activities		(1,642,410	)		(1,207,066	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits and other customer accounts		(490,951	)		(108,101	)
Net increase in borrowings		1,091,792			1,108,799
Proceeds from senior secured credit facility and senior and subordinated notes		200,000			775,210
Proceeds from issuance of Contingent Convertible Trust Preferred Equity Income Redeemable Securities		498,310			—
Repayments of senior secured credit facility and senior and subordinated notes		(105,792	)		(631,640	)
Net decrease in advance payments by borrowers for taxes and insurance		2,281			(849	)
Cash dividends paid to stockholders		(7,427	)		(6,638	)
Proceeds from issuance of common stock		2,948			5,879
Purchase of shares for ESOP		—			(7,152	)
Proceeds from issuance of warrants		285,435			—
Other net changes in treasury stock		(1,443	)		(19,331	)

Net cash provided by financing activities		1,475,153			1,116,177

Net change in cash and cash equivalents		(57,109	)		199,915
Cash and cash equivalents at beginning of period		950,302			972,614

Cash and cash equivalents at end of period	$	893,193		$	1,172,529

Supplemental Disclosures:
Income taxes paid	$	6,634		$	1,438
Interest paid	$	177,258		$	196,974

Non cash transactions: On February 6, 2004, Sovereign Bancorp, Inc. issued 12,687,985 shares in partial consideration for the acquisition of First Essex Bancorp, Inc. See Note 13 for additional discussion. During the first quarter of 2004, Sovereign reconsolidated the assets and liabilities of two special purpose entities that were previously considered off-balance sheet in accordance with SFAS No. 140. See Note 7 for additional discussion.

See accompanying notes to consolidated financial statements.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

(1) BASIS OF PRESENTATION AND ACCOUNTING POLICIES

Basis of Presentation

The accompanying financial statements of Sovereign Bancorp, Inc. and Subsidiaries (“Sovereign” or the “Company”) include the accounts of the parent company, Sovereign Bancorp, Inc. and its subsidiaries, including the following wholly-owned subsidiaries: Sovereign Bank, and Sovereign Delaware Investment Corporation. Prior to December 31, 2003, Sovereign consolidated the following subsidiaries: Sovereign Capital Trust I, Sovereign Capital Trust II, Sovereign Capital Trust III, MBNK Capital Trust I, and ML Capital Trust I (“Capital Trust Entities”). These subsidiaries were deconsolidated effective December 31, 2003 in accordance with new accounting standards. All intercompany balances and transactions have been eliminated in consolidation.

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

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

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

Sovereign adopted the expense recognition provisions of SFAS No. 123, “Accounting for Stock Based Compensation,” for stock based employee compensation awards during 2002. Sovereign continues to account for all options granted prior to January 1, 2002 in accordance with the intrinsic value model of APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Sovereign estimates the fair value of stock options issued to employees subsequent to January 1, 2002 using a Black-Scholes option pricing model and expenses this value over the vesting periods as required in SFAS No. 123. Reductions to compensation expense associated with forfeited options are estimated at the date of grant, and this estimated forfeiture rate is adjusted periodically based on actual forfeiture experience.

-10-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

The following table represents the amount of stock-option compensation expense, net of related tax effects, that would have been included in the determination of net income if the expense recognition provisions of SFAS No. 123 had been applied to all the stock option awards. (Amounts in thousands, except per share):


	Three-month Period
	Ended March 31,
	2004			2003
Net income as reported	$	102,227		$	75,856
Add: Stock-option expense included in net income, net of tax		780			829
Deduct: Total stock-option compensation expense, net of tax		(877	)		(1,022	)

Pro-forma net income	$	102,130		$	75,663

Basic earnings per share	$	.34		$	.29
Diluted earnings per share	$	.33		$	.27
Pro-forma basic earnings per share	$	.34		$	.29
Pro-forma diluted earnings per share	$	.33		$	.27

(2) EARNINGS PER SHARE

Basic earnings per share is calculated by dividing net income by the weighted average common shares outstanding, excluding options and warrants. The dilutive effect of options and our 2003 warrants is calculated using the treasury stock method for purposes of weighted average dilutive shares.

The holders of the PIERS units (see Note 7) may not tender their units or exercise the cash election in exchange for Sovereign shares until the closing price of Sovereign common stock is more than 130% of the effective conversion price per share of Sovereign common stock over a specified measurement period or upon the occurrence of certain other events. Since these conditions which allow the holders to exercise their option have not been met, no shares which may be potentially issued under the terms of the PIERS financing have been included in the basic or diluted shares calculation for 2004.

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


	Three-Month Period
	Ended March 31,
	2004		2003
CALCULATION OF INCOME FOR BASIC AND DILUTED EPS:
Net income	$	102,227	$	75,856

WEIGHTED AVERAGE SHARES OUTSTANDING:
Weighted average basic shares		300,720		261,322
Dilutive effect of:
Warrants		—		16,852
Stock options		5,958		3,191

Weighted average diluted shares		306,678		281,365

EARNINGS PER SHARE:
Basic	$	.34	$	.29
Diluted	$	.33	$	.27

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(3) INVESTMENT SECURITIES AVAILABLE-FOR-SALE

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


	March 31, 2004
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	49,016	$	284	$	111	$	49,189
Corporate debt and asset-backed securities		289,477		26,255		—		315,732
Equity securities (1)		1,521,895		18,635		16,389		1,524,141
State and municipal Securities		24,196		2,489		180		26,505
Mortgage-backed securities:
U.S. government agencies		6,799,944		107,882		2,182		6,905,644
Non-agencies		3,051,842		39,270		31		3,091,081

Total investment securities Available-for-sale	$	11,736,370	$	194,815	$	18,893	$	11,912,292


	December 31, 2003
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
U.S. Treasury and government agency securities	$	21,730	$	—	$	72	$	21,658
Corporate debt and asset-backed securities		325,306		29,073		—		354,379
Equity securities (1)		1,162,115		13,052		14,569		1,160,598
State and municipal securities		18,155		2,102		125		20,132
Mortgage-backed securities:
U.S. government agencies		6,368,139		60,712		12,360		6,416,491
Non-agencies		2,119,355		12,577		2,571		2,129,361

Total investment securities available-for-sale	$	10,014,800	$	117,516	$	29,697	$	10,102,619

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

Investment securities with an estimated fair value of $7.2 billion and $5.6 billion were pledged as collateral for borrowings, interest rate protection agreements and certain deposits at March 31, 2004 and December 31, 2003, respectively.

-12-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(4) INVESTMENT SECURITIES HELD-TO-MATURITY

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


	March 31, 2004
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
Corporate debt and asset- backed securities	$	81,600	$	7,711	$	—	$	89,311
State and municipal securities		754,113		11,314		5,831		759,596
Mortgage-backed securities:
U.S. government agencies		1,651,657		20,019		6,692		1,664,984
Non-agencies		1,660		7		26		1,641

Total investment securities held-to-maturity	$	2,489,030	$	39,051	$	12,549	$	2,515,532


	December 31, 2003
	Amortized		Unrealized		Unrealized		Fair
	Cost		Appreciation		Depreciation		Value
Investment Securities:
Corporate debt and asset- backed securities	$	56,057	$	4,696	$	—	$	60,753
State and municipal securities		754,240		5,950		11,531		748,659
Mortgage-backed securities:
U.S. government agencies		1,704,114		13,265		20,997		1,696,382
Non-agencies		1,941		6		31		1,916

Total investment securities held-to-maturity	$	2,516,352	$	23,917	$	32,559	$	2,507,710

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(5) COMPOSITION OF LOAN PORTFOLIO

The following table presents the composition of the loan portfolio by type of loan and by fixed and adjustable rates at the dates indicated:


	March 31, 2004					December 31, 2003
	Amount		Percent			Amount		Percent
Commercial real estate loans(1)	$	4,993,700		18.0	%	$	4,702,046		18.0	%
Commercial and industrial loans(2)		6,926,275		25.0			6,361,640		24.3

Total Commercial Loans		11,919,975		43.0			11,063,686		42.3

Home equity loans		6,971,401		25.1			6,457,682		24.7
Auto loans		3,621,169		13.1			3,240,383		12.4
Other		419,533		1.5			312,224		1.2

Total Consumer Loans		11,012,103		39.7			10,010,289		38.3

Residential Real Estate Loans		4,806,494		17.3			5,074,684		19.4

Total Loans (3)	$	27,738,572		100.0	%	$	26,148,659		100.0	%

Total Loans with:
Fixed rate	$	15,711,713		56.6	%	$	15,171,129		58.0	%
Variable rate		12,026,859		43.4			10,977,530		42.0

Total Loans (3)	$	27,738,572		100.0	%	$	26,148,659		100.0	%

(1) Includes multifamily loans of $355.3 million and $348.6 million at March 31, 2004 and December 31, 2003, respectively.

(2) Includes automotive floor plan loans of $719.9 million and $614.4 million at March 31, 2004 and December 31, 2003, respectively.

(3) Loan totals include deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts. These items resulted in a net increase in loans of $170.2 million and $159.8 million at March 31, 2004 and December 31, 2003, respectively.

Loans to related parties include loans made to certain officers, directors and their affiliated interests. At March 31, 2004 and December 31, 2003, loans made by Sovereign Bank to these parties totaled $30.8 million and $31.1 million, respectively. These loans were made on terms similar to non-related parties.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(6) DEPOSIT PORTFOLIO COMPOSITION

The following table presents the composition of deposits and other customer accounts at the dates indicated:


	March 31, 2004								December 31, 2003
						Weighted								Weighted
						Average								Average
Account Type	Amount		Percent			Rate			Amount		Percent			Rate
Demand deposit accounts	$	4,481,546		15.9	%		—	%	$	4,306,376		15.7	%		—	%
NOW accounts		6,248,412		22.2			0.65			6,068,163		22.2			0.63
Customer repurchase agreements		789,524		2.8			0.64			1,017,544		3.7			0.64
Savings accounts		3,317,836		11.8			0.53			3,098,892		11.3			0.56
Money market accounts		7,102,117		25.3			1.00			6,843,131		25.0			0.95
Certificates of deposit		6,178,871		22.0			2.21			6,009,902		22.1			2.40

Total Deposits	$	28,118,306		100	%		0.96	%	$	27,344,008		100	%		0.99	%

(7) BORROWINGS AND OTHER DEBT OBLIGATIONS

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


	March 31, 2004					December 31, 2003
			Effective					Effective
	Balance		Rate			Balance		Rate
Sovereign Bank borrowings and other debt obligations:
Securities sold under repurchase agreements	$	2,058,167		0.90	%	$	1,793,391		1.13	%
Fed funds purchased		965,000		1.06			400,000		0.97
FHLB advances		7,195,283		3.55			6,755,330		3.55
Asset-backed floating rate notes and secured financings		1,571,000		(0.21	)		1,571,074		(0.16	)
Subordinated notes		793,724		2.98			775,266		3.01
Other		118,926		6.96			—		—
Holding company borrowings and other debt obligations Senior secured credit facility		180,000		2.24			50,000		2.67
Senior notes		563,447		7.63			595,790		7.95
Junior subordinated debentures due to Capital Trust Entities		816,139		6.96			256,752		5.79

Total borrowing and other debt obligations	$	14,261,686		2.92	%	$	12,197,603		2.86	%

On February 26, 2004, Sovereign completed the offering of $700 million of Contingent Convertible Trust Preferred Equity Income Redeemable Securities (“PIERS”). On March 8, 2004, Sovereign raised an additional $100 million of Trust PIERS under this offering. The offering was completed through Sovereign Capital Trust IV (the ''Trust’’), a special purpose entity established to issue the Trust PIERS. Each Trust PIERS had an issue price of $50 and represents an undivided beneficial ownership interest in the assets of the Trust, which consist of:

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(7) BORROWINGS AND OTHER DEBT OBLIGATIONS (continued)

• Junior subordinated debentures issued by Sovereign with a distribution rate of 4.375% per annum on the $50.00 issue price, and each of which will have a principal amount at maturity of $50 and a stated maturity of March 1, 2034; and

• Warrants to purchase shares of Sovereign common stock from Sovereign at any time prior to the close of business on March 1, 2034, by delivering junior subordinated debentures (or, in the case of warrant exercises before March 5, 2007, cash equal to the accreted principal amount of a junior subordinated debenture).

Holders may convert each of their Trust PIERS into 1.6304 shares of Sovereign common stock: (1) during any calendar quarter if the closing sale price of Sovereign common stock is more than 130% of the effective conversion price per share of Sovereign common stock over a specified measurement period; (2) prior to March 1, 2029, during the five-business-day period following any 10-consecutive-trading-day period in which the average daily trading price of the Trust PIERS for such 10-trading-day period was less than 105% of the average conversion value of the Trust PIERS during that period and the conversion value for each day of that period was less than 98% of the issue price of the Trust PIERS; (3) during any period in which the credit rating assigned to the Trust PIERS by either Moody’s or Standard & Poor’s is below a specified level; (4) if the Trust PIERS have been called for redemption or (5) upon the occurrence of certain corporate transactions. The initial conversion rate of the Trust PIERS was equivalent to a conversion price of approximately $30.67 per share. The Trust PIERS and the junior subordinated debentures have a distribution rate of 4.375% per annum of their issue price, subject to deferral. In addition, contingent distributions of $0.08 per $50 issue price per Trust PIERS will be due during any three-month period commencing on or after March 1, 2007 under certain conditions. The Trust PIERS may not be redeemed by Sovereign prior to March 5, 2007, except upon the occurrence of certain special events. On any date after March 5, 2007, Sovereign may, if specified conditions are satisfied, redeem the Trust PIERS, in whole but not in part, for cash for a price equal to 100% of their issue price plus accrued and unpaid distributions to the date of redemption, if the closing price of Sovereign common stock has exceeded a price per share equal to $39.87, subject to adjustment, for a specified period. The Trust is not consolidated in Sovereign’s financial statements; however, the junior subordinated debentures issued by Sovereign to the Trust are included in “Borrowings and other debt obligations” in the Consolidated Balance Sheet.

The proceeds from the Trust PIERS of $800 million, net of transaction costs of approximately $16.3 million, were allocated pro rata between “Junior Subordinated debentures due Capital Trust Entities” in the amount of $498.3 million and “Warrants and employee stock options issued” in the amount of $285.4 million based on estimated fair values. The difference between the carrying amount of the subordinated debentures and the principal amount due at maturity is being accreted into interest expense using the effective interest method over the period to maturity of the Trust PIERS which is March 2, 2034. The effective interest rate of the subordinated debentures is 7.55%.

During the first quarter of 2004, Sovereign gave notice of its intent to exercise its “clean-up” call option to repurchase the remaining assets of two off-balance sheet securitization special purpose entities. Such option became available to Sovereign during the first quarter of 2004 and in accordance with SFAS No. 140, Sovereign consolidated the assets (loans of $120.5 million) and liabilities (bondholder certificate balances of $118.9 million) of these trusts at March 1, 2004. In April 2004, Sovereign repurchased the assets from these trusts. The trust utilized these proceeds to pay off existing bondholders’ certificate balances, and the excess cash was remitted back to

-16-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(7) BORROWINGS AND OTHER DEBT OBLIGATIONS (continued)

Sovereign. This transaction did not have a material impact to Sovereign’s results of operations.

(8) DERIVATIVES

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

Fair Value Hedges. Sovereign has entered into pay-variable receive-fixed interest rate swaps to hedge changes in fair values of certain brokered certificates of deposits and subordinated and senior notes. Sovereign includes all components of each derivative’s fair value in the assessment of hedge effectiveness. For the three-months ended March 31, 2004 and 2003, no hedge ineffectiveness was required to be recognized in earnings associated with fair value hedges.

Cash Flow Hedges. Sovereign hedges exposures to changes in cash flows associated with forecasted interest payments on variable-rate liabilities, through the use of pay-fixed, receive variable interest rate swaps. Sovereign includes all components of each derivatives fair value in the assessment of hedge effectiveness. For the three months ended March 31, 2004 and 2003, no hedge ineffectiveness was required to be recognized in earnings associated with cash flow hedges. No gains or losses deferred in accumulated other comprehensive income were reclassified into earnings during the three months ended March 31, 2004 or 2003 as a result of discontinuance of cash flow hedges for which the forecasted transaction was not probable of occurring. As of March 31, 2004, Sovereign expects approximately $39.9 million of the deferred net after-tax loss on derivative instruments included in accumulated other comprehensive income to be reclassified to earnings during the next twelve months.

Other Derivative Activities. Sovereign’s derivative portfolio includes derivative instruments not designated in SFAS No. 133 hedge relationships. Those derivatives include mortgage banking interest rate lock commitments and forward sale commitments used for risk management purposes and derivatives executed with commercial banking customers, primarily interest rate swaps and foreign currency contracts.

Net gains (losses) generated from mortgage banking derivative transactions is included in mortgage banking revenues on the income statement and totaled $0.1 million for the three-months ended March 31, 2004 compared with $1.3 million for the three-months ended March 31, 2003. Net gains generated from derivative instruments executed with customers are included as capital markets revenue on the income statement and totaled $4.1 million for the three-months ended March 31, 2004 compared with $2.5 million for the three-months ended March 31, 2003.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(9) COMPREHENSIVE INCOME

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


	Three-month Period
	Ended March 31,
	2004			2003
Net income	$	102,227		$	75,856
Change in accumulated losses on cash flow hedge derivative financial instruments, net of tax		(714	)		4,714
Change in unrealized gains/losses on investment securities available-for-sale, net of tax		68,565			46,805
Less reclassification adjustment, net of tax:
Derivative instruments		(3,045	)		—
Investments available-for-sale		11,623			11,395

Comprehensive income	$	161,500		$	115,980

Accumulated other comprehensive income, net of related tax, consisted of net unrealized gains on securities of $99.0 million and net accumulated losses on derivatives of $92.7 million at March 31, 2004 and net unrealized gains on securities of $42.1 million and net accumulated losses on derivatives of $95.0 million at December 31, 2003.

(10) CORE DEPOSIT INTANGIBLE ASSETS

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


	Calendar				Remaining
	Year		Recorded		Amount
Year	Amount		To Date		To Record
2004		$68,798	$	17,553		$51,245
2005		60,121		—		60,121
2006		53,222		—		53,222
2007		46,280		—		46,280
2008		$32,681	$	—		$32,681

-18-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(11) BUSINESS SEGMENT INFORMATION

The following tables present certain information regarding the Company’s segments:


	Consumer		Corporate
	Bank		Bank			Other			Total
For the three-month period ended March 31, 2004
Net interest income (expense)	$	233,539	$	70,273		$	19,004		$	322,816
Provision for loan losses		11,222		23,325			8,453			43,000
Fees and other income (1)		72,037		22,357			15,536			109,930
General and administrative expenses		177,286		40,634			8,114			226,034
Depreciation/Amortization		13,835		646			23,636			38,117
Income (Loss) before income taxes		117,478		28,661			(11,122	)		135,017
Intersegment revenues (expense) (2)		93,887		(62,315	)		(31,572	)		—
Total Average Assets	$	16,206,913	$	12,141,339		$	17,508,098		$	45,856,350


	Consumer		Corporate
	Bank		Bank			Other			Total
For the three-month period ended March 31, 2003
Net interest income	$	225,131	$	73,018		$	4,891		$	303,040
Provision for loan losses		10,692		22,066			10,599			43,357
Fees and other income (1)		68,621		21,744			12,694			103,059
General and administrative expenses		164,470		34,990			11,628			211,088
Depreciation/Amortization		14,814		480			23,622			38,916
Income (Loss) before income taxes		118,590		37,706			(51,230	)		105,066
Intersegment revenues (expense) (2)		116,640		(62,613	)		(54,027	)		—
Total Average Assets	$	13,903,172	$	10,877,217		$	15,691,773		$	40,472,162

(1) Corporate banking fees in the accompanying Statements of Operations include fees on commercial deposits. For management reporting purposes as outlined in the above table, these fees are included in the Consumer Bank results above.

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

(12) RECENT ACCOUNTING PRONOUNCEMENTS

The Company accounts for interest rate lock commitments (“IRLCs”) for mortgage loans which it intends to sell, as derivatives, in accordance with the requirements of SFAS No. 133. On March 9, 2004, the SEC staff released Staff Accounting Bulletin (“SAB”) No.105 that would require all registrants to exclude the future cash flows for servicing loans from the fair value of IRLCs. Sovereign enters into such commitments with customers in connection with residential mortgage loan applications. This statement delays the recognition of any servicing revenues related to these commitments until such time as the loan is sold, however, the pronouncement would have no effect on the ultimate amount of revenue or cash flows recognized over time. This pronouncement is effective April 1, 2004. The future cash flows associated with servicing recorded on IRLCs and closed, but unsold, mortgage loans which were reflected on the balance sheet at April 1, 2004 was $4.8 million.

-19-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(12) RECENT ACCOUNTING PRONOUNCEMENTS (continued)

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

-20-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(13) PURCHASE OF FIRST ESSEX BANCORP, INC. (“FIRST ESSEX”)

On February 6, 2004 Sovereign completed the purchase of First Essex, a commercial bank holding company headquartered in Andover, Massachusetts, and the results of First Essex’s operations are included in the accompanying financial statements subsequent to the purchase date. Sovereign issued 12.7 million shares of common stock and exchanged Sovereign stock options for existing First Essex options, whose combined value totaled $209.9 million, and made cash payments of $208.2 million to acquire and convert all outstanding First Essex shares and employee stock options and pay associated fees. The value of the common stock was determined based on the average price of Sovereign’s shares over the three day period preceding and subsequent to the announcement date. The First Essex acquisition has added eleven full-service banking offices in northern Massachusetts and nine full-service banking offices in southern New Hampshire to Sovereign Bank’s franchise.

The preliminary purchase price was allocated to the acquired assets and liabilities of First Essex based on fair value as of February 6, 2004. The Company is in the process of finalizing these values and as such the allocation of the purchase price is subject to revision. (dollars in millions):


Assets
Investments	$	394.8
Loans:
Commercial		710.4
Consumer		435.6
Residential		52.2

Total loans		1,198.2
Less allowance for loan losses		(14.7	)

Total loans, net		1,183.5
Cash paid, net of cash acquired		(199.0	)
Premises and equipment, net		9.2
Other real estate owned		1.0
Prepaid expenses and other assets		74.5
Core deposit intangible		10.4
Goodwill		265.5

Total assets	$	1,739.9

Liabilities
Deposits:
Core	$	777.0
Time		488.6

Total deposits		1,265.6
Borrowings and other debt obligations		236.9
Other liabilities (1)		27.5

Total liabilities	$	1,530.0

(1) Includes purchase accounting liabilities of $18.6 million of which $12.4 million represents amounts to be paid to First Essex senior executives for severance and acceleration of certain retirement benefits earned by employees at the date of the acquisition.

In connection with the First Essex acquisition, Sovereign recorded charges against its earnings for the three-month period ended March 31, 2004 for merger related expenses of $23.6 million pre-tax ($15.3 million net of tax).

These merger-related expenses include the following:


Branch and office consolidations	$	15,093
System conversions		3,160
Employee benefits and other		5,334

Total	$	23,587

-21-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(14) PURCHASE OF FIRST ESSEX BANCORP, INC. (“FIRST ESSEX”) (continued)

The majority of the previously noted charge relates to lease obligations for Sovereign branch and office locations that were vacated by Sovereign in the first quarter of 2004 as a result of the First Essex acquisition since management determined that these locations would no longer be required due to branch overlap or the creation of excess office space. This charge was based on the present values of the remaining lease obligations, or portions thereof, that were associated with lease abandonments, net of any expected recovery from subleasing. The fair value was estimated by comparing current market lease rates for comparable properties. If the actual proceeds from any subleases on these properties are different than our estimate, then the difference will be reflected as either additional merger related expense or a reversal thereof. These obligations will be paid over their lease expiration terms, which range from 2005 through 2020.

The status of reserves related to restructuring activities is summarized as follows:


	First Essex		Main Street
	acquisition		acquisition		Total
Reserve balance at December 31, 2003	$	—	$	5,566	$	5,566
Charge recorded in earnings		23,587		—		23,587
Amount provided in purchase accounting (Goodwill)		18,566		—		18,566
Payments		12,225		1,599		13,824

Reserve balance as of March 31, 2004	$	29,928	$	3,967	$	33,895

Additionally, Sovereign recorded a loan loss provision of $6.0 million pre-tax ($3.9 million net of tax) to conform First Essex’s allowance for loan losses to Sovereign’s reserve policies.

(15) PENDING ACQUISITIONS

On January 26, 2004, Sovereign announced that it had entered into a merger agreement with Seacoast Financial Services Corporation (“Seacoast”), pursuant to which Sovereign agreed to acquire Seacoast in an all stock transaction valued at approximately $1.1 billion. On April 12, 2004, Sovereign announced that Sovereign and Seacoast agreed to amend the Sovereign/Seacoast merger agreement to allow Seacoast stockholders to elect to receive a portion of the merger consideration in cash. Under the terms of the amended Sovereign/Seacoast merger agreement, Seacoast stockholders may elect to receive a specified amount of cash or shares of Sovereign common stock, subject to election and allocation procedures which are intended to ensure that, in the aggregate, 75% of the Seacoast shares of common stock will be exchanged for Sovereign common stock and 25% of the Seacoast shares of common stock will be exchanged for cash.

Seacoast has $5.4 billion of assets (proforma for its acquisition of Abington Bancorp, Inc. (“Abington”) which closed on April 29, 2004) and is a bank holding company based in New Bedford, Massachusetts and has 67 banking offices throughout Southeastern Massachusetts. Sovereign’s acquisition of Seacoast is expected to close in the third quarter of 2004. Completion of the Sovereign/Seacoast transaction is subject to a number of conditions, including, but not limited to, the approval by 75% of the outstanding shares of Seacoast common stock of the amended Sovereign/Seacoast merger agreement and the receipt of required regulatory approvals.

-22-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
(continued)

(15) PENDING ACQUISITIONS (continued)

On March 9, 2004, Sovereign announced that it had entered into a merger agreement with Waypoint Financial Corp. (“Waypoint”), pursuant to which Waypoint will merge with and into Sovereign. The value of the Sovereign/Waypoint merger on March 9, 2004 was approximately $980 million. Under the terms of the Sovereign/Waypoint merger agreement, Waypoint shareholders may elect to receive $28.00 in cash or 1.262 shares of Sovereign common stock in exchange for each of their shares of Waypoint common stock, subject to election and allocation procedures which are intended to ensure that, in the aggregate, 70% of the Waypoint shares of common stock will be exchanged for Sovereign common stock and 30% will be exchanged for cash.

Waypoint is a bank holding company headquartered in Harrisburg, Pennsylvania, with assets of approximately $5.3 billion and deposits of $2.7 billion. Waypoint operates 65 community banking offices in ten counties in south-central Pennsylvania and northern Maryland. Soveriegn expects to complete the Sovereign/Waypoint merger in the fourth quarter of 2004 or the first quarter of 2005. Completion of the Sovereign/Waypoint merger is subject to a number of customary conditions, including, but not limited to, the approval of the Sovereign/Waypoint merger agreement by Waypoint shareholders and the receipt of required regulatory approvals of the Sovereign/Waypoint merger.

-23-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

EXECUTIVE SUMMARY

Sovereign is a $47 billion financial institution with community banking offices, operations and team members located principally in Pennsylvania, Massachusetts, New Jersey, Connecticut, New Hampshire, New York, Rhode Island, and Delaware. Sovereign gathers substantially all of its deposits in these market areas. We use these deposits, as well as other financing sources, to fund our loan and investment portfolios. We earn interest income on our loans and investments. In addition, we generate non-interest income from a number of sources including: deposit and loan services, sales of residential loans and investment securities, capital markets products, cash management products, and bank owned life insurance. Our principal non-interest expenses include employee compensation and benefits, occupancy and facility related costs, technology and other administrative expenses. Our volumes, and accordingly our financial results, are affected by the economic environment, including interest rates, consumer and business confidence and spending, as well as the competitive conditions.

We are one of the top 25 largest banking institutions in the United States. Our customers select Sovereign for banking and other financial services based on our ability to assist customers by understanding and anticipating their individual financial needs and providing customized solutions. Our major strengths include: a strong franchise value in terms of market share and demographics; a stable, low cost core deposit base; diversified loan portfolio and products; a strong service culture and the ability to cross sell multiple product lines to our customers resulting in higher fee based revenues; and the ability to internally generate equity through earnings. Our weaknesses have included lower than average capital ratios when compared against our peers and higher cost holding company debt that has depressed our earnings. In addition, asset quality is not as strong as we desire and we do not possess desired market share in some of our geographic micro-markets. Management has implemented strategies to address these weaknesses. With respect to our capital position, we have strengthened our ratios significantly over the last two years through the generation of earnings. In 2003, we strategically accessed the financial markets to strengthen our capital position including the issuance of $800 million of bank subordinated debt (which qualifies as Tier 2 capital), and increased tangible equity by $188 million in connection with warrants exercises. In addition, in the first quarter of 2004, Sovereign completed an offering of $800 million of Contingent Convertible Trust Preferred Income Equity Redeemable Securities (“PIERS”) which qualifies as regulatory capital. Selected asset quality statistics have recently improved; however, we continue to work toward our goal of higher asset quality. To address the weakness in our position in certain micro-markets, we continue to investigate strategic acquisitions. In February 2004, we completed the acquisition of First Essex Bancorp, Inc. (“First Essex”). We have also executed definitive agreements to acquire Seacoast Financial Services Corporation (“Seacoast”) and Waypoint Financial Corporation (“Waypoint”). These transactions are expected to close in the second half of 2004 or early 2005. See additional discussion of these transactions in a later section of this MD&A and/or in the footnotes to the financial statements. Sovereign also may develop and construct new community banking offices to strengthen our market position. The ability to grow through acquisition or otherwise is significantly dependent upon our capital levels, stock price and the merger and acquisition market for banking institutions.

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

-24-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

RECENT INDUSTRY CONSOLIDATION IN OUR GEOGRAPHIC FOOTPRINT

The Banking industry has experienced significant consolidation in recent years. Consolidation may affect the markets in which Sovereign operates as new or restructured competitors integrate acquired businesses, adopt new business practices or change product pricing as they attempt to maintain or grow market share. Mergers and acquisitions continued at an increased level in the fourth quarter of 2003 and in early 2004. Recent merger activity involving national, regional and community banks in the northeastern United States, including acquisitions by Sovereign, have affected the competive landscape in the markets we serve. As noted above, Sovereign recently completed the acquisition of First Essex and announced a definitive agreement to acquire Seacoast and Waypoint. We believe these acquisitions will strengthen our franchise by further enabling Sovereign to capitalize on anticipated market disruption resulting from recent merger activity. These acquisitions also present conversion and systems integration risk. However, as a result of management’s extensive conversion and systems integration experience and the size of the acquisitions in relation to Sovereign, we believe the risk associated with these transactions is mitigated. Management continually monitors the environment in which it operates to assess the impact of the industry consolidation on Sovereign, as well as the practices and strategies of our competition, including loan and deposit pricing, customer expectations and the capital markets.

CURRENT INTEREST RATE ENVIRONMENT

Net interest income represents approximately seventy to seventy five percent of the Company’s revenues. Accordingly, the interest rate environment has a substantial impact on Sovereign’s earnings. Sovereign currently has an asset sensitive balance sheet. An institution that maintains an asset sensitive balance sheet generally experiences reduced net interest income in a low or declining rate environment, while earnings are enhanced in an increasing rate cycle. The impact of a low and declining rate environment on Sovereign has been mitigated in part by our large core deposit base. We would expect to benefit from any substantial increase in interest rates if they occur. See our discussion of Asset and Liability Management practices in a later section of this MD&A, including the estimated impact of changes in interest rates on Sovereign’s net interest income.

CREDIT RISK ENVIRONMENT

The credit quality of our loan portfolio has a significant impact on our operating results. We have experienced stable to positive trends in certain key credit quality performance indicators over the past several quarters. The improvement is due, in part, to the economic conditions in our geographic footprint. We believe the credit risk with respect to our investment portfolio is low. Any significant change in the credit quality of our loan portfolio would have a significant effect on our financial position and results of operations.

RESULTS OF OPERATIONS

General

Net income was $102.2 million, or $0.33 per diluted share, for the three-month period ended March 31, 2004, as compared to $75.9 million, or $0.27 per diluted share, for the same period in 2003.

During the first quarter of 2004, Sovereign completed the acquisition of First Essex. In connection with this acquisition, Sovereign recorded charges against its earnings for the three-month period ended March 31, 2004 for an additional loan loss provision of $6

-25-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

million pretax ($3.9 million net of tax) to conform First Essex’s allowance for loan losses to Sovereign’s reserve policies and merger related expenses of $23.6 million pretax ($15.3 million net of tax). The impact of these two charges reduced earnings per share by $0.06 per diluted share. In connection with the acquisitions of Seacoast and Waypoint in the second half of 2004 or the first quarter of 2005, Sovereign anticipates recording merger related charges of $0.11 to $0.12 per diluted share.

During the first quarter of 2003, Sovereign completed a tender offer for the 8.625% notes due March 2004 and the 10.25% notes due May 2004. In connection with the tender, Sovereign repurchased $139.2 million of the 8.625% notes and $162.4 million of the 10.25% notes, incurring a loss on this debt extinguishment of $29 million ($18.8 million net of tax or $0.07 per diluted share).

-26-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

CONSOLIDATED AVERAGE BALANCE SHEET / TAX EQUIVALENT NET INTEREST MARGIN ANALYSIS
THREE-MONTH PERIOD ENDED MARCH 31, 2004 AND 2003
(in thousands)


	2004								2003
				Tax								Tax
	Average			Equivalent		Yield/			Average			Equivalent		Yield/
	Balance			Interest		Rate			Balance			Interest		Rate
EARNING ASSETS
INVESTMENTS	$	14,120,951		$	176,374		5.00	%	$	12,294,287		$	171,299		5.57	%
LOANS:
Commercial loans		11,413,060			132,325		4.60	%		10,290,307			136,532		5.31	%
Consumer loans		10,472,369			135,709		5.21	%		8,611,316			130,028		6.12	%
Residential loans		5,105,900			66,743		5.23	%		4,374,139			68,275		6.24	%

Total loans		26,991,329			334,777		4.95	%		23,275,762			334,835		5.79	%
Allowance for loan losses		(343,684	)		—		—			(300,141	)		—		—

NET LOANS		26,647,645			334,777		5.02	%		22,975,621			334,835		5.86	%

TOTAL EARNING ASSETS		40,768,596			511,151		5.01	%		35,269,908			506,134		5.76	%
Other assets		5,087,754			—		—			5,202,254			—		—

TOTAL ASSETS	$	45,856,350		$	511,151		4.45	%	$	40,472,162		$	506,134		5.02	%

FUNDING LIABILITIES
Deposits and other customer related accounts:
Core deposits and other related accounts	$	21,346,218		$	31,661		0.60	%	$	19,404,801		$	44,737		0.93	%
Time deposits		6,108,153			33,351		2.19	%		6,888,521			48,914		2.88	%

TOTAL DEPOSITS		27,454,371			65,012		0.95	%		26,293,322			93,651		1.44	%

BORROWED FUNDS:
FHLB advances		8,063,115			77,815		3.83	%		5,626,752			75,403		5.38	%
Fed funds and repurchase Agreements		2,554,957			7,418		1.15	%		2,325,965			2,760		0.47	%
Other borrowings		3,563,656			26,702		2.98	%		1,986,990			26,110		5.26	%

TOTAL BORROWED FUNDS		14,181,728			111,935		3.14	%		9,939,707			104,273		4.21	%

TOTAL FUNDING LIABILITIES		41,636,099			176,947		1.70	%		36,233,029			197,924		2.20	%
Other liabilities		660,321			—		—			1,423,647			—		—

TOTAL LIABILITIES		42,296,420			176,947		1.67	%		37,656,676			197,924		2.12	%
STOCKHOLDERS’ EQUITY		3,559,930			—		—			2,815,486			—		—

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	45,856,350		$	176,947		1.54	%	$	40,472,162		$	197,924		1.97	%

NET INTEREST INCOME				$	334,204							$	308,210

NET INTEREST SPREAD (1)							2.91	%							3.05	%

NET INTEREST MARGIN (2)							3.28	%							3.50	%

(1) Represents the difference between the yield on total assets and the cost of total liabilities and stockholders’ equity.

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

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Net Interest Income

Net interest income for the three-month period ended March 31, 2004 was $322.8 million compared to $303.0 million for the same period in 2003. The increase in net interest income for the three-month period ended March 31, 2004, compared to the corresponding period in the prior year, resulted principally from growth in earning assets which more than offset the decline in yield.

Net interest margin was 3.28% for the three-month period ended March 31, 2004 compared to 3.50% for the same period in 2003. Net interest margin has contracted from the comparable 2003 levels due to continued declines in market interest rates, prepayment and sales of higher yielding fixed rate assets, the continued repricing of short duration consumer and commercial loans, and the impact of reclassifying our trust preferred securities into borrowings. Partially offsetting this decline was downward repricing of deposits, favorable funding costs on short-term repurchase agreements and term financing and the redemption of high coupon senior notes completed in March 2003 and May 2003. Also, the issuance of the Contingent Convertible Trust Preferred Equity Income Redeemable Securities (“Trust PIERS”) had a negative effect on margin for part of the first quarter. The Trust PIERS will have an additional unfavorable impact on margin as a full quarter effect of this financing is included in margin in the second quarter.

Interest on investment securities and interest earning deposits was $166.6 million for the three-month period ended March 31, 2004 compared to $167.3 million for the same period in 2003. The average balance of investment securities was $14.1 billion with an average tax equivalent yield of 5.00% for the three-month period ended March 31, 2004 compared to an average balance of $12.3 billion with an average yield of 5.57% for the same period in 2003. The decline in yield is due to prepayments and sales of higher yielding investments which are being replaced by lower yielding securities due to the current interest rate environment. The Company has attempted to mitigate the decline in market interest rates by lengthening the aggregrate duration of its investment portfolio from 2.3 years at March 31, 2003 to 3.6 years at March 31, 2004.

Interest on loans was $333.2 million for the three-month period ended March 31, 2004 compared to $333.6 million for the same period in 2003. The average balance of loans was $27.0 billion with an average yield of 4.95% for the three-month period ended March 31, 2004 compared to an average balance of $23.3 billion with an average yield of 5.79% for the same period in 2003. Average balances of commercial and consumer loans in 2004 increased $1.1 billion and $1.9 billion, respectively, as compared to 2003 primarily due to loan originations, loan purchases and loans acquired from First Essex. Average residential loans increased $731.8 million due to loan purchases executed in the fourth quarter of 2003 and loans acquired from the First Essex acquisition.

Interest on deposits and related customer accounts was $65.0 million for the three-month period ended March 31, 2004 compared to $93.7 million for the same period in 2003. The average balance of deposits was $27.5 billion with an average cost of 0.95% for the three-month period ended March 31, 2004 compared to an average balance of $26.3 billion with an average cost of 1.44% for the same period in 2003. The increase in the balance of deposits is due to the First Essex acquisition. The decrease in average cost year to year is due primarily to declining market interest rates which resulted in a downward repricing of deposits.

Interest on borrowed funds was $111.9 million for the three-month period ended March 31, 2004 compared to $104.3 million for the same period in 2003. The average balance of borrowings was $14.2 billion with an average cost of 3.14% for the three-month period ended March 31, 2004 compared to an average balance of $9.9 billion with an average cost

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

of 4.21% for the same period in 2003. The decline in the yield is due to the repayment of high cost debt obligations in 2003, the issuance of favorable term funding in the fourth quarter of 2003, repricing of variable rate borrowings from the decline in market interest rates, favorable short-term funding alternatives that Sovereign has experienced on repurchase agreements as well as specific strategies which were executed to reduce Sovereign’s asset sensitivity including termination of certain pay-fixed interest rate swaps and executing received fixed swaps. These favorable factors were partially offset by the reclassification of Trust Preferred Securities expense from other expense to net interest income during the third quarter of 2003, in accordance with Sovereign’s change in accounting policy.

Provision for Loan Losses

The provision for loan losses is based upon credit loss experience and on the estimation of losses inherent in the current loan portfolio. The provision for loan losses for the three-month period ended March 31, 2004 was $43.0 million compared to $43.4 million for the same period in 2003.

The provision for the three months ended March 31, 2004 included a charge of $6 million to conform the acquired First Essex Bancorp loan portfolio to Sovereign’s reserve policy. Excluding this item, the provision for loan losses in the three months ended March 31, 2004 includes a lower level of provision versus 2003 due to improvements in credit quality in the loan portfolio. Management regularly evaluates Sovereign’s loan portfolios, and its allowance for loan losses, and adjusts the loan loss allowance and related reserves as deemed necessary.

Sovereign’s net charge-offs for the three-month period ended March 31, 2004 were $34.5 million and consisted of charge-offs of $47.3 million and recoveries of $12.8 million. This compared to net charge-offs of $32.7 million consisting of charge-offs of $40.8 million and recoveries of $8.1 million for the three-month period ended March 31, 2003. Net charge-offs have increased modestly during the first quarter of 2004 compared to the prior year due in part to charge offs of approximately $1.4 million associated with the First Essex portfolio. Net charge-offs as a percent of average loans has improved to .51% for the three-month period ended March 31, 2004, compared to .56% for the corresponding period in the prior year.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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


	Three-month Period Ended March 31,
	2004		2003
Allowance, beginning of period	$	327,894	$	298,750
Charge-offs:
Residential		577		888
Commercial		27,618		24,137
Consumer		19,122		15,790

Total Charge-offs		47,317		40,815

Recoveries:
Residential		369		95
Commercial		4,293		2,109
Consumer		8,108		5,902

Total Recoveries		12,770		8,106

Charge-offs, net of recoveries		34,547		32,709
Provision for loan losses		43,000		43,357
First Essex’s allowance for loan losses		14,660		—

Allowance, end of period	$	351,007	$	309,398

Non-Interest Income

Total non-interest income was $127.8 million for the three-month period ended March 31, 2004 compared to $120.6 million for the same periods in 2003. Excluding securities and related derivatives transactions, total fees and other income for the three-month period ended March 31, 2004 were $109.9 million as compared to $103.1 million for the same period in 2003.

Consumer banking fees were $54.0 million for the three-month period ended March 31, 2004 as compared to $48.2 million for the same period in 2003, representing an increase of 12%. The increase year over year was due principally to growth in deposit fees to $45.4 million for the three month period ended March 31, 2004 compared to deposit fees of $40.2 million for the corresponding period in the prior year. Average core deposit balances have grown $1.9 billion or 10% since March 31, 2003 due primarily to the First Essex acquisition, specific product initiatives, municipal deposit growth and promotions which resulted in an increase in the number of core deposit accounts and balances.

Commercial banking fees were $28.7 million for the three-month period ended March 31, 2004 as compared to $25.2 million for the same period in 2003. This increase of $3.5 million, or 14%, for the three-months ended March 31, 2004, over the corresponding 2003 period were primarily due to higher loan fees resulting from growth in the commercial loan portfolio, increased levels of fees, and increased cash management fee income.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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


	Three-months ended March 31,
	2004			2003
Impairments to mortgage servicing rights	$	(11,260	)	$	(7,429	)
Mortgage servicing fees, net of amortization		137			(2,490	)
Net gains under SFAS 133		81			1,275
Sales of mortgage loans and mortgage backed securities		16,469			16,652

Total	$	5,427		$	8,008

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

The decrease in mortgage banking revenues for the three-month period ended March 31, 2004 is attributable principally to the increased impairment charge for mortgage servicing rights due to increased prepayment speed assumptions at March 31, 2004. However, based on current prepayment speed estimates, we anticipate recovering the majority of the first quarter impairment in the second quarter of 2004. At March 31, 2004, Sovereign serviced approximately $6.6 billion of mortgage loans for others and our mortgage servicing asset was $66.4 million, net of valuation reserves of $23.7 million, compared to $6.2 billion of loans serviced for others and a mortgage servicing asset of $52.0 million, net of valuation reserves of $31.4 million, at March 31, 2003.

The gains on the sales of mortgage loans and mortgage backed securities for the three-month period ended March 31, 2004 was consistent with the same period a year ago.

Capital markets revenues totaled $4.9 million for the three-month period ended March 31, 2004 compared with $7.7 million for the same period in 2003. The decrease from the prior year is due to decreased trading activity related to the current low interest rate environment.

The net gains on investment securities and related derivatives transactions were $17.9 million for the three-month period ended March 31, 2004 compared to $17.5 million for the same period in 2003. The three-month period ended March 31, 2003 included a charge of $1.1 million related to an other than temporary impairment charge related to one of our investment securities.

General and Administrative Expenses

General and administrative expenses for the three-month period ended March 31, 2004 were $226.0 million, compared to $211.1 million for the same period in 2003. General and administrative expenses increased in 2004 due to increased compensation and benefit costs associated with the hiring of additional team members, and the effect of the First Essex acquisition.

Other Expenses

Other expenses were $46.6 million for the three-month period ended March 31, 2004 compared to $64.1 million for the same period in 2003. The expense associated with the

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

junior subordinated debentures due to the capital trust entities in the first quarter of 2003 was classified in other expense. Management elected to change the Company’s accounting policy effective July 1, 2003, to treat these securities as liabilities and the associated dividends on the obligations as interest expense. Expense associated with amortization of core deposit intangibles decreased by $1.5 million during the three-month period ending March 31, 2004, compared to the corresponding period in the prior year. This decline was due to reduced amortization related to core deposits that are being amortized on an accelerated method, offset by additional amortization related to the First Essex acquisition. Merger-related and integration charges of $23.6 million ($15.3 million or $.05 per share, net of tax) related to the First Essex acquisition were recorded in the three-month period ended March 31, 2004. The three-month period ended March 31, 2003, includes a loss of $29.0 million ($18.8 million or $.07 per share, net of tax) on the extinguishment of debt.

Income Tax Provision

The income tax provision was $32.8 million for the three-month period ended March 31, 2004 compared to $29.2 million for the same period in 2003. The effective tax rate for the three-month period ended March 31, 2004 was 24.3%, compared to 27.8% for the same period in 2003. The effective tax rate differs from the statutory rate of 35% primarily due to income from tax-exempt investments and income related to bank-owned life insurance. The effective tax rate in the first quarter of 2004 is lower than the prior year rate due to the tax benefit associated with the First Essex merger related charges, which is reflected in the first quarter provision. In addition, the 2004 estimated annual effective tax rate includes the benefit from the expected increase in tax credits associated with investments in low income housing and synthetic fuel partnerships and additional purchases of tax exempt municipal investments in the fourth quarter of 2003 which will benefit the full year of 2004. Offsetting these benefits is Sovereign’s expectation that pretax earnings for 2004 will be higher than 2003. Our effective tax rate for the remainder of 2004 is expected to increase from the March 31, 2004 rate to approximately 26.5%.

Line of Business Results

The Company’s reportable segments include the Consumer Bank, the Corporate Bank and Other. The Company’s business lines are focused principally around the customers Sovereign serves. The Consumer Bank provides a wide range of products and services to consumers including mortgage, automobile and other consumer loans and lines of credit. The Consumer Bank also attracts deposits within its primary market area by offering a variety of deposit instruments including demand and NOW accounts, money market and savings accounts, certificates of deposit and retirement savings plans. The Corporate Bank originates small and middle market commercial and asset-based loans and provides cash management and capital markets services to customers in Sovereign’s market area. Other includes earnings from the investment portfolio, interest expense on Sovereign’s borrowings and debt, expense on Sovereign’s trust preferred securities and other minority interest expense, amortization of intangible assets, merger-related and restructuring charges and certain unallocated corporate income and expenses.

Segment results are derived from the Company’s business unit profitability reporting system by specifically attributing managed balance sheet assets, deposits and other liabilities and their related interest income or expense. Funds transfer pricing methodologies are utilized to allocate a cost for funds used or a credit for funds provided to business line deposits, loans and selected other assets using a matched funding concept. The provision for credit losses recorded by each segment is based on the net charge-offs of each line of business. The difference between the provision for

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

credit losses recognized by the Company on a consolidated basis and the provision recorded by the business lines at the time of charge-off is included in Treasury & Other. Other income and expenses directly managed by each business line, including fees, service charges, salaries and benefits, and other direct expenses as well as certain allocated corporate expenses are accounted for within each segment’s financial results. Designations, assignments and allocations may change from time to time as management accounting and business unit profitability reporting systems are enhanced or product lines change. Certain organization and allocation methodology changes have been made which enhanced the Company’s management reporting systems and the information provided to the chief executive officer. Where practical, the results are adjusted to present consistent methodologies for the segments. Accounting policies for the lines of business are the same as those used in preparation of the consolidated financial statements with respect to activities specifically attributable to each business line. However, the preparation of business line results requires management to establish methodologies to allocate funding costs and benefits, expenses and other financial elements to each line of business.

Consumer Bank net interest income increased $8.4 million to $233.5 million for the three-month period ended March 31, 2004 compared to the corresponding period in the preceding year. The increase in net interest income was principally due to loan growth, as well as an increase in low-cost deposits. The average balance of Consumer Bank loans was $15.6 billion with a yield of 5.22% versus $13.0 billion at a yield of 6.94% during the three-months ended March 31, 2004 and March 31, 2003, respectively. The average balance of deposits was $27.5 billion at a cost of 0.95% in the three-months ended March 31, 2004 compared to $26.3 billion at an average cost of 1.44% in the same period a year ago. The increase in non-interest income of $3.4 million to $72.0 million for the three-months ended March 31, 2004 was generated by deposit fees and to a lesser extent, loan fees, which grew in tandem with the increased level of deposits and loans. The provision for loan losses increased in 2004 compared to the same periods a year ago to $11.2 million for the three-months ended March 31, 2004 due to charge offs associated with acquired First Essex loans. General and administrative expenses (including allocated corporate and direct support costs) increased from $164.5 million at March 31, 2003, to $177.3 million for the three-months ended March 31, 2004. The increase in general and administrative expenses is due principally to Sovereign’s continued investment in people and processes to support its expanding franchise, including the effect of the First Essex acquisition.

Corporate Bank net interest income decreased $2.7 million to $70.3 million for the three-months ended March 31, 2004 compared to the corresponding periods in the preceding year. The decrease in net interest income was principally due to declines in the yield on loans due to current market rates. The average balance of Corporate Bank loans was $11.4 billion with a yield of 4.60% in the three-months ended March 31, 2004 versus $10.3 billion at a yield of 5.31% during the three-months ended March 31, 2003. Non-interest income has increased by $0.6 million to $22.4 million related to an increase in loan fees offset by declines in capital markets revenues. The provision for loan losses increased by $1.3 million for the three-month period ended March 31, 2004, to $23.3 million compared to the corresponding period in the preceding year. The increase was due to higher level of charge-offs. General and administrative expenses (including allocated corporate and direct support costs) increased from $35.0 million for the three-months ended March 31, 2003 to $40.6 million in the three-months ended March 31, 2004. The increase was due in part to increased costs to support the Corporate Bank’s loan growth.

The net loss before income taxes for Other decreased from $51.2 million in the first quarter of 2003 to $11.1 million in the first quarter of 2004. Net interest income increased from $4.9 million in the first quarter of 2003 to $19.0 million for the first

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

quarter of 2004. The Other segment includes net gains on security and derivative transactions of $17.9 million in the first quarter of 2004, as compared to $17.5 million recorded in 2003. The 2004 and 2003 results also include a pre-tax loss of 23.6 million and $29.0 million, on the First Essex acquisition and the extinguishment of debt, respectively.

Critical Accounting Policies

The Company’s significant accounting policies are described in Note 1 to the December 31, 2003 consolidated financial statements filed on Form 10-K. The preparation of financial statements in accordance with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and disclosure of contingent assets and liabilities. Actual results could differ from those estimates. We have identified accounting for the allowance for loan losses, securitizations, and goodwill as our most critical accounting policies and estimates in that they are important to the portrayal of our financial condition and results, and they require management’s most difficult, subjective or complex judgments as a result of the need to make estimates about the effect of matters that are inherently uncertain. These accounting policies, including the nature of the estimates and types of assumptions used, are described throughout this Management’s Discussion and Analysis and the December 31, 2003 Management’s Discussion and Analysis filed on Form 10-K.

A discussion of new accounting policies adopted by the Company and the impact of new accounting standards issued by the FASB and other standard setters are included in Note 13 to the consolidated financial statements.

FINANCIAL CONDITION

Loan Portfolio

At March 31, 2004, commercial loans totaled $11.9 billion representing 43% of Sovereign’s loan portfolio, compared to $11.1 billion or 42% of the loan portfolio at December 31, 2003 and $10.5 billion or 44% of the loan portfolio at March 31, 2003. At March 31, 2004 and December 31, 2003, only 5% and 6%, respectively, of our total commercial portfolio was unsecured. The consumer loan portfolio (including home equity loans and lines of credit, automobile loans, and other consumer loans) totaled $11.0 billion at March 31, 2003, representing 40% of Sovereign’s loan portfolio, compared to $10.0 billion, or 38%, of the loan portfolio at December 31, 2003 and $8.8 billion or 37% of the loan portfolio at March 31, 2003. In connection with the acquisition of First Essex, Sovereign acquired commercial, consumer and mortgage loans of $710.4 million, $435.6 million and $52.2 million, respectively.

Residential mortgage loans were $4.8 billion at March 31, 2004 and represent 17% of Sovereign’s loan portfolio as compared to $5.1 billion and 19% at December 31, 2003 and $4.7 billion or 20% of the loan portfolio at March 31, 2003. The gradual decrease during the periods shown is due to increased prepayment levels due to declining mortgage interest rates.

Non-Performing Assets

At March 31, 2004 Sovereign’s non-performing assets decreased by $8.5 million to $212.0 million compared to $220.4 million at December 31, 2003. Additionally, First Essex contributed $7.2 million of non-performing assets at March 31, 2004. This decrease is due to improvements in the credit quality of our portfolio. Non-performing assets as a

-34-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

percentage of total loans, real estate owned and repossessed assets were 0.76% at March 31, 2004 and 0.84% at December 31, 2003. Sovereign generally places all commercial loans on non-performing status at 90 days delinquent or sooner, if management believes the loan has become impaired (unless return to current status is expected imminently). All other consumer and residential loans continue to accrue interest until they are 120 days delinquent, at which point they are either charged-off or placed on non-accrual status and anticipated losses are reserved. Consumer and residential real estate loans with loan to values of 50% or less, based on current valuations, are considered well secured and in the process of collection and therefore continue to accrue interest. At 180 days delinquent, anticipated losses on residential real estate loans are fully reserved or charged off.

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


	March 31,			December 31,
	2004			2003
Non-accrual loans:
Commercial	$	71,521		$	83,976
Commercial real estate		42,213			45,053
Consumer		31,573			30,921
Residential		41,925			38,195

Total non-accrual loans		187,232			198,145
Restructured loans		1,378			1,235

Total non-performing loans		188,610			199,380
Other real estate owned		18,349			17,016
Other repossessed assets		5,006			4,051

Total non-performing assets	$	211,965		$	220,447

Past due 90 days or more as to interest or principal and accruing interest	$	31,498		$	36,925
Non-performing assets as a percentage of total assets		.45	%		.51	%
Non-performing loans as a percentage of total loans		.68	%		.76	%
Non-performing assets as a percentage of total loans and real estate owned		.76	%		.84	%
Allowance for loan losses as a percentage of total non-performing assets		165.6	%		148.7	%
Allowance for loan losses as a percentage of total non-performing loans		186.1	%		164.5	%

Loans ninety (90) days or more past due and still accruing interest fell by $5.4 million from December 31, 2003 to March 31, 2004. This decline was composed of $2.7 million of residential loans, $2.6 of consumer loans, and $0.2 million of commercial loans.

Potential problem loans (loans for which management has doubts as to the borrowers

-35-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

ability to comply with present repayment terms, principally commercial loans delinquent more than 30 days but less than 90 days, although not currently classified as non-performing loans) amounted to approximately $58.8 million and $46.8 million at March 31, 2004 and December 31, 2003, respectively. Potential problem loans included $21.1 million at March 31, 2004 related to loans acquired from the First Essex acquisition.

Allowance for Loan Losses

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


	March 31, 2004					December 31, 2003
			% of Loans					% of Loans
			to					to
	Amount		Total Loans			Amount		Total Loans
Allocated allowance:
Commercial loans	$	200,327		43	%	$	192,454		43	%
Consumer loans		111,690		40			94,199		38
Residential real estate mortgage loans		14,666		17			15,544		19
Unallocated allowance		24,324		n/a			25,697		n/a

Total allowance for loan losses	$	351,007		100	%	$	327,894		100	%

The adequacy of Sovereign’s allowance for loan losses is regularly evaluated. Management’s evaluation of the adequacy of the allowance to absorb loan losses takes into consideration the risks inherent in the loan portfolio, past loan loss experience, specific loans which have loss potential, geographic and industry concentrations, delinquency trends, economic conditions, the level of originations and other relevant factors. Management also considers loan quality, changes in the size and character of the loan portfolio, amount of non-performing loans, and industry trends.

Sovereign maintains an allowance for loan losses that management believes is sufficient to absorb inherent losses in the loan portfolio. Because historical losses are not necessarily indicative of future charge-off levels, Sovereign gives consideration to other risk indicators when determining the appropriate allowance level.

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

The specific allowance element of the allocated allowance is based on a regular analysis of criticized loans where internal credit ratings are below a predetermined classification. This analysis is performed at the relationship manager level, and periodically reviewed by the loan workout department. The specific allowance established for these criticized loans is based on a careful analysis of related collateral value, cash flow considerations and, if applicable, guarantor capacity.

The class allowance element of the allocated allowance is determined by an internal

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

loan grading process in conjunction with associated allowance factors. These class allowance factors are updated as required and are based primarily on actual historical loss experience, consultation with regulatory authorities, and peer group loss experience. The Company has the ability to revise the class allowance factors whenever necessary in order to address improving or deteriorating credit quality trends or specific risks associated with a given loan pool classification.

Regardless of the extent of the Company analysis of customer performance, portfolio evaluations, trends or risk management processes established, certain inherent, but undetected losses are probable within the loan portfolio. This is due to several factors including inherent delays in obtaining information regarding a customer’s financial condition or changes in their unique business conditions; the judgmental nature of individual loan evaluations, collateral assessments and the interpretation of economic trends; volatility of economic or customer-specific conditions affecting the identification and estimation of losses for larger non-homogeneous credits; and the sensitivity of assumptions utilized to establish allocated allowances for homogeneous groups of loans among other factors. The Company maintains an unallocated allowance to recognize the existence of these exposures. These other risk factors are continuously reviewed and revised by management where conditions indicate that the estimates initially applied are different from actual results.

A comprehensive analysis of the allowance for loan losses is performed by management on a quarterly basis. In addition, a review of allowance levels based on nationally published statistics is conducted on a periodic basis. Although management determines the amount of each element of the allowance separately and this process is an important credit management tool, the entire allowance for credit losses is available for the entire loan portfolio. The actual amount of losses incurred can vary significantly from the estimated amounts. Management’s methodology includes several factors intended to minimize the differences between estimated and actual losses. These factors allow management to adjust its estimate of losses based on the most recent information available.

Commercial Portfolio. The portion of the allowance for loan losses related to the commercial portfolio has increased primarily related to the First Essex acquisition and commercial loan growth, from $192.5 million at December 31, 2003 to $200.3 million at March 31, 2004. Of the additional loan loss provision of $6.0 million related to the First Essex acquisition, $4.5 million was recorded in the commercial loan portfolio.

Consumer Portfolio. The allowance for the consumer loan portfolio increased from $94.2 million at December 31, 2003, to $111.7 million at March 31, 2004 due to increases in loan balances and allowance acquired from the First Essex acquisition.

Residential Portfolio. The allowance for the residential mortgage portfolio decreased from $15.5 million at December 31, 2003 to $14.7 million at March 31, 2004.

Unallocated Allowance. The unallocated allowance for loan losses decreased to $24.3 million at March 31, 2004 from $25.7 million at December 31, 2003. Management continuously evaluates current economic conditions and loan portfolio trends. However, this balance is subject to changes each reporting period due to certain inherent but undetected losses which are probable of being realized within the loan portfolio.

Investment Securities

Investment securities consist primarily of mortgage-backed securities, U.S. Treasury and government agency securities, corporate debt securities and stock in the Federal Home

-37-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Loan Bank of Pittsburgh (“FHLB”), Freddie Mac and Fannie Mae. Mortgage-backed securities consist of pass-throughs and collateralized mortgage obligations issued by federal agencies or private label issuers. Sovereign’s mortgage-backed securities are generally either guaranteed as to principal and interest by the issuer or have ratings of “AAA” by Standard and Poor’s and Moody’s at the date of issuance. Sovereign purchases classes which are senior positions backed by subordinate classes. The subordinate classes absorb the losses and must be completely eliminated before any losses flow through the senior positions. The effective duration of the total investment portfolio at March 31, 2004 was 3.60 years.

Total investment securities available-for-sale were $11.9 billion at March 31, 2004 and $10.1 billion at December 31, 2003. Investment securities held-to-maturity were $2.5 billion at March 31, 2004 compared to $2.5 billion at December 31, 2003. For additional information with respect to Sovereign’s investment securities, see Notes 3 and 4 in the Notes to Consolidated Financial Statements.

Deposits and Other Customer Accounts

Sovereign attracts deposits within its primary market area with an offering of deposit instruments including demand accounts, NOW accounts, money market accounts, savings accounts, certificates of deposit and retirement savings plans. Total deposits and other customer accounts at March 31, 2004 were $28.1 billion compared to $27.3 billion at December 31, 2003. Sovereign continues to emphasize strategies to grow core deposits and limit higher priced time deposits.

Borrowings and Other Debt Obligations

Sovereign utilizes borrowings and other debt obligations as a source of funds for its asset growth and its asset/liability management. Collateralized advances are available from the FHLB provided certain standards related to creditworthiness have been met. Sovereign also utilizes reverse repurchase agreements, which are short-term obligations collateralized by securities fully guaranteed as to principal and interest by the U.S. Government or an agency thereof, and federal funds lines with other financial institutions. Total borrowings at March 31, 2004 and December 31, 2003 were $14.3 billion and $12.2 billion, respectively. See Note 7 in the Notes to Consolidated Financial Statements for additional information.

Securitization Transactions

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

In certain transactions, Sovereign has transferred assets to SPEs qualifying for non-consolidation (“QSPE”) and has accounted for the transaction as a sale in accordance with SFAS No. 140. Sovereign also has retained interests in the QSPEs. Off-balance sheet QSPEs had $1.0 billion of debt related to assets that Sovereign sold to the QSPEs which is not included in Sovereign’s consolidated Balance Sheet at March 31, 2004. Sovereign’s retained interests and servicing assets in such QSPEs were $84.9 million at March 31, 2004 and this amount represents Sovereign’s maximum exposure to credit losses related to these unconsolidated securitizations. Sovereign does not provide contractual legal recourse to third party investors that purchase debt or equity securities issued by the

-38-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

QSPEs beyond the credit enhancement inherent in Sovereign’s subordinated interests in the QSPEs.

During the first quarter of 2004, Sovereign reconsolidated certain assets and liabilities of two special purpose entities in accordance with SFAS No. 140. See Note 7 for additional discussion.

Sovereign will periodically sell qualifying mortgage loans to FHLMC, GNMA, and FNMA in return for mortgage-backed securities issued by those agencies. Sovereign reclassifies the net book balance of the loans sold to such agencies from loans to investment securities held to maturity and available for sale. For those loans sold to the agencies in which Sovereign retains servicing rights, Sovereign allocates the net book balance transferred between servicing rights and investment securities based on their relative fair values. If Sovereign sells the mortgage-backed securities which relate to underlying loans previously held by the Company, the gain or loss on the sale is recorded in mortgage banking revenues in the accompanying consolidated statement of operations. The gain or loss on the sale of all other mortgage backed securities is recorded in gains on investment securities and related derivative transactions on the consolidated statement of operations.

Bank Regulatory Capital

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

The FDICIA established five capital tiers: well-capitalized, adequately-capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. A depository institution’s capital tier depends upon its capital levels in relation to various relevant capital measures, which include leverage and risk-based capital measures and certain other factors. Depository institutions that are not classified as well-capitalized or adequately-capitalized are subject to various restrictions regarding capital distributions, payment of management fees, acceptance of brokered deposits and other operating activities. At March 31, 2004 and December 31, 2003, Sovereign Bank had met all quantitative thresholds necessary to be classified as well-capitalized under regulatory guidelines.

Federal banking laws, regulations and policies also limit Sovereign Bank’s ability to pay dividends and make other distributions to Sovereign Bancorp. Sovereign Bank is required to give prior notice to the OTS before paying any dividend. In addition Sovereign Bank must obtain prior OTS approval to declare a dividend or make any other capital distribution if, after such dividend or distribution, Sovereign Bank’s total distributions to Sovereign within that calendar year would exceed 100% of its net income during the year plus retained net income for the prior two years, or if Sovereign Bank is not adequately capitalized at the time. In addition, OTS prior approval would be required if Sovereign Bank’s examination or CRA ratings fall below certain levels or Sovereign Bank is notified by the OTS that it is a problem association or an association in troubled condition. The following schedule summarizes the actual capital balances of Sovereign Bank at March 31, 2004 and December 31, 2003 (in thousands):

-39-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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


				TIER 1			TIER 1			TOTAL
	TANGIBLE			LEVERAGE			RISK-BASED			RISK-BASED
	CAPITAL TO			CAPITAL TO			CAPITAL TO			CAPITAL TO
	TANGIBLE			TANGIBLE			RISK ADJUSTED			RISK ADJUSTED
REGULATORY CAPITAL	ASSETS			ASSETS			ASSETS			ASSETS
Sovereign Bank at March 31, 2004:
Regulatory capital	$	3,098,813		$	3,098,813		$	3,041,351		$	4,185,227
Minimum capital requirement (1)		908,294			1,816,588			1,379,783			2,759,565

Excess	$	2,190,519		$	1,282,225		$	1,661,568		$	1,425,662

Sovereign Bank capital ratio		6.82	%		6.82	%		8.82	%		12.13	%
Sovereign Bank at December 31, 2003:
Regulatory capital	$	2,814,384		$	2,814,411		$	2,732,636		$	3,852,507
Minimum capital requirement (1)		844,968			1,689,936			1,271,468			2,542,937

Excess	$	1,969,416		$	1,124,475		$	1,461,168		$	1,309,570

Sovereign Bank capital ratio		6.66	%		6.66	%		8.60	%		12.12	%

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

Listed below are capital ratios for Sovereign Bancorp.


	TANGIBLE			TANGIBLE
	EQUITY TO			EQUITY TO			TIER 1
	TANGIBLE			TANGIBLE			LEVERAGE
	ASSETS, EXCLUDING			ASSETS, INCLUDING			CAPITAL
REGULATORY CAPITAL	OCI			OCI			RATIO
Capital ratio at March 31, 2004 (1)		5.17	%		5.19	%		7.09	%
Capital ratio at December 31, 2003 (1)		4.78	%		4.66	%		5.58	%

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

Liquidity and Capital Resources

Liquidity represents the ability of Sovereign to obtain cost effective funding to meet the needs of customers, as well as Sovereign’s financial obligations. Sovereign’s primary sources of liquidity include retail deposit gathering, Federal Home Loan Bank (FHLB) borrowings, federal funds purchases, reverse repurchase agreements and wholesale deposit purchases. Other sources of liquidity include asset securitizations, liquid investment portfolio securities and debt and equity issuances.

Factors which impact the liquidity position of Sovereign Bank include loan origination volumes, loan prepayment rates, maturity structure of existing loans, core deposit growth levels, CD maturity structure and retention, Sovereign’s credit ratings, general market conditions, investment portfolio cash flows and maturity structure of wholesale funding, etc. These risks are monitored and centrally managed. This process includes reviewing all available wholesale liquidity sources. As of March 31, 2004, Sovereign had $4.3 billion in available overnight liquidity in the form of unused federal funds purchased lines, unused FHLB borrowing capacity and unencumbered investment portfolio securities.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Sovereign also forecasts future liquidity needs and develops strategies to ensure that adequate liquidity is available at all times.

Sovereign Bancorp has the following major sources of funding to meet its liquidity requirements: dividends and returns of investment from its subsidiaries, a revolving credit agreement and access to the capital markets. Sovereign Bank may pay dividends to its parent subject to approval of the OTS, as discussed above. Year-to-date Sovereign Bank has not declared or paid any dividends to Sovereign Bancorp. Sovereign also has approximately $100 million of availability under a shelf registration statement on file with the Securities and Exchange Commission permitting access to the public debt and equity markets. Sovereign is currently working on increasing the availability under this shelf registration.

Cash and cash equivalents decreased $57.1 million from December 31, 2003. Net cash provided by operating activities was $110.1 million for 2004. Net cash used by investing activities for 2004 was $1.6 billion and consisted primarily of the purchase of investments of $2.6 billion, purchases of loans of $0.6 billion, and the net change in loans other than purchases and sales of $0.3 billion, offset by sales, repayments and maturities of investments of $1.4 billion and proceeds from loan sales of $0.7 billion. Net cash provided by financing activities for 2004 was $1.5 billion, which was primarily due to an increase in borrowings and proceeds from the issuance of the Trust PIERS.

Contractual Obligations and Commercial Commitments

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

Contractual Obligations
(in thousands of dollars)


	Payments Due by Period
			Less than		Over 1 yr		Over 3 yrs		Over
	Total		1 year		to 3 yrs		to 5 yrs		5 yrs
FHLB advances (1)	$	7,448,700	$	2,396,338	$	679,835	$	560,979	$	3,811,548
Securities sold under repurchase agreements (1)		2,075,647		1,661,868		413,779		—		—
Fed Funds (1)		975,229		975,229		—		—		—
Other debt obligations (1)(2)		3,582,372		219,305		809,875		796,125		1,757,067
Junior subordinated debentures due to Capital Trust entities (1)(2)		2,626,473		53,378		106,757		106,757		2,359,581
Certificates of deposit (1)		6,323,799		4,904,819		1,096,734		210,671		111,575
Investment partnership commitments (3)		45,641		33,663		10,608		1,280		90
Business acquisitions		525,090		525,090		—		—		—
Operating leases		699,837		103,239		235,177		86,489		274,932

Total contractual cash Obligations	$	24,302,788	$	10,872,929	$	3,352,765	$	1,762,301	$	8,314,793

(1) Includes interest on both fixed and variable rate obligations. The interest associated with variable rate obligations is based upon interest rates in effect at December 31, 2003. The contractual amounts to be paid on variable rate obligations are affected by changes in market interest rates. Future changes in

-41-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

market interest rates could materially affect the contractual amounts to be paid.

(2) Excludes all carrying value adjustments, such as unamortized premiums or discounts and hedge basis adjustments.

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

Excluded from the above table are deposits of $21.9 billion that are due on demand by customers.

Certain of Sovereign’s contractual obligations require Sovereign to maintain certain financial ratios and to maintain a “well capitalized” regulatory status. Sovereign has complied with these covenants as of March 31, 2004 and expects to be in compliance with these covenants for the foreseeable future. However, if in the future Sovereign is not in compliance with these ratios or is deemed to be other than well capitalized by the OTS, and is unable to obtain a waiver from its lenders, the senior notes would be in default and callable by Sovereign’s lenders. Due to cross-default provisions in certain of Sovereign’s debt agreements, if more than 25 percent of Sovereign’s debt is in default, Sovereign’s senior notes and the full amount of the senior secured credit facility then outstanding will become due in full.

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

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

-42-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Amount of Commitment Expiration Per Period


	Total
Other Commercial	Amounts		Less than		Over 1 yr		Over 3 yrs
Commitments	Committed		1 year		to 3 yrs		to 5 yrs		Over 5 yrs
(in thousands of dollars)
Commitments to extend credit	$	9,510,568	$	5,395,754	$	1,617,750	$	396,433	$	2,100,631
Standby letters of credit		1,479,183		455,482		395,175		618,452		10,074
Loans sold with recourse		9,910		—		—		—		9,910
Forward buy commitments		473,247		473,247		—		—		—

Total commercial commitments	$	11,472,908	$	6,324,483	$	2,012,925	$	1,014,885	$	2,120,615

Sovereign’s standby letters of credit meet the definition of a guarantee under FIN 45. These transactions are conditional commitments issued by Sovereign to guarantee the performance of a customer to a third party. The guarantees are primarily issued to support public and private borrowing arrangements. The weighted average term of these commitments is 2.4 years. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. In the event of a draw by the beneficiary that complies with the terms of the letter of credit, Sovereign would be required to honor the commitment. Sovereign has various forms of collateral, such as real estate assets and customer business assets. The maximum undiscounted exposure related to these commitments at March 31, 2004 was $1.5 billion, and the approximate value of the underlying collateral upon liquidation that would be expected to cover this maximum potential exposure was $1.3 billion. The fees related to standby letters of credit are deferred and amortized over the life of the commitment. These fees are immaterial to Sovereign’s financial statements at March 31, 2004. We believe that the utilization rate of these letters of credit will continue to be substantially less than the amount of these commitments, as has been our experience to date.

Asset and Liability Management

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

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

-43-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

Sovereign simulates the impact of changing interest rates on its expected future interest income and interest expense (net interest income sensitivity). This simulation is run monthly and it includes up to tweleve different stress scenarios. These scenarios shift interest rates up and down. Certain other scenarios shift short-term rates up while holding longer-term rates constant and vice versa. This scenario analysis helps management to better understand its short-term interest rate risk and is used to develop proactive strategies to ensure that Sovereign is not overly sensitive to the future direction of interest rates. At March 31, 2004 and December 31, 2003, the general level of interest rates represented a unique economic environment in which several of Sovereign’s declining interest rate simulation scenarios would not apply. At March 31, 2004, if interest rates dropped in parallel 100 basis points, Sovereign estimates that net interest income would fall 3.44%. Alternatively, if interest rates rose in parallel 200 basis points, estimated net interest income would increase 4.55%.

Sovereign also monitors the relative repricing sensitivities of its assets versus its liabilities. Management attempts to keep assets and liabilities in balance so that when interest rates do change, the net interest income of Sovereign will not experience any significant short-term volatility as a result of assets repricing more quickly than liabilities or vice versa. As of March 31, 2004, the one year cumulative gap was 0.1%, compared to 3% at December 31, 2003 indicating Sovereign could benefit from rising rates.

Finally, Sovereign calculates the market value of its balance sheet including all assets, liabilities and hedges. This market value analysis is very useful because it measures the present value of all estimated future interest income and interest expense cash flows of the Company. Net Portfolio Value (NPV) is used to assess long-term interest rate risk. A higher NPV ratio indicates lower long-term interest rate risk and a more valuable franchise. As of March 31, 2004, the NPV as a percentage of the present value of assets was 9.94% as compared to 8.15% at December 31, 2003. Management reviews the sensitivity of NPV to changes in interest rates. As of March 31, 2004, a 200 basis point rise in interest rates would decrease the NPV ratio by 1.23% as compared to 1.25% at December 31, 2003 and a 100 basis point decline in interest rates would decrease the NPV ratio by 0.70% as compared to 0.79% at December 31, 2003.

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

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

At March 31, 2004, Sovereign was party to interest rate swaps to convert fixed rate assets and liabilities to variable rate assets and liabilities and vice versa. Sovereign utilizes interest rate swaps that have a high degree of correlation to the related financial instrument.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

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

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

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

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

Item 3. Quantitative and Qualitative Disclosures about Market Risk

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

Item 4. Controls and Procedures

An evaluation was performed under the supervision and the participation of the Company’s management, including the principal executive officer and principal financial officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15. Based on that evaluation, the Company’s principal executive officer and principal financial officer concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2004. There has been no change in the Company’s internal control over financial reporting that occurred during the quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

-45-

SOVEREIGN BANCORP, INC. AND SUBSIDIARIES

PART II – OTHER INFORMATION

Items 1 is not applicable.

Item 2 – Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity Securities.

The table below summarizes the Company’s repurchases of common equity securities during the quarter ended March 31, 2004:


		Average	Total Number of	Maximum Number of
	Total	Price	Shares Purchased as	Shares that may be
	Number of	Paid	Part of Publicly	Purchased Under to
	Shares	per	Announced Plans or	the Plans or
Period	Purchased	Share	Programs (1)	Programs (1)
1/2/04 through 1/31/04	None	None	Not Applicable	5,000,000
2/1/04 through 2/29/04	64,365	$22.18	Not Applicable	5,000,000
3/1/04 through 3/31/04	176,568	$21.51	Not Applicable	5,000,000

(1) Sovereign has a stock repurchase program in effect that would allow the Company to repurchase 5 million shares of common stock. No purchases have been made to date under this repurchase program as of March 31, 2004. Sovereign does occasionally repurchase its common securities on the open market to fund equity compensation plans for its employees. Additionally, Sovereign repurchases its shares from employees who surrender a portion of their shares received through the Company’s stock based compensation plans to cover their associated income tax liabilities.

Items 3 though 5 are not applicable or the responses are negative.

Item 6 – Exhibits and Reports on Form 8-K.

(a) Exhibits

(3.1) Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc.

(3.2) By-Laws of Sovereign Bancorp, Inc., as amended and restated as of August 14, 2002 (Incorporated by reference to Exhibits 3.2 to Sovereign’s quarterly report on Form 10-Q SEC file # 0011651), for the quarter March 31, 2002.

(31.1) Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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(b) Reports on Form 8-K

On January 21, 2004, the Company filed a current report on Form 8-K dated January 20, 2004, reporting information under Item 7 and 12.

On January 28, 2004, the Company filed a current report on Form 8-K dated January 26, 2004, reporting information under Item 5 and 7.

On February 17, 2004, the Company filed a current report on Form 8-K dated February 17, 2004, reporting information under Item 7 and 9.

On February 19, 2004, the Company filed a current report on Form 8-K dated February 19, 2004, reporting information under Item 7 and 9.

On March 11, 2004, the Company filed a current report on Form 8-K dated March 8, 2004, reporting information under Item 5 and 7.

On March 17, 2004, the Company filed a current report on Form 8-K dated February 26, 2004, reporting information under Item 7.

On March 25, 2004, the Company filed a current report on Form 8-K dated March 24, 2004, reporting information under Item 7 and 9.

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SOVEREIGN BANCORP, INC. AND SUBSIDIARIES


EXHIBITS INDEX
(3.1)		Articles of Incorporation, as amended and restated, of Sovereign Bancorp, Inc.

(3.2)		By-Laws of Sovereign Bancorp, Inc., as amended and restated as of August 14, 2002 (Incorporated by reference to Exhibits 3.2 to Sovereign’s quarterly report on Form 10-Q SEC file #0011651), for the quarter ended March 31, 2002.

(31.1)		Chief Executive Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

(31.2)		Chief Financial Officer certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.

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

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

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	Page
PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets at March 31, 2004 and December 31, 2003		5
Consolidated Statements of Operations for the three-month periods ended March 31, 2004 and 2003		6
Consolidated Statement of Stockholders’ Equity for the three-month period ended March 31, 2004		8
Consolidated Statements of Cash Flows for the three-month periods ended March 31, 2004 and 2003		9
Notes to Consolidated Financial Statements		10 – 22
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations		23 – 44
Item 3. Quantitative and Qualitative Disclosures About Market Risk		44
Item 4. Controls and Procedures		44
PART II. OTHER INFORMATION
Item 6. Exhibits and Reports on Form 8-K		45
SIGNATURES		47
EXHIBITS INDEX		48
RESTATED ARTICLES OF INCORPORATION
CERTIFICATION CEO, SECTION 302
CERTIFICATION CFO, SECTION 302
CERTIFICATION CEO, SECTION 906
CERTIFICATION CFO, SECTION 906


		SOVEREIGN BANCORP, INC. (Registrant)

Date May 10, 2004		/s/ Jay S. Sidhu

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

Date May 10, 2004		/s/ James D. Hogan

		James D. Hogan
		Chief Financial Officer

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

•		growth in earnings per share;

•		return on equity;

•		return on assets;

•		efficiency ratio;

•		Tier 1 leverage ratio;

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

•		fee income as a percentage of total revenue;

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

•		book value and tangible book value per share; and

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

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

•		inflation, interest rate, market and monetary fluctuations;

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

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

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

•		anticipated acquisitions may not close on the expected closing date or it may not close;

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

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

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

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

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

•		technological changes;

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

•		changes in consumer spending and savings habits;

•		terrorist attacks in the United States or upon United States interests abroad, or armed conflicts relating to these attacks;

•		armed conflicts involving the United States military;

•		regulatory or judicial proceedings;

•		changes in asset quality; and

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

(1)		Includes multifamily loans of $355.3 million and $348.6 million at March 31, 2004 and December 31, 2003, respectively.

(2)		Includes automotive floor plan loans of $719.9 million and $614.4 million at March 31, 2004 and December 31, 2003, respectively.

(3)		Loan totals include deferred loan origination costs, net of deferred loan fees and unamortized purchase premiums, net of discounts. These items resulted in a net increase in loans of $170.2 million and $159.8 million at March 31, 2004 and December 31, 2003, respectively.

•		Junior subordinated debentures issued by Sovereign with a distribution rate of 4.375% per annum on the $50.00 issue price, and each of which will have a principal amount at maturity of $50 and a stated maturity of March 1, 2034; and

•		Warrants to purchase shares of Sovereign common stock from Sovereign at any time prior to the close of business on March 1, 2034, by delivering junior subordinated debentures (or, in the case of warrant exercises before March 5, 2007, cash equal to the accreted principal amount of a junior subordinated debenture).

(1)		Corporate banking fees in the accompanying Statements of Operations include fees on commercial deposits. For management reporting purposes as outlined in the above table, these fees are included in the Consumer Bank results above.

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

(1)		Represents the difference between the yield on total assets and the cost of total liabilities and stockholders’ equity.

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

		market interest rates could materially affect the contractual amounts to be paid.

(2)		Excludes all carrying value adjustments, such as unamortized premiums or discounts and hedge basis adjustments.

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