Citigroup Acquires Wachovia Banking Units

Yet another bank has sought shelter from the fallout of mortgage-related losses as Wachovia Corp. agreed yesterday to sell its banking operations to Citigroup Inc. in a deal facilitated by the Federal Deposit Insurance Corp.

Citigroup will pay $2.16 billion in stock - about $1 per share - and assume Wachovia's senior and subordinated debt, worth approximately $53 billion. In addition, Citigroup will assume responsibility for the first $42 billion of losses on a $312 billion pool of loans identified as risky assets, with the FDIC picking up the rest in return for $12 billion in preferred stock and warrants.

The deal includes Wachovia's retail bank, private bank, and corporate and investment bank, but not retail brokerage Wachovia Securities LLC or Evergreen Asset Management, which Wachovia Corp. will continue to hold. The public finance unit was included in the sale, a Wachovia spokeswoman said.

"This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury," FDIC chairwoman Sheila Bair said in a statement. "This action was necessary to maintain confidence in the banking industry given current financial market conditions."

The deal firmly establishes Citigroup's presence in the U.S. retail banking sector. The combined bank will hold $600 billion of deposits in the U.S., or 9.8% of the entire market. Many believe deposits form a more stable capital base that would allow banks to better weather financial crises.

Citi said it will raise $10 billion in common equity and cut its dividend as a result of the transaction.

"The capital in the business is strong today and I think the importance of this is it will actually make our balance sheet stronger," Citigroup chief financial officer Gary Crittenden said in a conference call with investors. "We have a deposit base that is truly unassailable after this transaction, the strongest in the country."

It is unclear how the deal will affect staffing in the group's public finance units. Citi already stands as the top municipal underwriter, acting as the senior manager on 423 deals this year, with a par value of $49.2 billion, according to Thomson Reuters data. Wachovia ranks 10th as a senior manager in 2008, working on 298 issues with a par value of $9.2 billion.

Even though Citi already has a top public finance investment banking team, any wide-scale layoffs of Wachovia bankers could be a mistake given the strong bond between the commercial and investment banking sides in the public finance unit at Wachovia, said Robert Fuller, principal at Capital Markets Management LLC.

"Wachovia has a very good public finance unit with a lot better hooks through the commercial banking system into the public finance community in their footprint," he said. "I think it could work well, although there will be some blood on the floor."

Wachovia has also served as a top provider of letters of credit. Wachovia ranks fourth, providing a letter of credit on 80 deals with a par value of $3.9 billion this year, according to Thomson Reuters data. Citibank ranks 50th, working on $41.2 million in deals with four issues.

Citigroup acquired the unit of Wachovia that provided LOCs as part of the transaction, a Wachovia spokeswoman said. Issuers with liquidity facilities provided by Wachovia said they will wait to see the outcome of the transaction and its effects, but believe they could benefit from the deal.

"Hopefully, they'll trade better since they have an identified buyer," William Robinson, senior vice president and chief financial officer of Shands HealthCare, said about a 1996 issue Wachovia provided a standby bond purchase agreement on.

However, the transaction could make the environment even more difficult for issuers looking to enter the market with the new offerings. With banks like Bear Stearns out of the market and UBS Securities LLC out of the negotiated municipal market, and Bank of America Corp. set to acquire Merrill Lynch & Co., dealer capacity continues to shrink.

"Wachovia's sale to Citigroup further contracts the muni dealer universe and tightens an already overtaxed underwriting bandwidth," Matt Fabian, a managing director at Municipal Market Advisors, wrote in a weekly report. "Issuers prospects are correspondingly made more difficult; again, higher yields and fees, more onerous lending terms, more difficult market timing are likely to result."

In addition, Mitsubishi UFJ Financial Group agreed yesterday to invest $9 billion in equity in Morgan Stanley for a 21% interest in the company on a fully diluted basis. Last week, Morgan Stanley and Goldman Sachs Group Inc. announced they would become bank holding companies, ending the era of large, independent investment banks on Wall Street.

Also, the governments of Belgium, Luxembourg and the Netherlands stepped into to save Fortis NV yesterday, agreeing to inject more than $16 billion in capital into the Dutch-Belgian bank. Fortis provides letters of credit and standby purchases agreements in the municipal market.

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