SunTrust's

(STI) - Get Report

hostile offer for

Wachovia

(WB) - Get Report

initially drew praise from analysts and investors, who welcomed the bid's premium. But as the bidding war with

First Union

(FTU)

turns into one of the nastiest in banking, SunTrust's stock price is cooling down, diluting the appeal of its bid.

When SunTrust

announced its stock offer last week, its $64.81 a share price translated into a premium of about 17% over First Union's two-for-one stock swap, which it and Wachovia

agreed to in mid-April. Coupled with a longstanding belief among observers that SunTrust and Wachovia make a good fit culturally, many analysts and investors seemed to be

lining up behind a SunTrust deal.

But SunTrust now is down about 6% below its prebid level, after dropping more than 7% on May 14, when it announced its offer. And First Union sweetened its bid by guaranteeing that Wachovia shareholders would keep their annual dividend.

"The gap obviously may be what is driving peoples' beliefs," says Thomas Finucane, co-portfolio manager of the

John Hancock Regional Bank Fund

, which owns all three stocks. "The SunTrust deal is now 4% to 5% better than First Union's. But it's a hostile bid and there is a lot more risk attached. ... Perhaps the sentiment is that if

the SunTrust bid were better by 10% to 12% or where it was when announced, that would compensate you for the risk."

"I don't think the decision is as black and white as it appears," adds Jennifer Thompson, banks analyst at

Putnam Lovell

. She says both offers are compelling, even though they hold different advantages for Wachovia in terms of time frame. (Thompson rates SunTrust a buy and First Union and Wachovia holds. Her firm hasn't done underwriting for these banks.)

More to It

But there may be more to the shifting attitudes than price.

The fight has turned particularly nasty, and First Union and Wachovia appear to be winning the public relations battle. This week brought a more than 40-page tirade from Wachovia against SunTrust, deeming its bid a "desperate hostile attempt" and calling the premium "illusory," "opportunistic" and "unsustainable."

The presentation included a laundry list of criticism for SunTrust, including the assertion that it has "hit the wall" with earnings-per-share growth. At the same time, Wachovia touted the "superiority" of the First Union deal, including the bank's merger integration experience, growth businesses and "quality of earnings." Some of those claims are likely to raise eyebrows with investors, particularly First Union's acquisition track record.

First Union and Wachovia are taking this campaign to the people who count -- shareholders. "Wachovia and First Union are aggressively pitching their deal to the investment community," says Thompson, noting that the two banks have held a number of meetings with investors and sell-side analysts in the past few days.

But in the end, the discussion comes back to price.

What It Has to Do With

SunTrust's increasingly difficult battle "has everything to do with the fact that the deal had a 15% to 17% premium" over First Union when it was initially announced, says Christopher Mutascio, an analyst at

Legg Mason

in Baltimore. If that sizeable spread had remained, it would've at least put pressure on Wachovia's board from shareholders looking for near-term upside, he says. (Mutascio rates Wachovia and SunTrust market perform and does not rate First Union. His firm has no underwriting relationship with the banks.)

The Wachovia board isn't going to "break this deal with First Union for a 5% premium," says Mutascio, especially when it would be giving up control. When SunTrust and Wachovia held merger talks last December, the deal was structured as a merger of equals, as was the First Union deal. But under SunTrust's current hostile bid, it would clearly be in control of the merged bank.

Still, many people insist SunTrust and Wachovia are a better fit, especially on a cultural level. "The rank and file employee at Wachovia would much rather work for SunTrust than First Union," says John Hancock's Finucane, adding that they "actually do fit together very well." He says SunTrust's offer has been labeled hostile, but "it's only hostile to the top 10 guys at Wachovia."

Says Mutascio, "I don't think people changed their minds as to who is the better partner

for Wachovia. The dynamics of the deal have changed. First Union is in the catbird seat."

Still, no one expects the battle to end soon. "We think we are in the third inning of a game that is likely to run into extra innings," writes Putnam Lovell's Thompson in a note. And Mutascio thinks a proxy battle will materialize, with SunTrust actively courting Wachovia shareholders to vote against the First Union merger. "Thus while

SunTrust has an uphill battle, this saga is not over," he writes.