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Wachovia-Wells Fargo A Victory For Us All

Posted: Oct 06, 2008 14:42 PM by Stephen Simpson

Tickers in this Article: NCC, RF, STI, C, WB, WFC

About a week ago, I suggested that Wells Fargo (NYSE:WFC) was apparently not interested in surpassing Citigroup's (NYSE:C) government-assisted bid for Wachovia (NYSE:WB). Turns out that I was wrong. Wells Fargo was not sleeping, it was just resting.

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Wells Fargo shook up the markets late last week with an announcement that it had reached an agreement with Wachovia's board to buy Wachovia lock, stock and barrel for a little over $15 billion in stock. "But wait," you say, "Didn't Wachovia already have a deal in place with Citigroup?"

Well, yes, it did. But apparently from the perspective of Wells Fargo and Wachovia, it was more of an agreement in principle as opposed to a definitive deal. Citigroup does not share this opinion and is now suing keep a deal that I believe is extremely important to its future competitiveness. (For more on these deals, read our Mergers And Acquisitions Tutorial.)

Highlights of the Deal
There has already been a great deal of information to come out on the Wells Fargo-Wachovia tie up, so I will only touch on the highlights here. The deal will create a bank with a huge retail footprint across the country and requires no help from the government (Citi needed the FDIC to help out if losses on bad Wachovia loans exceeded a certain threshold). In addition, this deal would leave no messy entanglements behind, as Wells Fargo would be buying the entire company (Citi was going to leave the retail brokerage and asset management business behind, as well as some liabilities), and offers the chance of pairing Wells' excellent fee-generating businesses with Wachovia's customer service reputation.

Of course, Citi is not bowing out gracefully. The company maintains it had a "done deal" with Wachovia that forbid Wachovia from talking to other suitors, and Citi has secured a temporary hold from a New York judge to keep the deal from moving forward. In addition, the FDIC has expressed its support for the previous Citi-Wachovia deal.

When it's all said and done, however, I think investors should hope that Wells Fargo wins this battle. The Citi proposal is viable only because the FDIC stepped up to help indemnify Citigroup if Wachovia loan losses exceeded $42 billion, in exchange for $12 billion in warrants and preferred stock issued to the FDIC. In contrast, Wells Fargo has come back with a deal that "don't need no stinkin' FDIC", and Wells Fargo's anticipated capital raise will take place in the regular stock market.

Now, I will concede that Citigroup has provided a very valuable service. There was scuttlebutt that Wachovia was losing deposits rapidly and may have had difficulty staying liquid if Citigroup's deal hadn't been announced. What's more, Citigroup has provided liquidity support to Wachovia in the meantime. That is absolutely worth something and Citigroup should be compensated for it, but I don't believe that it is responsible (or respectable) government policy to allow deals that require government support to supersede deals that can be fully handled by the private sector.

Toss Another $32 Billion on the Fire
It's also worth noting that Wells Fargo has put the FDIC in a difficult and perhaps embarrassing situation. First, there's the aforementioned issue of allowing a government-brokered deal to go in place of a privately-negotiated transaction. Worse, though, is the fact that Wells Fargo has identified bigger writedowns in the Wachovia portfolio, to the tune of $74 billion. If I'm understanding this correctly, this means that Citigroup and the FDIC either have to explain why Wells Fargo's more conservative numbers are wrong, or they have to acknowledge that the government is likely to be on the hook for at least $32 billion if the Citi deal goes through.

Assuming that the Wells Fargo deal for Wachovia ultimately goes through, that leaves Citigroup in a tough spot. If the company is going to stay competitive, they have to do a deal. The trouble is, I have a hard time seeing them able to put together a deal attractive to a non-desperate seller. So while SunTrust (NYSE:STI), Regions Financial (NYSE:RF), and National City (NYSE:NCC) may be tabbed as potential targets for Citi, those could be tough deals to do.

Bottom Line
Let's hope that Wells Fargo wins this one. I appreciate the idea that "a deal is a deal", but when the deal in question requires taxpayers to act as a backstop, that's a deal that I'd rather not see.

By Stephen Simpson

Stephen Simpson, CFA, has worked as an equity analyst for both sell-side and buy-side investment companies, and presently works as a sell-side equity research analyst. He has worked as a consultant for the healthcare sector, and has written extensively for publication on topics pertaining to investments, security analysis, and healthcare. Simpson is the editor of Kratisto Investing, a website devoted to financial analysis and personal commentary.

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