Wachovia deal could help Citigroup raise capital

NEW YORK (Reuters) - If Citigroup Inc misses out on its chance to buy Wachovia Corp's banking assets, it will also miss out on a good chance to raise capital, which to some analysts would be Citigroup's biggest loss from a broken deal.

Citigroup announced last week that it had reached a preliminary agreement to buy Wachovia's banking assets for about $2.2 billion in stock, and said it planned to raise $10 billion of new capital to help finance the purchase.

Now there is some chance that Citigroup may not get the assets, after Wells Fargo & Co said Friday it signed a definitive agreement to buy all of Wachovia and announced plans to raise $20 billion of capital. Citigroup and Wells Fargo are negotiating with the U.S. Federal Reserve over how to resolve the dueling bids.

The Wachovia acquisition would make Citigroup's sales pitch for future capital raising much more convincing, because investors would likely prefer to fund Citigroup's growth rather than patch up holes on its balance sheet that come from writing down assets.

"The Wachovia deal was going to be the way they raise capital. Without the deal, it's much harder," said Walter Todd, portfolio manager at Greenwood Capital Associates, which has a small holding of Wachovia shares.

Whether Citigroup needs to raise capital without a Wachovia transaction is debatable. The bank itself believes it does not, according to a person familiar with the matter. Citigroup's tier one ratio, a measure of equity relative to risk-adjusted assets, was 8.74 percent at the end of the second quarter, among the highest of the major U.S. banks.

Citigroup is set to boost that ratio by 0.6 percentage point when it closes on its sale of its German retail banking operation in the fourth quarter, and has other asset sales planned, which should also boost the ratio. Citigroup has raised $50 billion of capital in the last seven months, and its management has consistently said that it has raised more than it expected to need.

TIMES GETTING TOUGHER

But some analysts argue that even if Citigroup looks well capitalized now, it could look less so in coming quarters as the weakening U.S. economy weighs on its businesses including credit cards, investment banking, and retail brokerage.

Citigroup said it expects third quarter net losses to be somewhere between the second quarter's net losses of $2.5 billion and the first quarter's losses of $5.1 billion. That loss alone would have a manageable impact on Citigroup's capital ratios, but if those losses were sustained or accelerated over several quarters, Citigroup would likely have to raise capital.

Bank of America Corp saw how quickly its capital ratios can fall. The company estimated on Monday that its tier one capital ratio would be 7.5 percent in the third quarter, down from 8.25 percent in the second quarter, spurring the bank to launch a $10 billion share offering and cut its dividend.

Citigroup appears at least somewhat concerned about the weakening economic outlook, having said last week it was cutting its dividend in half in conjunction with the Wachovia purchase, a move that should save it nearly $4 billion a year. A dividend cut is noteworthy because Citigroup's management said for months that the company's dividend was at an appropriate level.

Citigroup shareholders would clearly prefer the bank acquire Wachovia. On Friday, after Wells Fargo announced it had signed a merger agreement with Wachovia, Citigroup's shares fell 18 percent, shaving about $20 billion off the bank's market value. Owning Wachovia would boost Citigroup's U.S. access to deposit funding, which in tough times can be a more reliable source of money than borrowing in bond markets.

"A Wachovia deal would give Citigroup some coverage to raise capital, and it may be the last good buy of its size out there" said Ralph Cole, portfolio manager at Ferguson Wellman Capital Management in Portland, Oregon.

(Editing by Bernard Orr)