Sunday, October 5, 2008 0 comments ++[ CLICK TO COMMENT ]++

What's Happening With Wachovia?

If the word bizarre were to apply to something right now, I don't think you can find better candidates than Wachovia. For those not following the situation, Wachovia is a large US bank that has been rumoured to be on the verge of failure due to potentially large losses from real estate mortgages. After the collapse of Washington Mutual, the situation looked volatile. Wachovia had been trying to raise capital by selling off assets or somehow limit the damage by merging with a stronger party. It looked like it failed on that front.

It is not clear what exactly happened but a takeover of the core company by Citigroup was announced, with Wachovia shareholders ending up with a remaining small portion (essentially a huge loss for shareholders.) The deal was brokered through the bank regulator, FDIC, with FDIC absorbing losses above a certain amount. In return, Citigroup was to provide some compensation to FDIC.

The thing that is not clear is whether the FDIC "forced" Wachovia into a merger with Citigroup. Some also claim that Wachovia would have failed within one week if Citigroup didn't agree to the takeover. It looks like Citigroup provided funding on the Monday after the proposed deal to Wachovia in order to prevent any collapse. Wachovia was nowhere near a collapse if its accounting statements are to be believed. However, the way the government has been interpreting the situation, even a small threat seems to give enough reason for them to act. For instance, the takeover of Fannie Mae and Freddie Mac occurred under the most dubious of circumstances, where widely accepted accounting standards would not have shown them to be insolvent. If Fannie and Freddie were insolvent now, they were insolvent last year!

In any case, late last week, things started to enter the bizarre realm when Wells Fargo made an offer to buy Wachovia. Wells Fargo's offer is for the full company and shareholders would end up with a lot more. The FDIC also would not be involved and hence neither gets paid nor is there any possibility of it taking losses. Intially, Wells Fargo was asked to bid on Wachovia and chose not to before the deadline. But a change to a tax rule was made last week that now enables Wells Fargo to write off the potential losses from Wachovia.

Citigroup is suing to block the deal and a court has ruled in its favour. Some say that the Citigroup takeover agreement is not strong enough to prevent the alternate Wells Fargo takeover. It's not clear what will happen. If this ends up being a lengthy legal battle, it'll be interesting to see what the FDIC will do if Wachovia ends up almost collapsing. This situation is also different from some of the other ones in the past in that a shareholder vote is being taken (as far as I know.) Even if the court blocks the Wells Fargo deal, it may be void if Wachovia shareholders vote against it.

I guess this shouldn't be a surprise given how the story is unfolding but it looks like William Ackman--yes, that becoming-famous-by-the-day activist investor--has taken a huge stake in Wachovia after the Citigroup deal was announced. The market cap plummetted over the last year so Ackman's 9% stake is not that large in dollar terms. Nevertheless, it is quite possible that he is the largest shareholder right now. William Ackman is set to make a presentation on Wachovia during an event at the Value Investing Congress on Monday. I'm not sure what Ackman's strategy here might be. He isn't a passive investor so he clearly took this position to initiate some change.

There are huge implications from this situation--and I'm not talking about what happens to Wachovia.

The main result of all this is that it makes the FDIC look bad--real bad! If Wachovia wouldn't have collapsed by the Mondy of the week then it is questionable whether FDIC should have been involved in any of this. Furthermore, Wells Fargo blatantly ignored the FDIC bid deadline and made an offer behind FDIC's back later in the week. Admittedly, the tax change occurred afterwards--I really hope that the government didn't pass this just to placate Wells Fargo alone (it would be extreme corporate welfare if that were the case)--but the notion of bidding and making offers would face a huge setback if parties were allowed to come in and make bids after competitors disclose their bid and intentions. No one is going to bid by the deadline and no one is going to take anything FDIC says seriously. Reputational damage to FDIC is far greater than the failure or survival of Wachovia.

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