After Change In Tax Law, Wells Fargo Swoops In

The New York company said it is reviewing its options. Citigroup and Wachovia signed an agreement to negotiate a final deal exclusively. The agreement, provided to The Washington Post by Citigroup, bars Wachovia from talking with other companies. And legal experts said that it appears to be unusually strong, giving Citigroup considerable legal leverage.

"Citigroup is now in a good bargaining position to go to Wachovia and Wells Fargo and say, 'You know something, clearly you breached this agreement,' " said Elizabeth Nowicki, a law professor at Tulane University and an expert on mergers and acquisitions.

Nowicki said Citigroup could simply demand a large payment or it could try to force Wachovia back to the negotiating table. Citigroup also could choose to raise its bid, perhaps taking advantage of the tax benefits now available to any bank that buys Wachovia.

Those tax advantages are the key to understanding the unusual events of the past week.

Wachovia was laid low by a series of bad deals in recent years, culminating in 2006 with the $25 billion acquisition of Golden West Financial, a major California mortgage lender. As the housing market and the economy weakened, Wachovia found itself holding hundreds of billions of dollars in troubled loans. By last weekend, federal regulators were increasingly concerned that the company might collapse, forcing the FDIC to cover its depositors.

Federal regulators thought Wells Fargo was ready to buy the bank, but the company walked away from the table Sunday afternoon, saying it could not afford to absorb the losses on Wachovia's loan portfolio.

That left Citigroup as the sole bidder. Government regulators negotiated with the company through the night before announcing a deal early Monday morning.

Citigroup agreed to buy Wachovia's banking business but not its retail brokerage or asset management business. In exchange, the FDIC promised to limit Citigroup's losses on a $312 billion portfolio of Wachovia's most troubled loans. The government agreed to absorb all losses beyond $42 billion in exchange for a $12 billion stake in Citigroup.

Wachovia and Citigroup immediately entered final talks on a merger agreement. And Citigroup began providing Wachovia with cash to stay in business.

Then, on Tuesday, Wachovia's troubled loan portfolio -- specifically its losses -- were transformed by the government from straw into gold.

Companies are allowed to shelter profits from taxation based on their past losses. When a profitable company buys a company with losses, however, the government historically has limited the profitable company's ability to shelter its income based on the acquired company's losses. In the case of Wells Fargo, the company could only have sheltered about $1 billion in income each year, said Willens, the accounting expert.

The Tuesday change, however, specifically removes limits on the income banks can shelter based on the losses of acquired companies. In announcing its deal for Wachovia, Wells Fargo estimates it would write down $74 billion in losses on Wachovia's loan portfolio.