By Dan Wilchins
NEW YORK (Reuters) - Wells Fargo & Co agreed to buy Wachovia Corp for about $16 billion, catapulting it into the top ranks of U.S. consumer banking and upstaging a government-backed Citigroup Inc bid for the troubled bank.
Citigroup demanded Wells Fargo drop its surprise bid, which comes after Wachovia preliminarily agreed to sell its banking assets to Citi for $2.2 billion, with partial government guarantees on $312 billion of Wachovia's mortgages. Citi said Wachovia had agreed not to negotiate with other parties.
Regulators said on Friday they had not looked at the Wells Fargo bid, which would not require any government backing.
The lack of government support may make the Wells Fargo bid more attractive for regulators, analysts speculated, and some even argued that Citi ought to walk away.
"It's the right thing for the country for Citi to back off," Bill Hackney, managing partner at Atlantic Capital Management, which has $8 billion under management and owns Wells Fargo shares.
Wells shares closed down about 1.7 percent, after rising earlier in the day, while Wachovia shares closed up nearly 59 percent. Citigroup shares finished down about 18.4 percent.
But lawyers said Citigroup has a real case, including an exclusivity agreement and the fact that it has been providing support to Wachovia this week.
"Those are clearly strong facts on Citi's side," said Morton Pierce, chairman of the mergers and acquisition group at law firm Dewey & LeBoeuf. Dewey & LeBoeuf is not representing any of the parties in the transaction.
If Wells Fargo goes through with this deal, it will betaking a material risk. It will acquire $122 billion of "option pay" mortgages, where borrowers can choose every month whether to only pay interest on their mortgages, pay down some portion of their loan, and sometimes to pay less than the interest due.
In a plummeting housing market, such assets are seen as highly toxic, and Wells Fargo said it expects to write the assets down by $32 billion over time.
The bank estimates the total assets it is taking on will have to be written down by $74 billion in the years following the deal. Wells Fargo will issue up to $20 billion of securities, likely mostly common equity, to help offset those losses. These are big numbers for Wells Fargo, whose net worth as a company as measured by balance sheet shareholders' equity, was about $48 billion at the end of June.
KOVACEVICH
But many investors downplayed the risk to Wells Fargo, whose chairman, Dick Kovacevich, has a reputation for adeptly managing risk, and whose biggest shareholder is Warren Buffett's Berkshire Hathaway.
"I believe Kovacevich's and Buffett's history indicates they've done their due diligence on just how toxic this junk is," said Mike Holland, chairman of asset management firm, Holland & Co. Holland does not own shares of Citigroup, Wells Fargo, or Wachovia.
Wells Fargo may be able to secure some support through a $700 billion government program to buy bad assets that the House of Representatives approved on Friday afternoon.
The strategic benefits to Wells Fargo are compelling to some analysts. Wachovia has a strong branch presence on the East Coast, patching a major gap in Wells Fargo's network.
U.S. banks have been scrambling to build or buy branches, which allow them to raise money from depositors. In a credit crunch, deposit funding can be cheap compared to borrowing in bond markets.
Wells Fargo is one of the few major U.S. banks that has remained consistently profitable during the credit crisis, despite being headquartered in California, the state that has suffered most during the U.S. housing crisis.
Citigroup, meanwhile, has posted more than $17 billion of net losses in the last three quarters.
Winning the Wachovia branches would have helped Citi bolster its relatively weak network of U.S. branches, which number about 1,000 compared with Wachovia's 3,300 and Wells Fargo's 3,400.
"For Citigroup, this is a real loss ... This was a deal that was going to save them as much as it was saving Wachovia," said Cassandra Toroian, chief investment officer at Bell Rock Capital in Paoli, Pennsylvania.
In a joint statement, bank regulators at the U.S. Federal Reserve and the Office of the Comptroller of the Currency said they would work with all parties to achieve the best outcome. The Federal Deposit Insurance Corp said it stands behind its previously announced agreement with Citigroup.
BIG PREMIUM
For each share of Wachovia, investors will receive 0.1991 Wells Fargo share, which is equal to $7 a share based on Wells Fargo's closing price on Thursday of $35.16. Wachovia closed at $3.91 on Thursday, meaning that Wells Fargo is paying a 79 percent premium to Thursday's closing price.
The combined company will base its East Coast retail and commercial and corporate banking business in Charlotte. St. Louis will remain the headquarters of Wachovia Securities.
Wells Fargo, which would retain its name once the banks combined, is based in San Francisco.
Wachovia shares closed up $2.30 to $6.21, Wells closed down 60 cents to $34.56, and Citigroup closed down $4.15 to $18.35.
(Additional reporting by Mark Felsenthal, Elinor Comlay and Ed Tobin; editing by Jeffrey Benkoe; editing by Carol Bishopric)
