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Citigroup Faces Writedown on Morgan Stanley Deal (Update 1)

Updated to include analyst comments and Citigroup SEC filing

NEW YORK ( TheStreet) -- Citigroup (C - Get Report) faces a big writedown after investment bank Perella Weinberg appraised the value of its brokerage joint venture with rival Morgan Stanley (MS - Get Report) at $13.5 billion, $8.5 billion less than Citigroup's valuation.

On Tuesday, on the heels of Perella Weinberg's independent valuation, Morgan Stanley reached an agreement to up its 51% stake in the brokerage joint venture -- called Morgan Stanley Smith Barney (MSSB) -- by 14%. The investment bank also said that agreements on future stake acquisitions put it on track to take full control of the business by June 2015.

As of its most recent quarter, Citigroup valued the joint venture at $22 billion, signaling third quarter writedowns for the bank as it sells off its stake in MSSB to Morgan Stanley. In contrast, Morgan Stanley, which valued the brokerage at roughly $9.5 billion on its balance sheet, may have to write up its stake as it boosts ownership.

Perella Weinberg was hired as an appraiser of MSSB because Citigroup and Morgan Stanley were more than 10% apart on their respective valuations. Since Tuesday's appraisal signals a large valuation gap between the two banks, Morgan Stanley's remaining stake purchases will also be pegged to the $13.5 billion independent assessment.

"This mutually beneficial agreement gives both parties certainty and transparency on price and timing, and is a significant milestone for Morgan Stanley in the implementation of our strategy,' James Gorman, chief executive of Morgan Stanley, said in a statement.

"I am pleased we have reached agreement on a value for our remaining stake in Morgan Stanley Smith Barney," added Vikram Pandit, chief executive of Citigroup, in the statement. "Establishing certainty regarding the divestiture of this business is in the best interests of our shareholders," added Pandit, citing the bank's reduction of 'non-core assets' like its Smith Barney brokerage unit.

Inclusive of the Morgan Stanley Smith Barney joint venture reached in 2009, CitiHoldings has shed over $600 billion in unwanted assets, in what Pandit called, "an economically rational manner."

As part of Tuesday's deal, Morgan Stanley said it will acquire $5.5 billion of deposits at no premium, at an implied 100% valuation of the $13.5 billion joint venture value.

That signals Morgan Stanley will pay Citigroup - the nation's third largest bank -- $1.89 billion for its newly acquired 14% stake. Morgan Stanley said it has agreed to acquire the next 15% of MSSB from Citigroup by 2013, putting it on schedule to reach full ownership by 2015.

Still, for Citigroup, the exit will create a multi-billion dollar third quarter writedown that may dilute the positives it could get from exiting MSSB.

As a result of Tuesday's assesment, Citigroup said in a filing with the Securities and Exchange Comission it will take a $2.9 billion after-tax loss related to MSSB in third quarter earnings. On a pre-tax basis, the loss is $4.7 billion, and will slightly cut at Basel I capital ratios, the bank said.

Wells Fargo analyst Matthew Burnell, calculated in a Tuesday note to clients that the loss will reduce Citi's tangible book value by 2%. He estimates the MSSB exit will give provide some certainty on Citigroup's Federal Reserve stress tests and potential 2013 share buybacks or dividends increases.

Burnell also calls the valuation on MSSB a "slight positive" for Morgan Stanley, noting that the independent appraisal highlights a "slugglish market and economic environment" for the brokerage, reducing the profitability of the investment bank's push into wealth management.

Citigroup shares rose over 2% to $32.56 in early Tuesday trading, while Morgan Stanley shares gained over 3% to $17.11 on news of the MSSB valuation and stake purchases.

-- Written by Antoine Gara in New York

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