Citi M&A Could Stall Under Feds' Thumb

Citigroup's desire to jump on the M&A bandwagon is likely hamstrung if reports of federal regulators camped out in bank's offices are true.
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Citigroup's

(C) - Get Report

desire to jump on the M&A bandwagon is likely hamstrung by federal regulators permanently camped out in the banking titan's offices.

Regulators from the

Federal Reserve

and the Office of the Comptroller of the Currency have stepped up their scrutiny of the New York bank and, given Citi's troubles throughout the credit crisis, and are likely to weigh in on its "strategic direction" as well as "discouraging executives from certain acquisitions," according to an article that ran Wednesday in

The Wall Street Journal

.

The article says that in light of Citi's second capital infusion from the Troubled Asset Relief Program, or TARP, regulators "expect to essentially have veto power over key strategic decisions" at the bank. And in terms of deals, while the Federal Deposit Insurance Corp. has assessed Citi's interest in acquiring troubled banks, other regulators are telling the bank to stay on the sidelines for

M&A

deals that could be too large or too complex, the

Journal

says.

"There is a lot of pressure on regulators to show that they're exercising the oversight control that the bailout bill requires," some of which is spilling over from the auto bailout discussions, says Roger Cominsky, a partner in Hiscock & Barclay's financial institutions and lending practice area.

Given Citi's troubles, it makes sense for the bank to have regulators stationed at the firm, "so you don't go down the wrong road and spend a lot of effort" on a deal that won't win approval anyway, Cominsky says. He adds that it's likely that other large banks that received the first injections have regulators in their offices for now as well.

But Citi has received more government assistance than any other bank. After receiving $25 billion from the Treasury Department's first round of bank capital injections along with other large banks such as

Wells Fargo

(WFC) - Get Report

,

Bank of America

(BAC) - Get Report

,

Goldman Sachs

(GS) - Get Report

and

Morgan Stanley

(MS) - Get Report

, Citi received a second, $20 billion investment from the government in late November, after investor concerns intensified over the viability of the bank. Treasury also agreed to backstop $306 billion in risky assets.

Banks in general will be looking for acquisition targets primarily with healthy deposit bases, but on the asset side, regulators may be more prone to call a deal into question if the acquirer has substantial toxic securities and mortgages.

For Citi, that could mean "heightened scrutiny" by regulators, given its troubled loan and securities portfolios, says Jean Everett, also a partner at Hiscock & Barclay.

She says that the presence of regulators at Citi also "adds a little bit of a calming effect in the market" since there will be less speculation of acquisition, pulling Citi in wild stock swings.

Citi is one of the worst-hit banks in the credit crisis, suffering from from securities backed by real estate, soured subprime mortgages, and other asset classes, such as its credit card portfolio.

In October, it was engaged in a bitter legal battle over the ownership of

Wachovia

(WB) - Get Report

. Citi had agreed to purchase the Charlotte firm's banking operations -- with federal assistance -- in hopes to boost its deposit base and change the perception of the bank as one that is a survivor of the credit crisis. Wells Fargo swooped in with a better - unassisted -- offer to seal a deal for Wachovia.

Citi also had been rumored to be looking at smaller institutions as acquisitions, such as

Chevy Chase Bank

, which has since agreed to a sale to

Capital One

(COF) - Get Report

.

A Citi deal seems unlikely at best at this point, given its troubles. Still, Cominsky says given the right set of circumstances it's possible that Citi could make an acquisition in the near term, regardless of regulators increased scrutiny.

"Things are changing so fluidly, you can't tell who is a target and who is an acquirer," he says.

In the meantime, Citi is focused on improving its consumer banking business in the U.S., which has long struggled against more retail-savvy competitors, such as Wells Fargo and Bank of America.

The company hired Terri Dial, who held previous executive positions at Lloyds TSB Group and Wells Fargo, earlier this year to retool the business.

Sandler O'Neill & Partners analyst Jeff Harte said after meeting with Dial that she is focused on improving the bank's market penetration in its current footprint rather than geographic expansion, given that Citi already has a presence in 16 of the top 33 metropolitan statistical areas in the country.

According to Dial, Citi's consumer businesses "are too focused on product manufacturing, often having multiple consumer product silos independently pursuing the same customer," he wrote in a note Wednesday. Similar to her Wells Fargo roots, she "would ultimately like to have multiple products offered through a single customer relationship with Citigroup."

But the changes will take time, Harte added. Dial is "more concerned about getting the segment's retooling done right than with getting it done quickly," and expects the process will take roughly three to five years, he wrote.