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Wachovia Runs Out of Ground


Citi devours bank, shares loss with FDIC.

Saddled with mounting losses in its huge mortgage portfolio, Wachovia (WB) has become the latest bank to lose its independence.

Rumors swirled over the weekend: The company was said to be in advanced talks with both Wells Fargo (WFC) and Citigroup (C) about a potential merger. Formerly the nation's sixth-largest bank, Charlotte-based Wachovia would have provided either suitor a retail stronghold in its native southeast. For Wells Fargo in particular, this would have nicely complemented their strong presence on the West Coast.Minyanville's Why Wall Street Will Never Be the Same

In the end, Citigroup managed to close the deal, with a little help from its friends at the FDIC.

Citi will pick up the majority of Wachovia's operations, as well as the bulk of its assets and liabilities. With respect to its $312 billion mortgage portfolio, the Wall Street Journal reports, Citi will assume the first $42 billion in losses and the FDIC will be on the hook for the rest. In return, the FDIC will receive $12 billion in preferred stock and warrants.

Notably, Wachovia didn't fail, as Washington Mutual did just last week. Citigroup will be assuming the company's senior and subordinated debt, which is good news for the credit default swap market. After the collapses of Lehman Brothers and WaMu triggered billions in insurance obligations, the giant unregulated market is struggling to sort out the chaos of tangled contracts.

The transaction's sticking point was Wachovia's massive portfolio of Option Adjustable Rate Mortgages, or Option ARMs. After its ill-fated purchase of California thrift Golden West at the peak of the housing market in 2006, Wachovia has seen falling home prices and rising delinquencies chew through its balance sheet.

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No positions in stocks mentioned.

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