Citi, Wells Fargo: Why the Wachovia Fight?

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"It's a better deal for Wachovia shareholders and a better deal for the FDIC, and therefore for taxpayers," says Matthew Warren, an equity analyst at Morningstar (MORN). Standard & Poor's equity analyst Stuart Plesser said he expects Citigroup may be able to "collect a fee for the breakup of the deal."

The potential collapse of the Citi-Wachovia merger robs Citi of a large opportunity. "This was a really good deal for Citi," Plesser says.

Trumping Citi?

Citi won't get the extra capital from Wachovia's deposits. Plus, Wells Fargo, and not Citi, will get the first chance to get big enough to challenge the larger BofA and JPMorgan Chase as national players.

With Washington Mutual already sold to JPMorgan, few very large institutions remain that would come at a cheap price. "There are not many more that will give you a national presence," Ellis says. Banks looking to get huge may need to make several smaller acquisitions of regional players to make up for one Wachovia deal.

Wells Fargo's ability to trump Citi is a sign of how differently the two banks have fared during the past year's credit crisis. Wells Fargo shares are down just 6.6% in the past year, while Citi's stock has dropped 62%, including an 18% plunge to 18.35 on Oct. 3. That reflects the far more significant damage to Citi's balance sheet from the credit crisis compared to Wells Fargo, which, through conservative lending and investment strategies, has avoided the worst of the mortgage-related woes. Wells Fargo shares dipped 1.7% to finish the week at 34.56.

Opportunities in Bad Times

In a Sept. 25 interview with BusinessWeek, before the Wachovia deal was announced, Wells Fargo Chief Executive Officer Dick Kovacevich said his bank still prefers smaller, conservative transactions. "We've always done more deals in the bad times than in good times and right now we have more opportunities than we've ever had," Kovacevich said. "We still prefer small to big deals and we prefer those deals in the geographies we're already in. We will only do deals that make sense, where we think the risk is manageable and where the downside is very, very low relative to the upside."

When it comes to banks, "the weak will get weaker and the strong will get stronger," Plesser says. "That's a trend that's playing out."

Citi says it will be fine without a Wachovia acquisition. "With or without this transaction, Citi maintains an unmatched, globally dominant franchise with strong liquidity, total deposits exceeding $800 billion, and a Tier 1 capital ratio of 8.7% as of the second quarter," Citi said in an Oct. 3 statement.

"Without the deal, [Citi] kind of lumbers along," Morningstar's Warren says. "They're in rebuilding mode." A new management team at Citi has focused on repairing the bank's troubled balance sheet, partly through sales of its many businesses around the world. Charlie Smith, chief investment officer at Fort Pitt Capital Group, which owns Citigroup stock, says Citi needs to continue this strategy rather than pursuing a major acquisition. "They need to get their own balance sheet in order," he says.

Who's Next?

After Wells Fargo, many are wondering if other big banks will pursue acquisitions. There's a shortage of big banks strong enough to make large acquisitions, Plesser says, but one possible acquirer that hasn't been active yet is U.S. Bancorp (USB). The nation's sixth-largest commercial bank, U.S. Bancorp, like Wells Fargo, has avoided the worst of the credit crisis and its shares have gained 5% in the past year.

Still, banks looking to bulk up might not want to wait too long. Until now, banks have been content to watch their troubled acquisition targets slip toward collapse or bankruptcy, and only then pounce with cheap buyout offers.

If the credit crisis continues to deepen, that strategy may continue to work. But if the credit situation stabilizes, analysts say, banks may prefer to remain independent rather than be sold at cheap prices.

With its hopes for a Wachovia acquisition fading, Citi may have to wait, rehabilitate its balance sheet, and then hope there are more good buyout opportunities still available. If not, even this global bank may start to feel small in a banking world dominated by a few huge players.

Steverman is a reporter for BusinessWeek.com's Investing channel, based in Chicago.
With Mara der Hovanesian in New York