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Back to the future: 'New' Wachovia looks a lot like 'old' A.G. Edwards

This article first appeared in the St. Louis Beacon: September 29, 2008 - Monday's deal between Wachovia Corp. and Citigroup may provide temporary relief but could also cause uncertainty for Wachovia's St. Louis-based brokerage business.

The relief comes from Citigroup's willingness to buy the albatross of bad mortgages -- as well as the coveted retail banking business -- from Wachovia, essentially leaving the brokerage and asset management units as the "new" Wachovia.

The uncertainty is based on a lack of details as to the value of the new Wachovia, which will remain a public company.

Analysts say the Citigroup-Wachovia announcement didn't provide enough information about how much debt will be assigned to the new Wachovia.

The Wachovia brokerage and Evergreen mutual fund businesses "are good assets to start over with," says John J. "Joe" Terril, founder and president of Terril & Co., a St. Louis investment advisory firm. "The wild card is how much debt will be with this company."

Although the "immediate future" for the brokerage business isn't favorable due to the economic crisis, Washington University's Radhakrishnan Gopalan says a stand-alone company, unencumbered by heavy debt, can thrive.

"The biggest asset for a brokerage is its client relationship," says Gopalan, assistant professor of finance in the Olin Business School.

However, the relationship with Wall Street remains unsettled, and that means analysts don't know what stock price the new Wachovia will command. If the price is considered too low, the new Wachovia might be picked off by another financial institution seeking to build its retail brokerage and asset management businesses.

Wachovia's stock closed Friday at $10. The stock was halted on the New York Stock Exchange for most of Monday. When trading resumed, the stock fell to $1.81. In only 90 minutes of trading, more than 375 million shares -- or nearly four times the average daily volume -- were traded.

If the Citigroup deal is completed, the new Wachovia will look like a bulked-up version of the former A.G. Edwards. Wachovia hadn't fully digested its purchase of A.G. Edwards, a process that Wachovia executives had said would be completed next next year.

One short year ago, on Oct. 1, 2007, the day the A.G. Edwards deal was completed, Wachovia's stock closed at $50.92.

RUMORS, TALKS, AGREEMENT

Over the weekend, rumors spread that Wachovia was talking to several banks -- Citigroup, Wells Fargo and Spain's Banco Santander -- about them buying all or parts of Wachovia.

A total takeover by Citigroup would have presented extra difficulties, said Vikram Pandit, the Citigroup CEO in a Monday telephone conference call with analysts.

Pandit said his company had already exited the asset-management business, "so we have no real strategic need" for Wachovia's Evergreen mutual fund operation.

"You know we've got Smith Barney, which is a great retail [brokerage] system," Pandit added. Rather than combine the brokerages, the deal will "actually enhance the value both to Wachovia shareholders as well as our shareholders and keep the clarity of the fact that we only have to integrate one set of businesses."

Based on early 2007 figures supplied by Wachovia, Citigroup's Smith Barney unit ranked just behind the combined Wachovia-A.G. Edwards in the number of experienced brokers and was tied in total revenue from brokerage activities.

The bare bones of Monday's agreement, approved by the boards of both companies, calls for Citigroup to pay Wachovia approximately $2.16 billion in stock. It will assume Wachovia's senior and subordinated debt worth approximately $53 billion. Citigroup also will acquire more than $700 billion of assets of Wachovia's banking subsidiaries and related liabilities.

"During recent weeks, the financial landscape has changed significantly and presented us with unprecedented challenges," said Robert K. Steel, the Wachovia CEO, in a prepared statement. "Today's announcement is the best alternative for the company, enabling a resolution on the (distressed mortgage) portfolio."

Citigroup added that the new Wachovia "expects to have adequate capital to support its remaining businesses, an appropriate allocation of tangible equity, and certain tax assets that will be recognized immediately." The deal, which requires antitrust clearance, is expected to close by year-end.

Many, many questions yet to be answered

Banking analysts want to see more of the fine print in the Wachovia-Citigroup agreement.

"We believe there are more questions than answers at this point," says banking analyst Christopher Mutascio, of Stifel Nicolaus, in a Monday report to clients. "The next question is what is the 'new' Wachovia worth? This is hard to determine because we just don't have all of the pieces of the puzzle yet."

Mutascio, who has a hold rating, says the biggest question is what happens to $9.8 billion in preferred stock held by Wachovia shareholders. Although Citigroup is assuming most of Wachovia's debt, the analyst says it appears it isn't taking on preferred stock.

Preferred stock is considered less risky than common stock -- but riskier than bonds. In the pecking order of investors, common shareholders come last if a company is liquidated. Preferred shareholders are second to last.

If the new Wachovia assumes responsibility for the preferred stock, the after-tax charge would be $500 million, he says. In that case, the $1.3 billion in net income from the brokerage and asset management businesses over the past 12 months would be reduced to $800 million, Mutascio says.

"We are not assuming that the new Wachovia can earn $800 million a year," he adds. "We simply do not have the information yet as to what debt will be retained by Wachovia."

Mutascio also says it's unclear about how much corporate overhead would be assigned to the new Wachovia. "This could further reduce the earnings power," he says.

Another element of uncertainty traces back to Wachovia's incremental efforts to build its brokerage business prior to its acquisition of A.G. Edwards.

Between 1998 and 2007, Wachovia bought five other brokerages. In 2003, it signed a joint venture agreement with Prudential Financial for that company's brokerage business.

This deal enables Prudential to sell its stake under certain circumstances. According to a Monday report by UBS Securities, Prudential has a choice of selling its 38 percent stake in the Wachovia brokerage business created prior to the A.G. Edwards deal or a stake valued in the low-20 percent to mid-20 percent of the larger Wachovia brokerage business.

In any case, UBS insurance industry analyst Andrew Kligerman predicts Prudential could sell its stake for $5 billion whether the new Wachovia is a stand-alone company or is acquired. If Wachovia stays a stand-alone company, the major risk to Prudential Financial shareholders would be "client loss and reputation damage," Kligerman says in a Monday report.

"It is possible that Wachovia can operate as a stand-alone company," adds Matthew O'Connor, who follows Wachovia for UBS, in a Monday research note.

"However, given all of the turmoil from today's events, we wouldn't be surprised if Wachovia is sold at some point in the near term," says O'Connor, who is neutral on the stock.

Local analysts see silver lining

Closer to home, however, some St. Louis finance experts believe a stand-alone company could be good news.

A successful Citigroup deal "will calm down the brokers" at the St. Louis-based brokerage, says Juli Niemann, executive vice president of the Clayton-based financial advisory firm Smith, Moore & Co. Wachovia's brokers won't have to answer questions about the mortgage business that dragged down Wachovia's stock, she says. "It soiled the name."

And if the new Wachovia has to undergo restructuring, Niemann expects consolidation will send people into St. Louis, thus producing a "stabilizing event."

As for the new Wachovia becoming an instant takeover target, she doubts any financial services company will contemplate an acquisition "unless it is looking at a distressed property."

Washington University's Radhakrishnan Gopalan agrees that the new Wachovia could be safe from predators for a while. "Banks are in no position to diversify right now," he says.

"I think they will stick to their core businesses." A takeover "is always possible, but I don't see any banks healthy enough to make a big acquisition."

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