Debt May Leave Sovereign Too Weak to Challenge Fleet

Article excerpt

When Fleet Financial Group Inc. chief executive Terrence Murray was asked at a press conference in March which bank he would like to see buy 300 branches his banking company was forced to sell, he paused.

"Medford Savings Bank," he chuckled.

The joke was clear: Mr. Murray was suggesting that he wanted a bank that would not pose a competitive threat to FleetBoston Corp., the $185 billion-asset banking powerhouse in New England formed this year by Mr. Murray's Fleet and BankBoston Corp.

In the end, the winning bidder was Sovereign Bancorp., a Wyomissing, Pa., thrift company with $24 billion of assets. By using a highly leveraged debt plan, Sovereign agreed to buy 278 branches for $1.4 billion.

On the surface, Sovereign wasn't exactly Medford Savings Bank. But as details of Sovereign's financing have emerged, banking observers say it may turn out to be just as good a butt for Mr. Murray's joke.

"Fleet did a masterful job of finding the most minimally competitive but acceptable divestiture candidate," said John S Carusone, president of Bank Analysis Center, a Hartford, Conn.-based consulting firm. "They threaded the eye of the needle. I don't see the Department of Justice letting Bill Gates buy his competition. It was a masterful coup."

The doubts that Sovereign can challenge FleetBoston in the region stem from the fact that Sovereign's branches-to-be would not offer nearly the range of products that FleetBoston does, especially for middle-market companies.

And analysts say the thrift company would not be offering them soon, because of the unusually large and leveraged debt Sovereign is taking on to buy the branches. To pay off the debt, the thrift company must meet what analysts say is an unusually rosy growth projection that allows little room for error.

For instance, Sovereign told analysts on Sept. 2, the day the deal was announced, that tangible capital generation would grow by at least $500 million annually through 2003 to $1.91 billion -- an expectation that capital would grow 134% by 2001 alone. Sovereign also promised the buyout would be 1% accretive to earnings in the first year -- a target described as "next to impossible" by analysts. On Wednesday, the thrift company said the numbers were being revised and not currently available.

In addition, Sovereign shocked debt analysts last week by paying unusually high market prices to investors in its $1.5 billion debt. The company's $700 million issue of senior notes pay more than 10% annually. Sovereign's trust-preferred coupons pay 7.5%.

Finally, on the basis of current interest rates it would pay about 9.5% on its $500 million bank loan, or about $49 million a year. And that cost won't decline much in 2001. Sovereign need repay only 5% ($25 million) of the principal in 2000, and only $75 million in the loan's second year.

Part of the reason the loan will pay close to the rate of Sovereign's bonds is that, although collateralized, the loan is secured by Sovereign stock. Such loans have been under fire by the comptroller of the currency because if a loan defaults, a company's stock usually has become devalued to the point of being worthless.

Mark R. McCollom, Sovereign's chief accounting officer, said the company is comfortable with the loan and would be happy to make one like it to a client with a similar profile.

Still, Mr. McCollom and Jacquelyn K. Blue, the thrift's treasurer, concede that the cost of financing came in over original estimates. …