Wells to Buy Wachovia; Citi Threatens Suit

Updated from 10:36 a.m. EDT

Wells Fargo ( WFC) said Friday it has reached a definitive agreement to acquire Wachovia ( WB) for $15.1 billion, but Citigroup ( C) was threatening legal action to preserve a federally backed deal it had reached Monday .

In a statement Friday, Wells Fargo and Wachovia said the transaction requires no financial assistance from the Federal Deposit Insurance Corp. or any other government agency.

Just days ago, Citigroup reached an arrangement to purchase all of the banking subsidiaries of Wachovia for around $2.2 billion, but the deal was being done with aid from the FDIC.

Wachovia didn't offer a great deal of comment on the pact with Citi, which for now at least appears to be dead. It did say it "had been negotiating with Citigroup to complete a transaction supervised by the FDIC that included assistance from the government."

From the outset, the FDIC had stressed that Wachovia didn't fail. Failures of IndyMac and Washington Mutual in recent months led to government seizures and subsequent sales of the bulk of their banking operations, but in the case of Wachovia, the government was described more as a facilitator. The board of Wachovia approved Wells Fargo's offer Thursday night.

Citi said in a statement that the Wells Fargo deal constituted a "clear breach of an exclusivity agreement" Wachovia had entered with Citi and demanded a halt to the new transaction.

"Citi was negotiating in good faith and nearly completed the definitive agreements required to consummate the Citi/Wachovia transaction that was announced on Monday," the bank said in a statement. "The value of the Citi agreement to Wachovia shareholders was substantially in excess of Wachovia's closing price on Thursday, Oct. 2. Citi has also been providing liquidity support to Wachovia Bank since Monday's announcement."

Wells Fargo and Wachovia danced around the issue on a conference call Friday.

"We think that this deal is solid," Wells Fargo Chairman Dick Kovacevich said. "We're not aware of any merger agreements that had been consummated at the time with Citi . ... We feel very confident that this transaction has been done appropriately."

Wachovia's CEO Robert Steel said on the call he could not speak to the issue on whether or not Wachovia had a binding agreement with Citi, prior to the Wells' deal.

FDIC Chairwoman Shelia Bair said in a statement Friday that the agency "stands behind" the Citi deal it brokered and "will be reviewing all proposals and working with the primary regulators of all three institutions to pursue a resolution that serves the public interest."

"Since the close of our bidding process, Wells has apparently re-assessed its position and come forth with this new offer that does not require FDIC assistance," Bair said. "It should be emphasized that both the Citigroup proposal as well as the new Wells proposal would stand behind all creditors including depositors, insured and uninsured."

The Federal Reserve said in a statement that it had "not yet reviewed the new Wells Fargo proposal and the issues that it raises," adding that "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."

San Francisco-based Wells Fargo's deal would acquire Wachovia in a stock-for-stock transaction. Included in the deal are all of Wachovia's businesses and obligations, including its preferred equity and debt, and all of its banking deposits.

The terms of the deal call for Wachovia's shareholders to receive 0.1991 a share of Wells Fargo. The transaction, based on Wells Fargo's closing stock price of $35.16 on Thursday, values Wachovia at $7 a share. Shares of Wachovia closed the prior session at $3.91.

"This agreement represents a compelling value for Wachovia shareholders," Kovacevich said in a statement. "It provides superior value compared to the previous offer to acquire only the banking operations of the company and because Wachovia shareholders will have a meaningful opportunity to participate in the growth and success of a combined Wachovia-Wells Fargo that will be one of the world's great financial services companies."

Recently, shares of Wachovia were surging 76% to $6.90. Citi, meanwhile, was slumping 12% to $19.89, and Wells Fargo was up almost 8% to $37.89.

Wells Fargo said it will record Wachovia's credit-impaired assets at fair value. The acquisition is expected to "exceed Wells Fargo's internal rate of return goal and add to Wells Fargo's earnings per share in the first year of operations, excluding integration costs, writedowns, transaction charges and credit reserve build," the company said.

Wells Fargo executives said on the call that after the Citi deal was announced, the bank stopped having conversations with Wachovia, but continued to analyze data provided during the bidding process.

Wells expects losses on Wachovia's commercial and residential loan portfolios and other securities marks to total $74 billion before taxes -- most of which would be taken upfront through purchase accounting measures when the deal is completed. The bulk of the losses are clearly expected in Wachovia's option adjustable-rate mortgage portfolio, which it inherited through its 2006 acquisition of Golden West.

Wells Fargo said it expects to incur merger and integration charges of about $10 billion. Wells Fargo intends to issue up to $20 billion of new securities, primarily common stock.

The combined company's Tier-1 capital ratio is expected to be 7.5% once the deal is completed, executives said on the conference call. Wells' Tier-1 capital ratio at the end of the second quarter was 8.2%.

"This deal enables us to keep Wachovia intact and preserve the value of an integrated company, without government support. The market presence and composition of our businesses, along with our service-oriented cultures, are extraordinarily complementary and this combination creates great potential for sustained stability and growth," Steel said in a prepared statement.

The deal for Citi to buy Wachovia took shape quickly last weekend, as speculation swirled around the fate of the North Carolina lender.

On Thursday night, Washington Mutual had been taken over by the government and its banking operations sold to JPMorgan Chase ( JPM), which had just months earlier purchased Bear Stearns in another government-brokered transaction.

During the next trading session on Friday, traders sent shares of several banking companies sharply lower. Wachovia itself saw its stock plunge more than 40% at one point as investors feared it could be the next domino to fall amid the turmoil in the financial markets.

Following the close of that trading session, reports emerged that several bidders were considering offers for Wachovia, including Citi, Wells Fargo and Santander ( STD), but days later the Citi deal was announced.

Even before that, Wachovia was said to be holding talks with Morgan Stanley ( MS), although that prospect fell through after Morgan, along with fellow former investment bank Goldman Sachs ( GS), changed its status to a bank holding company.

Questions will now center on the next steps for Citi, which had been planning to assume all of Wachovia's senior and subordinated debt, totaling more than $50 billion. Citi had also said it would take as much as $42 billion of losses on $312 billion of Wachovia loans identified as potentially troubling, and the FDIC would take responsibility for any additional losses. Citi was prepared to give the FDIC $12 billion in preferred stock and warrants for assuming the risk.

Citi CEO Vikram Pandit, who took charge of the company after Charles Prince resigned under a cloud late last year, had hailed the proposed tie-up as "good for both Citigroup and Wachovia. It's great for our clients and customers and I believe it's great for the U.S. financial system."

Like many of its large financial counterparts, Citi has been beaten down by the global credit crisis that is now a year and a half old. The New York-based company has been selling some assets to focus on its core banking operations, and the breakdown of the Wachovia deal could inspire it to continue shopping.

Additionally, Citi had been planning to raise $10 billion in common stock and cut its quarterly dividend in half to 16 cents a share, but at this point, it wasn't known if those strategies would still be pursued.

The biggest Wells Fargo shareholder is Warren Buffett's Berkshire Hathaway ( BRK-A), which itself has been on a buying spree of late. Berkshire recently made big investments in two other firms, Goldman Sachs and General Electric ( GE), the latter of which has a significant financial operation.

The end of Wachovia's days of independence continues a string of buyouts and bailouts that have radically transformed the financial sector in the past few months.

Along with the takeouts of Bear Stearns and Washington Mutual, Lehman Brothers filed for bankruptcy, the government arranged backstops for Fannie Mae ( FNM), Freddie Mac ( FRE) and AIG ( AIG), Bank of America ( BAC) agreed to buy Merrill Lynch ( MER), and roughly a dozen smaller banks have failed outright.

To attempt to stem the crisis, the Bush administration has proposed a multibillion rescue package for the financial group. On Monday, the House of Representatives voted down the plan, but two days later a measure passed the Senate. The House will hold a new vote on Friday to try to get legislation put in place.

A combined Wells Fargo and Wachovia will have assets of $1.42 trillion, deposits of $787 billion, and assets under management, through mutual funds, of $258 billion. Together, the companies have more than 10,000 banks in 39 states and Washington, D.C., 12,000 ATMs and 280,000 employees.

For Wells Fargo, the acquisition will give it a first-time banking presence in several states along the East Coast and in the South, including Alabama, Connecticut, New York, New Jersey, Tennessee and North Carolina.

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