October 4, 2008
Will Wells Fargo Buy Wachovia?
By Associated Press
NEW YORK (AP) -- A battle broke out Friday for control of Wachovia as Wells Fargo agreed to pay $14.8 billion for the struggling bank, while Citigroup and federal regulators insisted that Citi's earlier and lower-priced takeover offer go forward.
The surprise announcement that Wachovia Corp. agreed to be acquired by San Francisco-based Wells Fargo & Co. in the all-stock deal -- without government assistance -- upended what had appeared to be a carefully examined arrangement and caught regulators off guard.
Wells' original offer totaled about $15.1 billion, but since the value of its shares closed down 60 cents Friday, the deal is now valued at about $14.8 billion.
Only four days earlier, Citigroup Inc. agreed to pay $2.1 billion for Wachovia's banking operations in a deal that would have help of the Federal Deposit Insurance Corp.
The head of the FDIC said the agency is standing behind the Citigroup agreement but that it is reviewing all proposals and will work with the banks' regulators "to pursue a resolution that serves the public interest."
Citigroup, which demanded that Wachovia call off its deal with Wells Fargo, said its agreement with Wachovia provides that the bank will not enter into any transaction with any party other than Citi or negotiate with anyone else.
Barring legal action, the future of Wachovia will be determined by the bank's shareholders and regulators, which both have to approve a final deal.
It was clear which they preferred Friday, as Wachovia shares climbed as high as 80 percent.
The FDIC is talking out of both sides of its mouth, said Roger Cominsky, partner in law firm Hiscock & Barclay's financial institutions and lending practice. The agency says it stands behind the deal with Citigroup because it hasn't been nixed yet, he said. "But at the same time, they are saying they are reviewing all proposals."
By law, he said the FDIC is required to find the least-costly resolution for taxpayers. The Wells Fargo deal would not rely on any assistance from the government.
The Federal Reserve, which has regulatory oversight of the three big banks, said it hasn't had time to review the proposed sale of Wachovia to Wells Fargo but will work to ensure that all creditors and depositors of Wachovia are protected.
The Fed said regulators will be working with Wachovia and Wells Fargo "to achieve an outcome that protects all Wachovia creditors, including depositors, insured and uninsured, and promotes market stability."
Under Wells Fargo's deal, Wachovia shareholders would receive 0.1991 shares of Wells Fargo for every share of Wachovia stock they own, valuing Wachovia at about $7 per share. This is a nearly 80 percent premium over the stock's Thursday closing price of $3.91. Shares closed at $10 on Sept. 26, the last trading session before the deal with Citigroup was announced.
"This deal enables us to keep Wachovia intact and preserve the value of an integrated company, without government support," Robert Steel, Wachovia's president and chief executive, said in a statement.
In its planned takeover of Wachovia, Citigroup said it would assume $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio. The FDIC agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants.
"Wells' deeper and more considered due diligence has probably revealed fewer risky assets and a larger number of higher valued assets than originally thought," said Anant Sundaram, professor of finance at the Tuck School of Business at Dartmouth College in an e- mail to The Associated Press. "Although it is still too early to tell, this could presage a significant shift in market sentiment toward the value of companies such as Wachovia, and may suggest that there has been an overreaction in the downdraft that we saw in the past few weeks. It is a huge shot in the arm for market confidence. It is also a signal that market forces are capable of resolving some aspects of the crisis without undue congressional, and hence, taxpayer, intervention."
The fight for Wachovia comes at a turbulent time for banks and financial firms as they grapple with the ongoing credit crisis, which led to the recent bankruptcy of Lehman Brothers Holdings Inc. and the failure of Washington Mutual Inc.
It also comes at a time of unprecedented government intervention in the financial markets.
Wells Fargo may have decided to make a move as the passage of the government's financial bailout plan seemed imminent, said Donn Vickrey, co-founder and chief analyst at Gradient Analytics.
"At the time they made the decision, it looked a lot more likely that it would pass," he said. "You have the possibility of offloading these loans at a price that is higher than current values."
The failure of the government's proposed $700 billion bailout for financial institutions Monday cast doubt on whether Citigroup would be able to rid itself of some of Wachovia's bad debt.
The proposal would have allowed Citigroup to sell Wachovia's distressed mortgage-related assets to the government for a profit.
Congress approved a sweetened version of the bailout plan Friday and President Bush quickly signed it.
The core of the plan remains little changed from its inception -- the Treasury Department would have $700 billion at its disposal to purchase bad mortage-related securities that are weighing down the balance sheets of institutions that hold them.
But in analyzing the deal, Wells Fargo assumed it would not sell any of the loans to the government.
"We couldn't assume that they would necessarily give us prices equal to what we think the values are," said Chairman Dick Kovacevich in an interview with The Associated Press.
Wells Fargo said it expects to take a $74 billion hit on Wachovia's $498 billion loan portfolio. That values the portfolio at 85 cents on the dollar. But the most troubled real estate loans, known as pick-a-pay -- where borrowers got low introductory rates and were allowed to defer some interest payments until later years - - are worth only an estimated 74 cents on the dollar, according to a fact sheet released by Wells Fargo.
The bank said it expects to incur the majority of credit costs in the next two years, and for the transaction to add meaningfully to earnings after that.
One factor that did play in to the deal was the clarification of a tax rule issued this week by the Internal Revenue Service.
On Tuesday, the IRS issued guidance on a rule allowing companies to offset losses from companies they acquire with tax breaks applied to their profits after the takeover.
"It was an element that gave us clarity on an area of uncertainty," Kovacevich said.
The potentially bigger tax offsets could boost the income of banks that buy other banks with losses from mortgage assets.
"We suspect that the new IRS guidance allowed Wells Fargo to place a higher bid for Wachovia today than it might have been willing to a few days ago," said Jeff Harte, an analyst at Sandler O'Neill & Partners, in a note issued Friday.
Essentially, Wells Fargo could use the $74 billion of tax losses on Wachovia's loan writedowns to offset its own income, which means the bank's taxes could be much lower for several years, said Deutsche Bank analyst Mike Mayo.
In connection with the agreement, Wachovia is issuing Wells Fargo preferred stock representing 39.9 percent of Wachovia's voting power. This increases the probability that the transaction gets consummated quickly and that Wells Fargo will receive a positive shareholder vote, Wells Fargo said.
Wells Fargo plans to issue up to $20 billion of stock, primarily common stock, to maintain a strong capital position.
Charlotte will be the headquarters for the combined company's East Coast retail and commercial and corporate banking business. St. Louis will remain the headquarters of Wachovia Securities.
The combined company will have total deposits of $713 billion and more than 6,500 locations -- more than any other bank in the U.S.
While there is some overlap in states like California and Texas, the deal essentially opens up the entire East Coast to Wells Fargo, giving it a footprint in new markets such as New York and Miami.
In terms of total assets, a combined Wells Fargo-Wachovia would have $1.37 trillion in estimated pro forma assets as of the end of this year. As of June 30, Bank of America Corp. had $2.72 trillion in assets including those of Merrill Lynch & Co., which it is acquiring. Citigroup had $2.10 trillion and J.P. Morgan Chase & Co. had about $1.78 trillion, including WaMu's assets.
"This is the transaction that we thought should have been done and makes sense," Mayo said. "The biggest loser, in our view, is Citi, and we suspect that there is no breakup fee since their agreement with Wachovia was not finalized."
Citigroup has not turned a profit for three straight quarters, and lost a total of $17.4 billion in that period after writing down its assets by about $46 billion. That's the most write-downs of any U.S. bank.
While Wells Fargo has logged three straight quarters of profit declines, the bank has been weathering one of the nation's worst credit crises much better than most of its competitors, in part because it had less exposure to the subprime mortgages whose failure undermined the financial sector.
Wachovia shares rose $2.30, or 58.8 percent, to close Friday at $6.21. Wells shares slipped 60 cents to $34.56, and Citigroup shares dropped $4.15, or 18.4 percent, to $18.35.
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