Citigroup, Morgan Stanley to merge brokerages

NEW YORK (Reuters) - Citigroup Inc (C.N) agreed to merge its Smith Barney brokerage with Morgan Stanley's (MS.N) wealth management unit, a big step in the possible dismantling of what was once the world's largest bank.

The joint venture will create the largest U.S. brokerage, known as Morgan Stanley Smith Barney, with more than 20,000 brokers and $1.7 trillion in client assets. The brokerage force will surpass Bank of America Corp (BAC.N), which bought former No. 1 Merrill Lynch on January 1.

Morgan Stanley will pay Citigroup $2.7 billion in cash for an initial 51 percent stake in the venture that could increase to 100 percent after five years, the companies said on Tuesday.

Citigroup, meanwhile, is expected to shed "non-core" businesses and may announce plans on January 22, a person familiar with the matter said, the same day it is expected to post a big fourth-quarter loss.

The joint venture could be a major step in the dismantling of Sanford "Sandy" Weill's "financial supermarket" vision when his Travelers Group bought Citicorp in 1998 to create New York-based Citigroup.

Chief Executive Vikram Pandit is now shedding assets as the bank, the nation's third largest, was humbled by massive credit losses and writedowns tied to the world financial crisis. Citigroup lost $20.3 billion in the year ended September 30, largely from mortgage and other complex debt.

"Citigroup's model was let's get bigger, and that will make us better," said Robert Millen, who helps invest $2.5 billion at Jensen Investment Management in Portland, Oregon and doesn't own the bank's shares. "It didn't work that way."

The two companies were awarded a combined $55 billion from the Treasury Department's $700 billion taxpayer-funded Troubled Asset Relief Program (TARP).

COST SAVINGS EXPECTED

The venture will include Morgan Stanley's wealth management business, and Citigroup's Smith Barney, Smith Barney Australia and its British unit Quilter. It will not include Citi Private Bank or Nikko Cordial Securities.

Morgan Stanley may boost its stake in the venture to 65 percent after three years, 80 percent after four years, and 100 percent after five years.

The banks expect $1.1 billion in cost savings, or 15 percent of combined expenses, excluding broker commissions.

About $320 million of the savings would come from personnel, $350 million from technology and back-office operations, and $180 million from marketing and other services.

In after-hours trading, Citigroup shares fell 8 cents to $5.82, after closing up 30 cents to $5.90 in regular trading. Morgan Stanley shares fell 35 cents after hours to $18.51 after rising 7 cents to $18.86 in regular trading.

Morgan Stanley will be able to diversify its revenue stream less than four months after adopting a bank holding company structure to gather low-cost deposits and survive, unlike smaller rivals Bear Stearns and Lehman Brothers Holdings Inc (LEHMQ.PK).

Wealth management "will be an increasingly important and profitable part of Morgan Stanley's business in the years ahead," Morgan Stanley Chief Executive John Mack said in a statement.

Citigroup expects to recognize a $5.8 billion aftertax gain on the transaction and add $6.5 billion of tangible common equity, strengthening its balance sheet.

This would follow the bank's receiving $45 billion from TARP, including $20 billion in an emergency November rescue that shielded Citigroup from some losses on $306 billion of troubled assets.

"We will generate equity capital that we can deploy to other core businesses," Pandit said in a statement.

Morgan Stanley got $10 billion of TARP money. The company said the venture will likely cause its Tier-1 capital level to fall, though book value will increase.

KEEPING BROKERS

James Gorman, a Morgan Stanley co-president, will retain that role and be chairman of the joint venture, making him a top candidate to eventually succeed Mack at the helm of all of Morgan Stanley.

Charles Johnston, who has been president of Citigroup's global wealth management business in the United States and Canada, will be president of the joint venture.

Brokerage combinations often result in attrition, and the joint venture will need to focus on retaining brokers, according to Paul Tramontano, CEO of Constellation Wealth Advisors and a Smith Barney broker for 17 years.

He said five Smith Barney brokers called him on Tuesday afternoon for guidance about their futures.

"At a big firm, the temptation is to stuff products into your sales channel, which are not always the best products for clients," Tramontano said. "How often will a big firm produce a product that is in the best interests of clients? Clients and brokers will vote with their feet."

Fox-Pitt Kelton analyst David Trone said Tuesday the venture may impede JPMorgan Chase & Co (JPM.N) CEO Jamie Dimon's efforts to expand in retail brokerage. The bank was not immediately available for comment.

The transaction is expected to close in the third quarter, pending regulatory approvals and other conditions. A board of directors will include representatives from both companies.

The law firm Wachtell Lipton Rosen & Katz advised Morgan Stanley, and the law firm David Polk & Wardwell advised Citigroup. The law firm Cravath, Swaine & Moore LLP said it advised Citigroup's independent directors.

(Reporting by Joseph A. Giannone and Dan Wilchins; additional reporting by Paritosh Bansal, Jonathan Spicer and Jonathan Stempel; writing by Jonathan Stempel; editing by Jeffrey Benkoe)