Cautionary tale in Sovereign's sudden decline

The kind of panic that hit Sovereign Bank two weeks ago is precisely what government officials around the world are trying to make sure doesn't happen again.

It was the afternoon of Sept. 29, and the smell of bank failures was in the air. The stock market was plunging and shares of Sovereign, the state's third-biggest bank, were down 72 percent. Congress had just rejected the bailout bill. And in the preceding days, Washington Mutual was seized by the government, Lehman Brothers filed for bankruptcy, and Wachovia was sold. Would Sovereign be next?

As the stock sunk to $2.33, customers lost faith. Those with large accounts started moving deposits out of the bank, and some businesses withdrew money, too. At 3 p.m., the Commonwealth of Massachusetts delivered a bigger blow: State officials pulled out $300 million and moved it to Fidelity Investments.

"We weren't abandoning Sovereign. We just felt it was a smart move on the state's part to protect our assets," Treasurer Timothy P. Cahill said. But the state kept the move quiet, he said, because "we didn't want to spark a run on the bank."

The outflow of deposits from Sovereign that day offers a window into the fear gripping customers and banking systems in the United States and elsewhere. A bank can go under when customers rush to pull money out, because its cash is tied up in loans and investments.

To avoid a series of bank runs and instill confidence in the global financial system, the US Department of the Treasury, the Federal Reserve, and European governments announced this week that they are injecting hundreds of billions of dollars into financial institutions.

Yesterday, the US Treasury ordered nine of the nation's largest banks to accept multibillion-dollar government investments, and it has brokered takeovers of weak banks by stronger institutions. On Monday, Sovereign disclosed that customers withdrew $4.2 billion, or nearly 9 percent of the bank's deposits in the quarter ended Sept. 30. Sovereign also agreed to be acquired by its largest investor, Spain's Banco Santander, for $1.9 billion in stock.

But on Sept. 29, investors and depositors were running for the doors.

Money manager Jim Kaplan of Cubic Asset Management in Boston was among those closely watching Sovereign's stock that day. He had more than $1 million in accounts there and was concerned because the Federal Deposit Insurance Corp. covered accounts only up to $100,000. If the bank failed, he feared, he could lose the rest of his money.

"The stock was suggesting there was a major problem, and I thought it was prudent to act," Kaplan said. He went to a Sovereign branch in Boston's Park Square and began wiring funds out of his personal and business accounts to other institutions. But it wasn't simple.

Employees at the branch were limited in their authority to immediately move money out of his account. Since Kaplan wanted to withdraw the funds right away, he had to process a series of wire transfers - each with a limit of $250,000. He said the process took about an hour and a half.

And Kaplan wasn't alone in moving money from the branch, he said. While there, he saw a customer closing out an account and withdrawing $68,000 in cash, he said.

Steven Mantelli, Sovereign's director of branch administration, said a number of customers - he declined to say how many - had withdrawn funds, apparently to spread them to other institutions, to keep their balances below $100,000. The government has since raised the deposit insurance cap to $250,000.

While the withdrawal of deposits was happening person by person and account by account, Sovereign's stock was a very public reflection of the market's concern about the Philadelphia-based bank. Two European investors were dumping the stock that day, analysts said, having already suffered losses on Washington Mutual and Wachovia shares.

When Massachusetts treasury officials called Sovereign to ask why the stock had fallen below $3, they couldn't get a good answer, said Cahill, the Massachusetts treasurer. Bank officials were attributing the drop to the market's overall plunge; the Dow Jones industrial average fell 777 points, its worst one-day point loss, after the first version of the bailout bill failed to pass.

The state Treasury had a total of $575 million at Sovereign. Of that, $275 million was for state operations, money that was collateralized, or insured against any losses. But the other $300 million, which covered a number of programs, was uninsured.

The treasury staff first started worrying about the stock price at about 2 p.m. By 2:55 p.m., it had advised Cahill that the state should move the funds. "I said, 'Do it,' " Cahill recalled.

And within 20 minutes, the funds were wired out - not to another bank, but to Fidelity, the Boston investment giant that manages $7.5 billion in state and municipal funds in a money market account.

"We felt that was the safest place to put it," Cahill said. "We didn't know what was going on with the banking world that day."

Later that same day, Cahill got a phone message from Sovereign's chief executive, Joseph Campanelli. He no longer had a job. The next day the bank announced that Paul Perrault had replaced him.

Bernard R. Horn Jr., president of Polaris Capital Management Inc., a Boston investment firm that owns Sovereign stock, said the bank was a victim of hysteria and panic.

"It's just a matter of which day the whims of hysteria focus on one bank or another," said Horn, who opposes Banco Santander's purchase. He and other stockholders say that even though Sovereign is in a vulnerable position, it's worth more than the $1.9 billion the Spanish bank is paying.

But to depositors, news of the deal was reassuring - the latest in a stunning series of corporate takeovers and government interventions that have shored up banks that seemed unshakeable just a year ago.

Yesterday, the state moved $100 million back to Sovereign, Cahill said. Kaplan also said he returned to Sovereign, and redeposited several hundred thousand dollars, but not all of his money.

Beth Healy can be reached at bhealy@globe.com; Steven Syre can be reached at syre@globe.com. Ross Kerber of the Globe staff contributed to this report.