Citigroup Drama Continues

As you may have noted in my previous post, I thought, even with the Wachovia deal, Citigroup was in trouble. To make this absolutely clear, Wachovia is not insolvent. There is a good chance they will face solvency issues in the future if the bailout is not passed, but right now they are still in the black. In any case, this morning it was reported that Wells Fargo offered to buy Wachovia for $15.1 Billion, seven times more than Citigroup was offering and without federal assistance. Additionally, as recently as yesterday, Wachovia shares were trading in the $4 range, four times the Citigroup offer. Indiciating that a significant number of Wachovia shareholders were going to oppose the Citigroup bid.

In any case, this begs a lot of questions about the initial Citibank-Wachovia merger. Most importantly, why was the FDIC trying so hard to push this deal through, especially in light of the fact that there may have been better deals out there that did not require government assistance? I previously made the case that Citigroup is pretty weak financially. Above all else, wachovia is a commercial bank, with a strong focus on its retail and small business operations. Despite having asset management and broker-dealer arms, the bank is not much of a player on Wall St. By contrast Citigroup has historically been the big business bank, with very little focus on the retail side. In the past Citigroup has acquired other retail-focused banks with a strong emphasis on small and medium-sized business lending, but has failed to integrate them. Whenever Citi gets its hands on a new bank, Citibank usually ends up diverting their assets to Citi's core Wall St. activity, completely ignoring the retail and small and medium-business lending of their recent acquisition. See the European-American Bank for instance. Additionally, dating back to the Citibank-Travelers merger, Citi has done an awful job integrating mergers. In short, very few synergies would have likely resulted from the Wachovia-Citibank merger. In that sense, the Wachovia-Wells Fargo merger makes much more sense, considering their business lines are so similar. From a strategic standpoint, the Citi-Wachovia merger just doesn't make much sense.

Another question is why was the government willing to providing backing for the Wachovia deal when they had previously let some pretty big players fail. As you may remember, the government refused to provide any backing for potential acquirers of Lehman Brothers, resulting in not only the firms bankruptcy, but also the end of several hedge funds and chaos in the money markets. That seems to me to have caused quite a deal of systemic risk. According to the terms of the Citi-Wachovia deal, Wachovia shareholders would be paid with shares of Citibank stock, with no cash changing hands, thus leaving Citibank's balance sheet in tact. Additionally, the FDIC would assume any losses over $42 Billion, possibily stemming from Wachovia's adjustable rate mortgage book. Citibank would have also gotten its hands on valuable deposits at a time when credit markets are frozen and banks are having trouble rasing debt. A failure of Citigroup, one of the three US Mega-banks, with $2 Trillion in assets, would have posed a far greater systemic risk than Lehman Brothers' $600 Billion failure or an $800 Billion failure of Wachovia alone. The fact of the matter is the Wachovia-Citi deal had very little to do with Wachovia's survival. The FDIC pushed it through for the sake of Citi's survival, at the expense of Wachovia's shareholders.

One futher question is what took Wells Fargo so long to push this deal through? Why didn't they jump on this deal over the weekend, rather than wait a week to snatch it from Citibank and face possible litigation? Citibank is indeed going to pursue litigation. Warren Buffet is Well Fargo's main shareholder, with around 10% of the company's stock. Recently, Warren Buffet went on a spending spree, buying $5 Billion in preferred shares from Goldman and $3 Billion in preferred shares of GE, with warrants for a corresponding value of common shares. In an interview on MSNBC, Buffet was asked how the bailout plan affected his decision to buy these companies. Buffet responded frankly, admitting that if the bailout plan is not passed, he has done a very dumb thing. The bailout would present Wachovia an opportunity to unload some of their toxic ARMs, perserving the solvency of the company. Seeing that the bailout was about to pass, Buffet may have asked the management of Well Fargo to jump into the fray offering a bid.