John Costas, who helped make UBS AG into one of the world's biggest investment banks, wants to build a lasting Wall Street player -- and put the 2007 demise of hedge fund Dillon Read Capital Management behind him.

Costas and long-time partner Michael Hutchins have launched The PrinceRidge Group, a boutique broker-dealer that is, for now, focused on trading mortgage and corporate debt.

Over time, though, he intends to expand into a mid-size investment bank, seizing unprecedented opportunities created by the shake-up on Wall Street.

We're trying to create an investment bank that will, over the long term, become a major player, Costas, 52, said in an interview.

The combined balance sheets of the top 20 firms today is $15 trillion (9 trillion pounds) less than the Top 20 of two years ago, a void smaller trading firms have been eagerly filling, he said.

Even with the industry healthier, 40 or 50 percent of the market is still up for grabs, he said. It's a great time to establish a business.

As many as 100 firms have opened their doors or launched expansion plans in the past year.

PrinceRidge has hired more than 40 people in just the past few weeks and expects to have about 60 before long.

Yet as markets stabilize, the crop of small broker-dealers will go through wave of consolidation, Costas said.

Because of the dislocation, these firms have had the best results they ever had, but competition will drive tremendous consolidation among these 100 players, he said. It's our view there will be five to 10 survivors that come out of this competition and spawn new mid-size investment banks.

PrinceRidge intends to be one of those survivors.

The partnership, founded with working capital of $25 million, has already been approached by several investors interested in buying a stake, Costas said.

DRASTIC CAREER MOVE

There are private equity investors who see the opportunity we have described, or, in one case, a potential strategic investor who see us as a complementary addition to their existing portfolio, said Costas, the new firm's chairman.

Joining them as founding partners are four other former UBS and Dillon Read executives: Ahmed Alali, head of investment banking and advisory services; Colette Dow, chief operating officer; Ronald Garner head of structured products sales and trading; and Matthew Johnson, head of corporate credit trading.

PrinceRidge will trade commercial and residential mortgage securities, corporate bonds, as well as provide financial and restructuring advice to companies.

The new firm will likely expand into government and emerging markets bonds, said Hutchins, its CEO.

Costas, who began his career in 1981 as a First Boston bond trader, rose through the ranks to head fixed income trading before jumping to Union Bank of Switzerland in 1996.

There, he led one of the most remarkable expansions on Wall Street, personally hiring about 1,500 staff, boosting UBS Investment Bank's profit tenfold over eight years and transforming the bank into a Top 5 player globally by 2005.

Then he made a drastic career move, engineering the transfer of UBS proprietary fixed-income trading business into an independent unit housed within the bank, Dillon Read Capital Management, which he took over as CEO.

At the time, investment banks were anxious to retain traders being lured away by hedge fund riches and also wanted to tap into the souring demand for alternative investments.

Dillon Read was launched with 250 staff trading $3 billion of UBS capital and in 2006 a hedge fund with $1.1 billion was raised from outside investors.

Then Dillon Read posted first-quarter 2007 loss of $150 million as the subprime mortgage market deteriorated and on May 3, UBS shocked markets when it pulled the plug on the unit, whose assets and employees returned to UBS.

DISASTROUS YEARS

What followed were two disastrous years at UBS, which since then has suffered $54 billion of credit losses. UBS said Dillon Read's trades produced $3 billion, or 16 percent, of the $19 billion of subprime losses UBS reported in 2007.

The episode triggered the ouster of UBS Group CEO Peter Wuffli, who with former Chairman Marcel Ospel had approved the Dillon Read plan, and fuelled resentment of Costas at the bank.

Costas, speaking publicly on the episode for the first time, said UBS offered him the choice of spinning off Dillon Read, although that meant losing the bank's financial support.

It was a mutual decision. There were options. We chose the best one for our clients, he said. We made money as a proprietary trading business and we made our investors money.

Costas and Hutchins left UBS soon after.

The proprietary trading business that became Dillon Read had made money in every quarter since 1999, he said.

Carved out from UBS in July 2005, Dillon Read generated $1.2 billion of profit that year and another $1.2 billion in 2006 before incurring the first-quarter 2007 losses.

The hedge fund was also successful, he said, generating a net return of 16 percent in six months.

Costas said Dillon Read could have raised $1.6 billion from investors, but capped the fund at $1.1 billion to avoid overloading its ability to generate good results.

Dillon Read does not deserve blame for UBS's credit woes, he said.

UBS has acknowledged it expanded fixed-income trading after forming Dillon Read and, in some cases, pursued the same trades. UBS also amassed exposure to mortgages and other debt just as the credit bubble reached its bursting point.

Costas still believes it was right to launch Dillon Read. The independent hedge fund business was formed two years before Fortress Investment Group LLC and Blackstone Group LP went public and tapped demand for alternative investments.

There was a chance to create a business that could have realized a market value of $10 billion to $15 billion, he said. Investment banks don't often find ideas to create that kind of value.

His big regret, he said, is that he and UBS did not communicate its Dillon Read strategy more widely within the bank.

It was introduced very quickly and was viewed as competition with the investment bank, he said. So it's fair to say there was some tension.

(Reporting by Joseph A. Giannone; editing by Ted Kerr, Andre Grenon and Maureen Bavdek)

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