Citigroup [will] acquire Wachovia's banking operations . . . . The FDIC is providing loss protection to Citi in support of transaction . . . . Wachovia will remain a public company and retain its asset management, retail brokerage, and certain select parts of its wealth management businesses, including the Evergreen and Wachovia Securities franchises. . . . Citi will pay Wachovia approximately $2.16 billion in stock and assume Wachovia senior and subordinated debt, totaling approximately $53 billion.
The transaction still leaves some questions about what "loss protection" for Citi from the FDIC means. How real is the risk of a loss and what is its likely and possible magnitude?
The Citigroup press release helps a little in understanding the isuse:
Citi will acquire more than $700 billion of assets of Wachovia's banking subsidiaries, and related liabilities. The Federal Deposit Insurance Corporation (FDIC) has agreed to provide loss protection in connection with approximately $312 billion of mortgage-related and other Wachovia assets. Citi is responsible for the first $30 billion of losses on this portfolio, and expects to record these expected losses under purchase accounting upon closing of the transaction. Citi is also responsible for the next $12 billion in losses up to a maximum of $4 billion per year for the next three years. Citi has also agreed to issue to the FDIC preferred stock and warrants with a combined value of approximately $12 billion. The FDIC has agreed to be responsible for any further losses on this portfolio.
The scale of this loss protection is breath taking. It rivals the proposed bailout bill in the scale of the assets guaranteed. At 10% loss on the mortgage related assets certainly doesn't seem out of the realm of possibility, so the FDIC may take a real loss on this deal. I certainly hope that the good folks at the FDIC have properly evaluated the risk and determined that they won't get burned too badly.
It also raises questions about what the financial structure of rump Wachovia will look like after the transaction closes. The press release mearly notes that "Going forward, 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."
Will Wachovia have no debt at all? Presumably rump Wachovia will still have some publicly held shares. Will current shareholders get some rump Wachovia shares and then cash or will they get Citi shares, or will they have publicly held shares merely in the Wachovia subsidiary? This is quite odd for this type of business, which is usually more leveraged than a commercial bank.
Still, it does prove once again how effective the FDIC has been a dealing with the financial crisis in a way that appears to have the federal government spending little on the deal. The conversion of other big investment banks to the commercial banking regimes presumably allows the FDIC to deal with their failures, if any, as well and to broker similar deals with them.
Other FDIC brokered deals have often swiftly led to the bankruptcy of the rump entity. Is Wachovia's rump operation likely to follow in the same footsteps? The very fact that the FDIC was involved at all suggests that Wachovia's financial situation was perilous before this deal was concluded.