Citigroup Acquires Wachovia Banking Operations

This morning the Federal Deposit Insurance Corporation (FDIC at www.fdic.gov) announced that Citigroup (Citigroup Charts) will acquire the banking operations of Charlotte, North Carolina's Wachovia Corporation (WB.) This transaction was facilitated by the FDIC and concurred with by the Board of Governors of the Federal Reserve and Hank Paulson, the Secretary of the Treasury, in consultation with the President, George Bush.

Wachovia did not fail. Instead it was acquired by Citigroup Inc with assistance from FDIC. Comments from FDIC Chairman Sheila C. Bair:

"For Wachovia customers, today's action will ensure seamless continuity of service from their bank and full protection for all of their deposits."

"On the whole, the commercial banking system in the United States remains well capitalized. This morning's decision was made under extraordinary circumstances with significant consultation among the regulators and Treasury."

"This action was necessary to maintain confidence in the banking industry given current financial market conditions."

Citi will pay Wachovia about $2.16B in Citigroup stock. Wachovia will continue to own AG Edwards and Evergreen which will add to this baseline valuation. The Citigroup shares give Wachovia a value of about $1.00 per share (Wachovia has 2.14B shares outstanding) plus whatever value the market assigns to the remaining assets.

Further terms of the agreement:

• Citigroup will absorb up to $42 billion of losses on a $312 billion pool of loans.
• The Federal Deposit Insurance Corp. will absorb losses beyond that in exchange for $12 billion in Citigroup preferred stock and warrants to compensate the FDIC for bearing this risk.

On the acquisition, Citi cut its quarterly dividend 50% to 16¢ a share . On an annual basis, the dividend was cut from $1.28 to $0.64 per share. At $20.00 a share, Citigroup yields 3.20%.

Citigroup also announced it will raise about $10B in new capital, further diluting stockholder equity.

Citigroup CEO Vikram Pandit said of the deal,

“Citi will have more than $600 billion in deposits in the United States, giving us about a 9.8 percent market share. Our total deposits will be $1.3 trillion globally, $350 billion more than our next largest U.S. competitor, making us one of the world’s largest core deposit-funded financial institutions.”

On this deal with government backing, Citigroup became one of the "anointed banks" that the government has deemed worthy of FDIC assistance or too large to fail.

Citigroup traded as low as $19.44 near the open then quickly recovered to $20.00, down 15¢ from Friday's closing price.

Disclaimer: I own in my personal portfolio and have recommended trading Citigroup around a core position in "Kirk's Investment Newsletter Explore portfolio" that is on "house money" from buying in 1998 and taking significant profits (more than twice what I put into the stock) in July and August 2000. Since then, I have done some minor trading around the remaining shares as a core position. I my buy back some of the shares I sold eight years ago when it looks like the dust settles as these huge financial panics are usually exceptional times to buy the very best of the best that survive. To learn what I recommend for newsletter portfolios, subscribe now!

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Washington Mutual - Largest Bank Failure in History

Yesterday the government seized the assets of Seattle's Washington Mutual (WM,) affectionately known as WaMu. At the same time, the government brokered an emergency sale of most of the assets to JP Morgan Chase (JPM.) The deal saves taxpayers and FDIC from another loss as JPM assumes the risk in exchange for the assets at a bargain basement price. WaMu customers should not be affected while shareholders and some bondholders will get nothing.

The failure of Seattle's Washington Mutual is the largest bank failure in History.

We knew Washington Mutual was in trouble because it has appeared high on the survey of "Best CD Rates" where it had the highest 5-year CD rate, currently at 5.0%, for some time. Troubled banks are paying high CD rates to attract capital at far better rates then they can get on Wall Street. For example, AIG is paying LIBOR plus 8% and 80% share dilution to the Government. The current LIBOR rate is 3.46% so AIG is paying more than double the rate WaMu pays for CDs. I suspect WaMu will continue to offer high rates to keep customers during the transition to JP Morgan Chase.

See "Washington Mutual Bank Best CD Rates with FDIC" for current rates as of 9/23/08

WaMu was also #14 on "Dick Bove's List of Banks In Danger of Failing" under the category of "non performing assets as a percentage of equity" so we had plenty of warning in advance. Someone close to me cashed in their WaMu CDs last week, paid the penalty, reinvested $99,000 at WaMu for total FDIC protection of principal and interst until the dust settled then invested the remainder of the money in a new bank for to get full FDIC protection. The government acted before more people pulled their money out and created another run on a bank.

Jamie Dimon, Chairman and CEO of JP Morgan Chase said, "We think this builds a great franchise for us....We are building this franchise for the long term, not next year or the next five years but the next one hundred years."

Merrill Lynch: "The strategic fit is good and exactly what the company has long articulated it wanted, at a knock-down price which manages the risks. "

Deutsch Bank: "Earnings accretion (to JPM ) is mostly offset by P/E dilution and a higher risk profile. Maintain Hold."

Disclaimer. I own and trade XLF, the financial sector ETF, around a core position that is well in the money for both my personal portfolio and "Kirk's Investment Newsletter Explore portfolio." JPM is the number two holding of XLF according to ETFConnect.com:

Holding As of 04/30/2008	% of XLF
Bank Of America Corporation	8.05
Jp Morgan Chase & Co	7.82
Citigroup Inc	6.08
American Intl Group Inc	5.02
Wells Fargo & Co New	4.78
Goldman Sachs Group Inc	3.67
Wachovia Corp New	2.91
Us Bancorp Del	2.87
American Express Co	2.8
Morgan Stanley	2.51

The best news is for taxpayers who won't have any loss from this deal.

FDIC List of Banks in Danger of Failure Soars

FDIC List of Problem Banks up 30%: On Tuesday, August 26, 2008 the Federal Deposit Insurance Corporation (FDIC www.fdic.gov) announced in its quarterly banking report that their list of "problem banks" (see "Problem List" below) for the second quarter of 2008 increased 30% from to 117 financial institutions. The 117 institutions on the problem list is the largest number since the middle of 2003. Total assets of institutions on the problem list increased 200% from $26 billion to $78 billion. $32 billion of this $56 gain came from IndyMac Bank, F.S.B., Pasadena, CA, which failed in July.

NEW==> Thursday, February 26, 2009:
FDIC List of Banks in Danger of Failure Soars 47%

Reported net income of member institutions fell 86.5% or $31.8 billion to only $5.0 billion, the lowest earnings for the industry except for the fourth quarter last year (2007) and the fourth quarter of 1991.

"By any yardstick, it was another rough quarter for bank earnings, but the results were not unexpected as the industry coped with financial market disruptions, the housing slump, worsening economic conditions and the overall downturn in the credit cycle." said FDIC Chairman Sheila C. Bair.

This decline in the banking industry is reflected in the Economic Cycle Research Institute's (ECRI) Weekly leading index which has fallen to a 28-year low, the lowest reading since June 13, 1980.

For more information, see:

• ECRI WLI Growth Rate at 28-Year Low
  and
• August 2008 Fixed Income Report with a graph of ECRI's WLI vs the DJIA
  

Other major findings in the FDIC's latest Quarterly Banking Profile include:

Provisions for loan losses continue to be the main cause of falling earnings.

"Rising levels of troubled loans, particularly in real estate portfolios, led many institutions to increase their provisions for loan losses in the quarter. Loss provisions totaled $50.2 billion, more than four times the $11.4 billion the industry set aside in the second quarter of 2007. Almost a third of the industry's net operating revenue (net interest income plus total noninterest income) went to building up loan-loss reserves."

Noncurrent loans are up 20% to 2.04% of all loans. The number continues to rise quickly to the highest level since 1993.

"The amount of noncurrent loans and leases (90 days or more past due or in nonaccrual status) increased by $26.7 billion during the second quarter, following a $26.2 billion increase in the first quarter and a $27.0 billion increase in the fourth quarter of 2007. Almost 90 percent of the increase in noncurrent loans and leases in the last three quarters consisted of real estate loans, but noncurrent levels have been rising in all major loan categories. "

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Assets of insured member institutions declined.

"Total assets of FDIC-insured institutions declined during the quarter for the first time since 2002. The $68.6 billion (0.5 percent) decline was caused by a reduction in trading assets at a few large banks. Assets in trading accounts, which increased by $135.2 billion in the first quarter, declined by $118.9 billion (11.8 percent) in the second quarter. In addition, the industry's holdings of one- to four-family residential mortgage loans fell by $61.4 billion (2.8 percent). Real estate construction and development loans declined for the first time since 1997, falling by $5.4 billion (0.9 percent)."

==> Very Best CD Rates with FDIC <==

The FDIC's Deposit Insurance Fund reserve ratio fell.

"Due to a significant increase in loss reserves, including reserves for failures that have occurred since June 30th, the DIF balance fell to $45.2 billion at the end of the second quarter, down from $52.8 billion at the end of the first quarter. While insured deposits rose only 0.5 percent during the quarter, the decline in the fund balance caused the reserve ratio to fall to 1.01 percent as of June 30th from 1.19 percent one quarter earlier. Because the reserve ratio is now below 1.15 percent, the Federal Deposit Insurance Reform Act of 2005 requires the FDIC to develop a restoration plan that will raise the reserve ratio to no less than 1.15 percent within five years."

Problem List: The FDIC does not make its list of member institutions in danger of failing public because it does not want to contribute to a "run on the bank" by concerned depositors. One indication a bank may be on the list is they pay very high CD rates in an attempt to attract capital. Richard (Dick) Bove of Landenburg Thalmann has a methodology for estimating what banks are in trouble.

See Dick Bove's List of Banks In Danger of Failing

IndyMac Bankcorp was at the top of Bove's list before it failed based on non performing assets as a percentage of equity.

Graph: ECRI's WLI growth vs the DJIA

Make sure you read the attached "August 2008 Fixed Income Report" to see my graph of ECRI's WLI growth rate vs. the DJIA. You can see WLI growth started its plunge well before the stock market peaked last summer.