Citi ends talks, Wells says it will buy Wachovia

On Monday, the parties agreed to a legal standstill, which was extended on Wednesday and set to expire Friday morning.

Federal Reserve officials had been working this week with Citigroup and Wells Fargo to try and reach a quick resolution and avoid a lengthy court battle. But the parties could not come to an agreement on how to divide Wachovia’s assets, including its risky mortgage and complex investment portfolios, according to two people close to the talks. The people agreed to speak on condition of anonymity due to the sensitivity of the matter.

In the end, Citigroup was not willing to take on more risk than the $42 billion in losses to which it had originally agreed, the sources said.

Under Citigroup’s deal with Wachovia, the bank planned to assume $53 billion worth of debt and agreed to absorb up to $42 billion of losses from Wachovia’s $312 billion loan portfolio. The FDIC agreed to cover any remaining losses in exchange for $12 billion in Citigroup preferred stock and warrants.

Wells Fargo, on the other hand, said it expected to take a $74 billion hit on Wachovia’s $498 billion loan portfolio. The bank said it expects to incur the majority of credit costs in the next two years, and for the transaction to add meaningfully to earnings after that.

Wells Fargo, which has logged three straight quarters of profit declines, will likely benefit from new tax leeway from the Internal Revenue Service that allows companies to offset losses from companies they acquire with tax breaks. The potentially bigger tax offsets could boost the income of banks that buy other banks with losses from mortgage assets.

In connection with the agreement, Wachovia will issue Wells Fargo preferred stock representing 39.9 percent of Wachovia’s voting power. This increases the probability that the transaction gets consummated quickly and that Wells Fargo will receive a positive shareholder vote, Wells Fargo said.

Subsequently, Wells Fargo plans to issue up to $20 billion of stock, primarily common stock, to maintain a strong capital position.

Wells Fargo said last week that Charlotte will be the headquarters for the combined company’s East Coast retail and commercial and corporate banking business. St. Louis will remain the headquarters of Wachovia Securities.

The combined company will have total deposits of $713 billion and more than 6,500 locations — more than any other bank in the U.S.

While there is some overlap in states like California and Texas, the deal essentially opens up the entire East Coast to Wells Fargo, giving it a footprint in new markets such as New York and Miami.

In terms of total assets, a combined Wells Fargo-Wachovia would have $1.37 trillion in estimated pro forma assets as of the end of this year. As of June 30, Bank of America Corp. had $2.72 trillion in assets including those of Merrill Lynch & Co., which it is acquiring. Citigroup had $2.10 trillion and J.P. Morgan Chase & Co. had about $1.78 trillion, including Washington Mutual’s assets.

Wells Fargo has been weathering one of the nation’s worst credit crises much better than most of its competitors, in part because it had less exposure to the subprime mortgages whose failure has undermined the financial sector.

Wachovia shares jumped $1.09, or 30 percent, to $4.69 in after-hours trading. Wells Fargo shares gained 10 cents to $27.35, while Citigroup shares fell 22 cents to $12.71.

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