Wells Wrestles Wachovia from Citi
What would the deal mean for investors?
Each Wachovia share will be exchanged for 0.1991 share of Wells Fargo. Wells will not get any FDIC assistance in the deal. In fact, the total purchase price is very near what Citigroup offered earlier this week, but all of the $15 billion Wells will pay goes to Wachovia shareholders. This compares favorably with Citigroup's total purchase price of $14 billion, of which $2 billion would have gone to Wachovia shareholders and $12 billion to the FDIC for insurance against loan losses.
The combined entity will be one of the largest retail banks in the United States, rivaling Bank of America BAC and the newly enlarged reach of J.P. Morgan Chase JPM. With more than $1.4 trillion of combined assets, this deal has vaulted the company into the top tier of U.S. banks by size. However, Wells will have to deal with the $120 billion of toxic pick-a-payment loans on Wachovia's book without the FDIC backstop that Citigroup was extended. Wells will put the loans on its books at fair value, which in today's market means just a fraction of the valuation logged on Wachovia's books. This is both a good and a bad thing. On the plus side, current market prices are so pessimistic that only a severe recession would cause Wells to take additional losses on these loans after the deal closes. In fact, the more likely outcome is that the company will gradually recognize gains as the loans perform significantly better than the market currently believes. On the downside, taking those large mark-to-market losses because of acquisition accounting will force Wells to raise additional funds to support the loan book.
Wells has announced it will raise as much as $20 billion in additional capital, mostly through common stock, to fund this deal. This will be necessary if Wells has to take the expected mark-to-market losses, but nothing is guaranteed. It is possible Wachovia or Wells will arrange a sale of some of the more toxic assets to the government shortly before or after the transaction is completed, as a part of the proposed bailout plan. It is these types of details that leave us highly uncertain as to the long-term value of this deal. While we currently have a favorable eye on the transaction, we are placing Wells Fargo under review until we get more information.
