After Reloading With Wachovia's Banking Business, Citigroup Takes a New Aim at the U.S. Banking Market

By Jason Simpkins
Associate Editor

Citigroup Inc. (C) will acquire Wachovia Corp.’s  (WB) banking operations for $2.l6 billion, a deal that will restore Citi’s title as the biggest U.S. bank by assets while transforming the once-highly regarded Wachovia into an investment-management operation.

In becoming the latest big U.S. bank to bolster its assets by rummaging through the remains of a nearly defunct financial institution, Citi agreed to buy Wachovia’s banking operations for $1 per share. The deal gives Citi a strong retail-banking network – adding 3,300 branches and offices in 21 states – as well as $2.2 billion in deposits; but the bargain also brings City $42 billion in prospective losses from Wachovia’s $312 billion loan portfolio.  The Federal Deposit Insurance Corp. (FDIC), in exchange for $12 billion in preferred stock and warrants, will cover any losses over that $42 billion ceiling.

With the deal’s completion, Citi will have 4,300 U.S. bank offices and more than $600 billion in deposits, giving it a hefty 9.8% share of the U.S. banking market. With total assets of $2.91 trillion once the takeover is concluded, Citi will have regained its position as the No. 1 U.S. bank by assets. However, in terms of how shareholders value each bank’s stock, Citi will remain the third-largest U.S. bank, behind leader Bank of America Corp. (BAC) and second-largest bank, JP Morgan Chase & Co. Inc. (JPM), reported.

Wachovia will retain its brokerage and wealth-management, which include such properties as A.G. Edwards Inc. and the Evergreen Investment Management Co. LLC mutual fund family.

Wachovia’s Woes

In little more than two decades Charlotte-based Wachovia grew into the United States’ fifth-largest bank, but quickly found itself hamstrung by a series of poor decisions that cost the company three-quarters of its value in the past nine months.

The most costly decision for Wachovia was the 2006 buyout of Golden West Financial Corp. – a California-based lender that specialized in adjustable-rate mortgages (ARMs). The acquisition of Golden West made Wachovia the largest holder of option ARMs, ahead of even Washington Mutual Inc. (WM)  – the lender that was snapped up by JPMorgan Chase & Co. last week. Wachovia was confronted with more than $30 billion in losses stemming from Golden West’s option ARM portfolio, BusinessWeek reported.

Wachovia’s collapse was hastened by JPMorgan’s purchase of Washington Mutual, which raised doubts about whether or not Wachovia had adequate reserves to cover mortgage-related losses.

The J.P. Morgan/Washington Mutual transaction raised the bar in terms of potential marks/reserves against consumer real estate for other commercial banks,” said analysts at Credit Suisse Group AG (ADR: CS), led by Todd L. Hagerman.  “Our aggressive capital-sensitivity analysis for both Bank of America Corp. and Wachovia, incorporating J.P. Morgan's $31 billion of marks, or 20% cumulative-loss assumption, suggests a blended potential capital shortfall of $40 billion to $50 billion for Bank of America and $15 billion to $20 billion for Wachovia, under a recession-type scenario.”

The result, many believe, was a run on Wachovia that resulted in a massive outflow of deposits, and ultimately, the bank’s collapse.

“The problem must have occurred last week with their ability to continue to attract and hold deposits after the failure of Washington Mutual,” Gary Townsend of Hill- Townsend Capital in Chevy Chase, Maryland told Bloomberg. “On Thursday and Friday they must have had a large run on the bank.”

Citigroup, JPMorgan On the Hunt

Collapses, like those experienced by the likes of Wachovia and WaMu, have paved the way for greater industry consolidation, with the remaining firms salvaging what usable assets can be found amid all the carnage, in a desperate bid to bolster their own positions.

Citi broadened its base with the addition of Wachovia’s 3,300 retail-banking branches and the $2.2 billion in deposits that come along with them. Those deposits will provide Citi with a cheap, stable source of funding at a time when credit is scarce.   

Citi, already the largest U.S. bank by assets, will have $1.3 trillion in total deposits worldwide, roughly $350 billion more than JPMorgan Chase & Co.

However, JPMorgan, under the stewardship of Chief Executive Officer Jamie Dimon, has made several strong acquisitions of its own – leaving the firm well positioned to compete.

After taking over The Bear Stearns Cos. Inc. in March, Dimon moved swiftly to acquire failed Washington Mutual from the federal government. JPMorgan paid $1.9 billion to the FDIC to acquire WaMu’s $188 billion in deposits, 2,200 retail branches and a loan portfolio valued at $176 billion.

While JP Morgan immediately wrote down roughly $30 billion in mortgages and home-equity loans, the acquisition left a total of $900 billion in deposits and 5,400 branches Bloomberg reported.

“JPMorgan is putting together quite an interesting empire of assets,” Douglas Ciocca, managing director of Renaissance Financial Corp. told Bloomberg. “Jamie Dimon has the right pedigree to be able to pull something like this off, as did J.P. Morgan himself.”

JPMorgan took $18.8 billion in write-downs and credit-related losses since the beginning of 2007 – a fraction of the $55 billion taken by Citigroup.

The Evolution of Goldman Sachs and Morgan Stanley

Competition will also come from the likes of Goldman Sachs Group Inc. (GS) and Morgan Stanley (MS), which have abandoned their roles as investment banks and converted to holding companies.

Goldman Sachs, the largest and most profitable U.S. securities firm, immediately took its place behind Bank of America, JPMorgan, and Citigroup, as the fourth-largest U.S. holding company last week, and is already moving forward with plans to revamp its business model.

The Financial Times reported yesterday that Goldman was looking to spend up to $50 billion on assets from ailing U.S. banks. That’s in addition to the $150 billion of its own assets it is moving to its Utah industrial loan corporation, CIT Bank, which currently has about $20 billion in deposits and $25.7 billion in assets.

Goldman has just $8 billion in securities backed by commercial mortgages, and if it sold all of those securities today, the company would record a gain, officials told the FT. Goldman has also reduced its exposure to private equity deals from $52 billion to $8 billion.

Morgan Stanley, formerly the second-biggest U.S. securities firm, had $36 billion of deposits and three million retail accounts at the end of August. The company will also convert its Morgan Stanley Investment Bank, an industrial bank based in Utah, into a national bank.

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