By David Mildenberg and Josh Fineman
Citigroup demanded Wells Fargo abandon the takeover, claiming it breaches an exclusive deal reached earlier this week in which the New York-based lender agreed to buy Wachovia's banking operations for $2.16 billion with government help.
Well Fargo's surprise offer for Wachovia, run by former U.S. Treasury official Robert Steel, may lead to a face-off with federal regulators and a bidding war with Citigroup Chief Executive Officer Vikram Pandit. The bank may take legal action to block the deal, and a person with knowledge of the deliberations who also said Citigroup may increase its offer.
``If Citigroup is serious, they should boost their bid and become a more competitive buyer, rather than whining,'' said Sean Egan, managing director of Egan-Jones Ratings Co. in Haverford, Pennsylvania. ``It should be easy for Wells Fargo to compensate Citigroup if they decide that's the right course.''
Buying Wachovia would give Citigroup the third-biggest U.S. bank network and cement its status as the nation's largest lender by assets. A final decision on whether to raise the bid hasn't been made, according to the person, who declined to be identified because the deliberations are private.
Wells Fargo's stock swap values Charlotte-based Wachovia at $7 a share and includes the whole company, without any aid from the U.S., the banks said in a statement. Citigroup's bid worked out to about $1 share, left out the securities brokerage and Evergreen mutual-fund units and was tied to help from the Federal Deposit Insurance Corp.
``We think this deal is solid,'' Richard Kovacevich, chairman of Wells Fargo, told investors on a conference call.
Wachovia rose 54 percent to $6.02 in 2:46 p.m. New York Stock Exchange composite trading. Wells Fargo advanced 2.5 percent to $36.05 and Citigroup dropped 18 percent to $18.46.
Citigroup provided a copy of an exclusivity agreement dated Sept. 29 that says Wachovia won't seek or help new bidders. The document is signed by a Wachovia officer, though the name and title weren't included.
``I'm still not convinced that Citigroup can force this sale to happen,'' said Elizabeth Nowicki, a professor at Tulane University Law School in New Orleans and a former M&A lawyer at Sullivan & Cromwell LLP. ``Citigroup may be facing the chance to get themselves a small settlement, and that's a nice shot in the arm for a company that's struggling.''
The Federal Deposit Insurance Corp., which helped broker Citigroup's purchase when Wachovia's health faltered, ``stands behind its previously announced agreement,'' FDIC Chairman Sheila Bair said in a statement today. ``The FDIC will be reviewing all proposals and working with the primary regulators of all three institutions.''
Other bank regulators said they haven't evaluated Wells Fargo's offer.
``We have not yet reviewed the new Wells Fargo proposal and the issues that it raises,'' the Federal Reserve and Office of the Comptroller of the Currency said today in a statement. ``The regulators will be working with the parties to achieve an outcome that protects all Wachovia creditors, including depositors, insured and uninsured, and promotes market stability.''
Wells Fargo, whose biggest shareholder is billionaire Warren Buffett's Berkshire Hathaway Inc., may have been helped in its bid by the issuance of an IRS notice Tuesday that makes Wachovia's loan losses more valuable as tax deductions.
``The pronouncement, in effect, allows Wells Fargo to deduct, without limitation, the loan losses and bad debt deductions that Wachovia sustains following the acquisition,'' said Robert Willens, a certified public accountant who analyzes how accounting and tax rules affect Wall Street. That's a change from more stringent limits, he said.
``It's possible that the cost of the deal to Wells will be entirely offset with tax savings resulting from the relaxation of this rule.''
Buffett said in an interview with CNBC that tax law changes had made the deal more attractive. ``Wachovia shareholders will get a lot more money,'' Buffett said.
The bank had no comment on whether the change affected its view toward Wachovia, spokeswoman Julia Tunis Bernard said.
The Wells Fargo bid ``provides superior value compared to the previous offer to acquire only the banking operations of the company,'' Kovacevich, 64, said in a joint statement from the banks. ``Wachovia shareholders will have a meaningful opportunity to participate in the growth and success of a combined Wachovia- Wells Fargo.''
Steel, 57, Wachovia's CEO, endorsed the Wells Fargo bid during a conference call with investors this morning. In the joint statement, he said the transaction will ``keep Wachovia intact and preserve the value of an integrated company.''
The stock swap gives Wachovia shareholders 0.1991 shares of Wells Fargo common stock for each share they own, allowing them to salvage some value after Wachovia's 90 percent decline this year. The stock traded below $2 on Sept. 29. Citigroup's offer would have left the remnants of Wachovia including the securities brokerage to trade as an independent company.
If the original bid fails, ``Citigroup loses an attractive, accretive deal,'' Fox-Pitt Kelton Cochran Caronia Waller analyst David Trone wrote in a note today, adding that the Citi deal is probably dead. ``Citi will be on the sidelines waiting for the call from the Fed for assistance on bailouts, but not aggressively bidding on troubled franchises,'' he said.
The bank may cancel its $10 billion share offering, Trone said. ``One silver lining is that Citi can refocus on its own operational problems.''
Wells Fargo expects merger costs of $10 billion as it cuts about 25 percent of Wachovia's expenses. It also anticipates $74 billion in losses and writedowns from Wachovia's $498 billion loan portfolio, mostly from real estate loans. The company plans to issue as much as $20 billion of new securities, mostly common stock. Wachovia agreed to give Wells Fargo preferred stock that will represent 39.9 percent of Wachovia's voting power.
Wells Fargo said it will acquire all of Wachovia's businesses, preferred equity and banking deposits. Chief Financial Officer Howard Atkins said in the statement that the acquisition will add to earnings per share by the third year after completion and should produce an internal rate of return of at least 15 percent.
``This is a franchise that Wells Fargo wanted and this is one they didn't want to get away,'' said Mark Morgan, senior analyst at Thrivent Financial for Lutherans in Minneapolis. Thrivent held 1.8 million Wells shares as of June 30, according to Bloomberg data. ``This provides an opportunity for Wells Fargo to expand in the eastern U.S., particularly in the Southeast, in markets they've wanted to be in.''
Buying Wachovia detours from the strategy outlined by Wells Fargo Chief Executive Officer John Stumpf, who has said he prefers smaller acquisitions with less risk that would fill gaps in the existing branch network. After the combination, the bank would have $1.42 trillion in assets, which may rank third in the U.S. depending on what other bank mergers are completed. All told, the bank would have $787 billion in deposits and 10,761 branches in 39 states.
``Citi's purchase was too cheap for the assets and operations involved,'' said Jason Pride, research director at Haverford Trust Co. in Haverford, Pennsylvania. ``It's an excellent strategic deal for Wells Fargo given the geography of the branch network.''
The deal also gives Wells Fargo responsibility for about $122 billion of option ARMs sold by Wachovia, the No. 1 provider of such loans. The home mortgages are prone to default because they allow borrowers to defer part of their interest payments and add it to the principal of the loan. Those terms backfired when housing markets weakened, leaving borrowers with loans larger than the price of their homes.
Wachovia issued more than half its option ARMs in California, according to the bank's second-quarter earnings presentation to investors. Wells Fargo is already the biggest bank based in that state. The stock gained 16 percent this year through yesterday.
``The credit issues are the risk in this,'' Morgan said. ``It gives them a lot of concentration in California and mortgage business in general. But they are paying a pretty low price, so it's not out of line with their acquisition philosophy.''
Wells Fargo was advised on the transaction by Wachtell, Lipton, Rosen & Katz and JPMorgan Chase & Co., the statement said. Wachovia relied on Sullivan & Cromwell LLP, Goldman Sachs Group Inc. and Perella Weinberg Partners, the statement said.
``The deal doesn't sit too well with me,'' said Jocelynn Drake, an equity analyst at Schaeffer's Investment Research in Cincinnati. ``Wells was doing very well, and merging with Wachovia, which has such a bad rap among Wall Street investors, looks questionable to me.''
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