Citi close to Morgan Stanley brokerage deal: sources

By Megan Davies and Dan Wilchins

NEW YORK (Reuters) - Citigroup Inc was closer to a deal on Sunday to join its Smith Barney business with Morgan Stanley's brokerage operation in a move that would create the world's largest retail brokerage.

The creation of the joint venture deal would lead to Morgan Stanley making a cash payment to Citi of about $2.5-$3 billion, a source familiar with the situation said.

The deal will also lead to Citi revaluing the unit as part of the bigger venture rather than a stand-alone business, leading to a gain of $5-$6 billion post-tax in tangible common equity, said the source, who asked not to be identified because the talks aren't public.

The cash would be a big boon for Citi, which is under tremendous pressure from the U.S. government to shore up its balance sheet after taking $45 billion of government capital in October and November.

Capital is crucial for the bank, which has posted more than $20.3 billion of net losses for the four quarters ended Sept 30.

Under the deal being discussed, Morgan Stanley would take a 51 percent stake in the venture and would also have options to increase that amount at a period of 3-6 years in the future, the source said.

The cash payment would allow Morgan Stanley -- which has a smaller brokerage business than Citi -- to take a controlling rather than a minority stake in the venture.

A deal could be announced this week but is unlikely to come as soon as Monday, the source said. A second source said an announcement was expected this week.

The new business would have a combined estimated value of $16 billion to $20 billion, the first source said.

It would have more than 23,000 financial advisers before attrition, ranking as the world's largest retail brokerage, surpassing rivals Bank of America Corp and Wells Fargo & Co.

For Citi, securing a joint venture deal is an easier move than selling the asset at a bad time in the market. Indeed, few buyers have the cash available to buy Smith Barney outright.

The deal also allows Citi to enjoy a share of the venture's earnings. The new joint venture could extract cost savings from consolidating real estate and trade processing platforms.

The combined business would likely have Morgan Stanley Co-President James Gorman as chairman, and Citigroup Global Wealth Management President Charles Johnston as its chief executive, a source previously told Reuters. That could strengthen Gorman's position in any future discussions over a possible successor to Morgan Stanley CEO John Mack.

A source previously told Reuters that Citi had also discussed internally the possibility of selling its Banamex Mexican banking unit. However, a source on Sunday said that unit wasn't on the block.

BIG CHANGES