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Citi-Morgan talk may spark fresh wave of deals

Sunday January 11, 7:35 pm ET
By Sara Lepro, AP Business Writer

NEW YORK (AP) — The anticipated combination of brokerage units at Citigroup and Morgan Stanley is seen by analysts as the likely start of a fresh wave of consolidation in the troubled and thinning banking industry.
The potential deal between Citi and Morgan Stanley, which could be announced as early as Monday, underscores the problems still facing the industry after a year in which several well-known financial firms toppled under the weight of rising losses tied to bad mortgages.

“This really shows the continued vulnerability of the banking system,” said Keith Springer, president of¬†Springer Financial Advisors¬†in Sacramento CA.

During the past several months of financial turmoil, many banks have had to overhaul their business models. Morgan Stanley and Goldman Sachs Group Inc. became bank holding companies shortly after rival Lehman Brothers Holdings Inc. filed for bankruptcy protection and Merrill Lynch & Co. was sold to Bank of America Corp. in an emergency sale initially valued at $50 billion. Investors had grown concerned that stand-alone investment banks would no longer be viable amid continued weakness in the credit markets.

Analysts generally expect 2009 to be another year of multibillion-dollar losses for banks as the forecast for a turnaround in the economy remains cloudy at best. As losses mount, other banks might need to consider selling off parts of their business to raise funds.

The industry will need to focus on stemming credit losses and raising capital this year, Friedman, Billings, Ramsey & Co. analyst Paul Miller wrote in a recent note to clients.

“Current capital levels, which should be considered inadequate in even the best of times, pose an even greater risk entering 2009, a year that will remain challenging for financials,” he wrote. Specifically, analysts foresee rising problems in banks’ credit card and commercial real estate portfolios.
Some analysts believe that a sale of Citigroup’s brokerage reinforces the progression toward a much leaner industry consisting of a handful of big banks offering many services. And consumers could feel the repercussions.

“Less competition is never good for consumers,” Springer said.
Morgan Stanley is likely to pay Citigroup between $2 billion and $3 billion for a 51 percent stake in the brokerage Smith Barney, a person close to the negotiations said Saturday.

Morgan Stanley would then have the option to buy the rest of Smith Barney over the next three to five years, the person said. The person spoke on condition of anonymity because he was not authorized to speak about the ongoing talks.

A spokesman for Citigroup declined to comment on Sunday. Calls to Morgan Stanley were not immediately returned.

Citigroup has been hit particularly hard by the housing and credit crises. Though the bank has received $45 billion in support from the government’s $700 billion financial rescue fund, its financial footing remains shaky. The New York bank has reported four straight quarters of losses totaling $20.2 billion through September 2008 and is expected to post yet another loss when it releases fourth-quarter results on Jan. 22.

“It looks to me like they are rethinking the business model that Sandy Weill had, which was a one-stop shop model,” said Chris Probyn, chief economist at State Street Global Advisors, referring to Citigroup’s former chairman and chief executive. “Now they are thinking about maybe going back to a more streamlined division.”

Weill built Citigroup into the conglomerate it is today through a series of mergers and acquisitions over the past couple decades before handing the reins to Charles Prince in 2003. The bank has been criticized for years that it had grown too big for its own good, with many investors clamoring for a break-up of its units.

But while Citigroup has struggled with its size, its competitors have gotten bigger.

Rivals JPMorgan Chase & Co., Bank of America Corp. and Wells Fargo & Co. all made acquisitions in the last year to better diversify their businesses.
Bank of America bought Merrill Lynch & Co. and mortgage lender Countrywide Financial Corp. JPMorgan, meanwhile, scooped up storied investment bank, Bear Stearns Cos., in March, as well as the lucrative deposits of failed thrift Washington Mutual Inc. And Wells Fargo beat Citigroup in its pursuit of troubled Charlotte, N.C., bank Wachovia Corp.
A deal to combine the brokerages of Citigroup and Morgan Stanley would not only give Citi much-needed cash, it would also give Morgan Stanley more manpower, analysts said.

“If Morgan and Citi get together, they would be able to put together a retail brokerage unit that is larger than Merrill’s thundering herd, which could position them well in the marketplace,” Probyn said. “This may be a way of staying competitive.”

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