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is setting its sight on smaller fish, after its quest to build its deposit base suffered a setback in its failed effort to buy


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The Wall Street Journal

on Thursday reported that the New York banking titan is in acquisition talks with privately held

Chevy Chase Bank

, which has 285 branches in the mid-Atlantic and roughly $11 billion in deposits and $15 billion in assets.

Citi has also may have had discussions with

Valley National Bank

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, according to Gary Townsend, the CEO and president of private equity firm Hill-Townsend Capital. Townsend says he had no firsthand knowledge of the talks, but had heard the rumor from "market sources."

While the regional banks are much smaller than


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, which Citi failed to acquire last month, they may be more manageable targets for the troubled bank.

Citi on Thursday declined to comment regarding the merger rumors, according to a spokeswoman.

Citi's domestic retail banking operation has suffered over the past few years as the company focused on its institutional and international businesses.

While Citi has solidified some branch acquisitions, it hasn't done much in the way of acquiring whole retail bank franchises over the past five years. The last deal Citi completed for a retail bank was in 2005 when it acquired First American Bank of Bryan, Texas. That deal gave Citi just over 100 branches in Texas.

But these days, since the capital markets essentially remain frozen, Citi CEO Vikram Pandit, along with other banks, has been scoping out acquisition targets in order to boost their deposit bases. The deposits provide a cheap source of funding for the banks.

Citi currently has approximately 1,000 branches in 13 states and the District of Columbia under its retail bank brand, Citibank. Those branches are located mostly along the East Coast, but also in Texas, Nevada, Illinois and California.

Pandit, in his first large deal, announced in late September that Citi had agreed to purchase the banking operations of Wachovia, which included $448 billion in deposits and roughly 3,300 branches nationwide for $2.16 billion, while the Federal Deposit Insurance Corp. agreed to take on most of the risk in Wachovia's loan portfolio. But Citi lost the deal after

Wells Fargo

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offered $15 billion for Wachovia, without needing assistance from the FDIC.

Last month, speculation mounted that

Goldman Sachs

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was interested in merging with Citi, but that Pandit immediately rejected the proposal, according to reports.

Purchasing Wachovia would have kick-started Citi's struggling retail bank, particularly after rival

JPMorgan Chase's

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acquisition of

Bear Stearns

and failed

Washington Mutual's

deposits and

Bank of America's

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deal for

Merrill Lynch

( MER).

But integrating Wachovia was bound to prove challenging for Citi, as the two cultures were vastly different. It also was likely to have detracted Citi from continuing its mission to shed $400 billion in non-core assets and businesses from its balance sheet.

Citi is less likely to add to those challenges -- at least on a large scale - by acquiring smaller institutions.

But Chevy Chase is not without its warts. Since the Bethesda, Md.-based bank is mostly private, "there isn't a lot of visibility toward their operations," Townsend says.

"It's never been particularly profitable. It has non-performing assets problems due to lending outside of its footprint," says Townsend, a former equity analyst who spent seven years as chief examiner of the Federal Home Loan Bank system. He co-founded his current firm with ex-

Commerce Bancorp

CEO Vernon Hill.

Townsend adds that the company also engaged in exotic mortgages such as negative amortization loans, like the option adjustable-rate mortgages that caused so much trouble for

Countrywide Financial

and Washington Mutual.

Still, Chevy is "one of the premier deposit franchises in the region," Townsend says. "It's not going to move the needle like Wachovia could have.

It strengthens

the company, but it's not strategic."

Ken Thomas, a Miami-based independent bank consultant and economist, says that despite the unprecedented circumstances surrounding Citi at the time of the bidding war with Wells Fargo, Citi should not have let Wachovia "slip through its fingers."

"This was their only opportunity" to become a national player and keep "Wells Fargo out of their backyard," he says. Instead, the company will now have to search for acquisitions piecemeal.

Chevy Chase is an "excellent network," but what it really needs is a better presence in fast growing states like Florida, California and Texas, he says.

"If you're not in those three states you're not a national player. And you got to be there in a big way. Wachovia was a way they could do that," Thomas says.

Citi shares traded at a 13-year low of $8.27 earlier Thursday, but more recently were down 4.4% to $9.22.