Sovereign Of Pa., Challenging Fleet, Establishes Capital Markets Group

Sovereign Bancorp, on a mission to prove itself a legitimate competitor to New England's biggest banks, plans to unveil as early as this week a capital markets group to provide asset securitization, derivatives, and trading services for middle-market companies.

In stepping into the capital markets, Sovereign is making an extremely unusual move for a thrift, but one consistent with its own recent thrust. The $25 billion-asset company has been trying to shed its thrift image - and boost the percentage of revenues it gets from fees - by opening a trust company, a brokerage, and an insurance agency. It is also developing an Internet-only bank.

Sovereign has already hired top executives for the capital markets unit, a development to which it made passing reference in its latest quarterly earnings statement. The Wyomissing, Pa., company hired James J. Calla, a former managing director at CoreStates Capital Markets Group, to set up the unit, which is housed on a new trading floor in Philadelphia. Mr. Calla has also hired at least two other employees - one from CoreStates and the other from Morgan Stanley Dean Witter & Co. - and plans to hire up to 15 bankers for the group.

The unit will initially focus on three product areas: asset securitization for customers and for the bank's own balance sheet, derivatives and hedging capabilities for commercial and retail customers, and foreign exchange. Expanded advisory services and fixed-income trading may be added later, according to Jay S. Sidhu, president and chief executive officer of Wyomissing, Pa.-based Sovereign.

Mr. Sidhu said there are no plans to start underwriting securities.

Sovereign is jumping into capital markets at the same time it prepares to enter the New England market, which is dominated by $190 billion-asset FleetBoston Financial Corp. This spring it is expected to complete the acquisition of 279 branches in Massachusetts and surrounding states, $12 billion in deposits, and $8 billion in loans; Fleet Financial Group and BankBoston Corp. agreed to divest the assets as part of their merger last year.

Mr. Sidhu said his company needs to build capabilities to attract midsize corporate customers. "We would have done this even if we were not moving into New England," he said in an interview. "Most medium-size companies are looking for these services, but they fall under the radar screens of the big Wall Street firms," Mr. Sidhu said. "We can obviously offer options."

Sovereign, like other thrifts, enjoys a slight advantage to commercial banks, which have tougher capital adequacy requirements. Still, off-balance-sheet activities such as capital markets have drawn scrutiny from regulators.

Analysts and investors are skeptical that Sovereign can pull off the New England acquisition and effectively compete against FleetBoston, even with the capital markets operations. To pay for the $1.4 billion New England deal and have enough money left to boost its capital levels, Sovereign had to raise $1.8 billion in a combination of equity and debt issues.

Capitalization and expense issues have been concerns among investors. "They have a lot to prove," said John M. Kline, an analyst at Sandler O'Neill & Partners. "They have to try to differentiate themselves, but they don't have the resources of Fleet to do it."

Securitization may help alleviate some of the concerns, analysts said. The business would give Sovereign more flexibility to manage its own balance sheet and capital levels. Derivatives trading could prove to be more challenging, because Sovereign's lower credit rating makes it less attractive as a counterparty, analysts said.

The formation of the capital markets group inflated Sovereign's fourth-quarter expenses, though the company did not disclose the start-up costs. Sovereign told analysts last week that the group would break even on earnings this year and is expected to add to profits in 2001.

Mr. Calla hired Charles Clark from Morgan Stanley to oversee the securitization business. Brad Geist was hired from CoreStates to set up Sovereign's derivatives and hedging operations.

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