Wachovia Deal: A Home Run for Citi

People have been so transfixed by the implosion of Wachovia (WB), they’re overlooking the fact that the buyer in the transaction, Citigroup (C), is getting a spectacularly good deal.

The FDIC has basically gift-wrapped Wachovia’s national deposit base and handed it over for free. Citi gets Wachovia’s retail bank, its commercial and investment bank, and its private banking unit, including assumption of debt. In all, that adds up to $700 billion in assets and related liabilities, including $448 million in deposits.

For this, Citi hands over $2.2 billion in stock, and will issue $12 billion in warrants to the FDIC to backstop losses on $312 billion in troubled Wachovia assets. Citi’s loss on those assets will stop out at $42 billion.

Meanwhile, the company says it can generate $3 billion in costs saves after integration, to be offset by $1.5 billion or so of “dis-synergies.” The deal should be accretive to earnings starting in year one, net of a one-time restructuring charge. As a result of the deal, Citi becomes the largest depositary in the industry, and will have the third-largest branch network and completely reshapes the balance sheet and improves - overnight - the company's funding profile. All good.

Vik Pandit says—and I agree—there are really just two key risks: credit risk and integration risk. Neither should be especially tough to manage.

For its part, credit risk seems contained, given the FDIC backstop. If you exclude the commercial and industrial loans Citi is acquiring, the FDIC is actually reinsuring something like 85% of the total acquired loan portfolio. Even the lamest risk manager in the world (which Citi is not) can pick which 85% are most likely to be stinky. As for the other Wachovia assets Citi’s taking on (roughly $200 billion worth), the securities portfolio is relatively clean  (principally agency MBS) and 55% of that remaining amount. The rest is mostly PPE, goodwill, and sundry items . Oh, and via those FDIC warrants, the government now owns a 10% equity stake in the company  -- further incentive to protect the company's equity.

And integration risk?  Certainly present but, again, manageable. Citi is paying a conservative purchase price and is assuming some fairly high revenue "dis-synergies” following the close. Yes, there might be some difficulty here, given the upheaval in Citi's executive management the past few years. But if the company’s smart, it will turn the entire retail banking business, including its integration process, over to the Wachovia team, among the most capable set of retail bank managers in the business.

Citi’s capital position will improve as a result of the deal, as well. Pro forma Tier I will go to 8.8% (including all of the FDIC investment) and TRBC goes to 11.8%. This includes the impact of a $10 billion raise of common, a halving the dividend, and the $12 billion in preferred stock  (and warrants)  to the FDIC at a 6% yield. The company also says it will receive "regulatory capital relief" on the $312 billion risky portfolio it’s acquiring.

In all, the Citi’s earnings are set to rise, its capital position improve, while its competitive position is strengthened. As I say, a very good deal.

Comments

[Ishortyou:]

Wachovia got rid off the prior toxic risky wasted bank subsidiaries and kept the good ones. Now it can start from scratch to build a new banking subsidiary with safe practice together with its remaining good outstanding subsidiaries. The current subsidiaries of Wachovia make it look like “Merrill Lynch without the toxic risky waste”, good job from management it separated the good bank from the bad bank overnight, plus its CEO Bob Steel is one of the top rated mutual fund managers. Wachovia will keep the valuable human resources and the talent that have expirience in the banking business saving them for the new banking subsidiary. Buying the municipal bonds or the auction rate securities will give the inflow of cash as long as its hold even to maturity. Some investors are taking money away from Hedge Funds going wild and putting that money into accounts manage by people that know what they are doing, Bob Steel is one of those people that know what they are doing, dont be surprise some of this money will go to Wachovia subsidiaries. Earnings will be adjusted accordingly, like simple arithmetics they will manage its expenses vs its earnings to come ahead in capital and start piling up cash (saving cash a hard job for most of us that live on debt), this new cash will give them the jump start of a new banking subsidiary without even thinking about to sell its remaining subsidiaries.Forgot to mention that Wachovia owns a hudge Insurance subsidiary which is making money and has sound book of business. Lehman debt is bonds most of them senior, as bankrupt as Lehman is those bonds get paid. ARS are Municipal Bonds as bonds they get paid, hold into maturity they get paid in principal, those ARS are cash flow. Preferred dividends will get paid accordingly because the holding company does not own the banking subsidiaries anymore so modification are going to be made. Getting rid off the toxic waste risky bank related subsidiaries is a good strategy and converting the remaining broker one to a new bank subsidiary with clean sheets is a good one too.

2008 Oct 01 04:42 PM

[Big Al45:]

The FDIC's actions show that no bank stock is safe except for the favored four (Citibank, JPM, WFC, and BAC). If you're a shareholder in any other bank, you're one bank run away from having your equity position destroyed.

Either Steele is a first class liar or a concerted bank run destroyed his recovery plans. It would be very interesting to know who pulled their deposits out of Wachova and whether these people had short positions in WB. The SEC should investigate this, but they won't. I'm sure the right people in DC have been paid off.

Short This is how the WB story ends. The remainder gets bought by Morgan Stanley for $1.50 in stock, Steele gets to be the next CEO of MS (and recover his $15 million WB investment loss in 18 months); four clowns from the WB board get to join the join the MS and Citi boards, and the WB shareholders get the magnificent sum of $2.50 a share.

Isn't capitalism wonderful.

2008 Oct 01 05:02 PM

[ajhough:]

Usually I prefer to own stock in companies that have been bought but I have own C for many years and have a certainty that it will survive this disaster. I also own WFC, JPM, and BAC and they will survive, I believe. Some have recently increased in share price.

2008 Oct 01 05:03 PM

[Reinko:]

Is this for real?

Only 448 million US$ in deposits? (That is 0.4 billion by the way).
And 312 billion US$ in troubled Wachovia assets?

In other media files it is told that this costs the FDIC absolutely nothing...

In relation to the mark to market rule (accountancy rule 157) Barry Ritholtz has some details to share, link:

bigpicture.typepad.com...

It says:

Wachovia book value = 75 billion US$
Citi paid = 2 billion US$

While in the meantime the banks only complain about that stupid 157 rule because it makes 'no sense' to put prices on stuff that cannot be sold. But when you cannot sell this in a period of 15 months (the length of the credit crisis) what is the stuff actually worth?

It is mostly garbage, the banks did it all to themselves. It was garbage from the beginning and it is garbage now.

2008 Oct 01 05:14 PM

[Ishortyou:]

I am not so sure how Morgan Stanly can get the money to buy the rest of the Wachovia assets if they still have a huge toxic risky waste in their books, even with the government 'bail out' those assets are going to be auction at market price, that means that the rest of the hole still needs to cover somehow, I would guess they will go to the FED window to raise that capital or raise more capital somehow the rest also applies to BAC, JPM, Citi.

2008 Oct 01 05:30 PM

[livesinhiscar:]

WB stockholders sure got raped on this one.

2008 Oct 01 07:31 PM

[clod:]

As a WB shareholder, I am going to vote against the merger with Cit. This requires shareholder approval. This is a $75B company being forced to sell for $2.2B by the FDIC. When the bailout bill passes, WB can offload these assets just as Citi is planning on doing. Save our equity and vote NO with me.

2008 Oct 01 10:15 PM

[User 273433:]

If you are interested in seeing some information on alternatives to completing the transaction with Citi. More information is coming. WWW.SAVEWACHOVIA.COM

2008 Oct 01 10:36 PM

[Ishortyou:]

@clod: if the bail out bill buys the Wachovia toxic waste such option pay and ARMs for what it cost Wachovia, which is unlikely, and Wachovia will not need to raise more capital after the transaction is done due to the difference, and the rating agencies do not downgrade the ratings in Wachovia debt, and depositors stop running from the bank like chickens without heads, then you got a deal!

2008 Oct 01 10:56 PM

[vatexas645:]

If this buy-out is in fact required to have WB shareholder approval, it may not be a done deal.

2008 Oct 02 07:56 AM

[directcommu...:]

through out this entire time, companies are being acquired with pennies on the dollar. Some people, including the governemnt are going to make a killing by buying these assets for so cheap. It seems like this was all put together in 2002 by the administration to help the good old boys get richer.

2008 Oct 03 01:53 AM

[debtacid:]

OOPS, Tom. Looks like XLF just fell below it's July 15th low...

2008 Oct 07 02:05 PM