Citigroup (C)

All financial services businesses, as you know, are people businesses, and the story here starts with people on both sides. Bob Steel and I have known each other for almost two decades. We worked together both as colleagues and competitors. Others on both sides of the two companies have known each other and respect each other. We believe we share each other’s values and aspirations, and all that’s important because that’s what really makes an ideal combination.

By the time Bob and I started to talk we at Citigroup had the opportunity to look at a number of deals. We passed on these because they were not compelling. This one is compelling. This combination creates a dominant US franchise in great markets. From an earnings and economic return perspective, this makes a lot of sense. We have contained the risk in this transaction so not only is this a high-opportunity deal for us, it’s also a low-risk transaction. We’ve contained the asset risk and we believe the operational risk is also contained.

Let me start by talking about the deal. We’re buying Wachovia’s retail bank, its private bank, its middle-market business and its corporate investment bank. We are not buying its retail brokerage and asset management business. We are paying approximately $2.2 billion in common stock as consideration. To finance this deal, we’re raising approximately $10 billion of common equity and are issuing $12 billion of preferred stock and warrants to the FDIC. We’re reducing our dividend by half. All of these things together keep our capital ratios very strong.

We have identified $312 billion of risk assets on Wachovia’s balance sheet. Our maximum loss exposure on these assets is the $30 billion of expected losses we’re taking up front and another $12 billion over the next three years with no more than $4 billion a year. This combination makes sense for us strategically. It makes sense for our shareholders, our customers and our people. Let me talk about each of these.

Strategically, Wachovia is among the best retail franchises in the country, whether you look at its footprint, management, culture, service, technology. We all know it as a very strong and well-respected brand. This transaction completes Citi’s global universal bank model by adding depth to our US retail franchise. We’ll have approximately $600 billion of deposits in the US, giving us a 9.8% deposit share. Globally, we’ll have $1.3 trillion of deposits, which makes it one of the largest deposit-taking institutions and clearly the largest US deposit-taking institution.

The transaction supports our goal to build a franchise with a high annuity-like earnings stream with controlled risk. It increases cash flow and capital generation, which in turn will help fuel our international growth. We believe there are significant synergies in our cash management business, in our cards business, in the SME area and in the mortgage business.

Let me talk about this from a shareholder perspective. This is a unique transaction. We paid $12 billion to the FDIC to limit our risk on the assets we’re acquiring. We are incurring this cost up front, but on an accounting basis we will expense this over the next four years on a pro rata basis. Leaving that aside, this transaction is more than 10% accretive in year two and very strongly accretive in the out years.

When you look at economic value, it doesn’t matter whether you look at net present value, IRR, ROIC -- whatever you look at, the economics are exceptional. The risk is capped. We’re taking $30 billion up-front losses, and the losses beyond that are capped to no more than $4 billion a year for the next three years, on this portfolio of assets, therefore capped at a total of $12 billion. Anything above that will be absorbed by the FDIC. And for this risk sharing, for this tail risk mitigation, we have paid them $12 billion up front in preferred and warrants as consideration.

As I said before and I said at Citi Day, 75% of our businesses are in annuity-type businesses. This increases that number significantly. That also, in our view, implies a lower risk earnings profile going forward. It improves our already strong liquidity and funding profile. With the $1.3 trillion in deposits, we’ll have approximately 71% of our total assets funded with deposits, long-term debt and equity, which is extremely compelling. And, our capital ratios remain strong.

Let me turn it over to Gary, who is going to take you through the details of the transaction, and then I’ll come back and talk about our clients and our people.

Gary Crittenden - Citi - CFO

Thank you very much, Vikram, and good morning to everyone. Vikram took you through the key elements that are covered on the first slide in the presentation that’s entitled, transaction structure, and so I won’t repeat any of those. The unique feature of this transaction is obviously the loss protection arrangement that we have with the FDIC. So let me have you turn to page two in the presentation, if I could, and I will spend just a minute talking about the terms of the loss protection arrangement that we have with the FDIC.

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So this arrangement has a couple of different parts to it. In aggregate it has $12 billion of face value that will be split between preferred shares and warrants that will be granted to the FDIC. The preferred shares will have a 6% dividend and they will have a five-year non-call feature. It will be recorded at a discount to par value. The preferred shares will be recorded at a discount to par value for which we receive 100% Tier 1 credit, and the discount accretes over time through our retained earnings.

We will also issue warrants, and as I said, the warrants taken together with the discounted value of the preferred stock gives us a combined value of $12 billion and results in Tier 1 credit also of 100% of the $3 billion. So, taken in aggregate, the preferred shares along with the warrants give us an aggregate value of $12 billion.

Now, this insurance that, essentially, we are buying up front, as Vikram said, cuts off the tail risk associated with this transaction. Let me explain on chart number three how this tail risk insurance actually works. So what I’ve selected here is just an illustrative example. We are finalizing the exact assets that will become part of the $312 billion that are the so-called protected portfolio, where the riskiest assets of Wachovia will reside.

In the example that I’ve used here, I’ve listed $156 billion of residential mortgages, $100 billion of commercial real estate and $56 billion of other assets. Again, the sum total of these assets adds up to $312 billion. Against the losses that would take place for the first $30 billion, we are reporting through purchase accounting the losses associated with the first $30 billion. So that will happen at the time we close the transaction.

We then have agreed to have up to $12 billion in losses over a three-year period that would be capped at $4 billion a year. So the total exposure that we have in this portfolio after we record the $30 billion at the time that the transaction takes place will be $12 billion. For the remaining amount of the tail risk in the portfolio, of $312 billion, the Company bears no further risk. That risk essentially has been moved as a result of the arrangement that we have with the FDIC to the FDIC.

Now, Vikram talked a little bit about the economic impact of this transaction, and it is extraordinary. Let me talk, first of all, about the first year, which will be in 2009, and then years two through four.

The transaction is expected to be accretive in the first year before accounting for $2 billion in pretax restructuring charges. There are also some modest restructuring charges that are taken in the purchase accounting as well, a total of approximately $1.5 billion, but it’s accretive before the $2 billion in restructuring charges.

We have approximately $1.3 billion in pretax expense synergies that are offset by some revenue dis-synergies associated with a modest program of branch closings and in the corporate and investment bank. We have approximately a $4 billion pre-tax charge that is related to the loss protection agreement that we have with the FDIC. As Vikram stated, this will be taken through earnings over the first three years of this arrangement. We have a 6% dividend on this $12 billion of the face value of the preferred.

In years two through four, it is accretive taking into account all costs, and the trajectory associated with earnings per share is very, very strong. The fully loaded pre-tax impact of the annual expense synergies are approximately $2.8 billion to $3.2 billion, depending on the year, and that is offset somewhat by revenue dis-synergies of $1.5 billion to $1.7 billion. We have restructuring charges during that time period of about $600 million and, again, we have the same $3 billion pretax annual charge related to the loss protection.

Then, obviously, we have the 6% dividend that we pay on the $12 billion of preferred stock. As Vikram said, no matter how you look at this transaction, it’s extremely strong from a net present value standpoint, internal rate of return, return on invested capital.

So what we have is we have a bank with very limited downside and extremely strong earnings power, compounded by significant synergies.

So let me take you through some of the elements of the balance sheet, if I could, and I am now turning to page number five. I’m going to focus on the left-hand side of the page first and just cover a few of the balance sheet balances. This is the pro forma balance sheet, assuming that we add the two companies together. So the GAAP assets will be about $2.9 trillion as you can see on the page, RAP assets of $1.5 trillion. Our Tier 1 capital, would be approximately $130 billion, and total capital of $170 billion. As you can see, we have very strong pro forma capital ratios.

Our Tier 1 capital is 8.8%. Our TCE ratio will be about 7%, and our leverage ratio about 5%. Our total capital ratio will be just north of about 11.8%.

Taking all of these factors together, we obviously have an overall improvement from the capital situation that we have today. Now, these are pro forma numbers for the second quarter, taking their second-quarter numbers into account with our second quarter, and it does not include the

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benefit that we get from the German business, from the sale of the consumer finance business that we have in Germany that we anticipate taking place in December of this year.

Now, an important feature associated with these capital ratios is, because we have insulated ourselves essentially from the loss associated with the assets that are part of the $312 billion pool, we get regulatory capital relief against those assets. So we have taken the first $30 billion of losses upfront. We have, then, $12 billion over three years that we have responsibility for. All of the remaining assets essentially have no risk associated with them. So we are insulated, effectively, for any losses in excess of $42 billion in aggregate on the $312 billion. As a result of that, these assets have virtually no risk weighting, and that obviously plays a significant role in the overall capital ratios that we have.

The remaining assets that we have that are part of the transaction are very attractive. Let me just take you through a couple of these categories. So we have approximately $200 billion of liquid securities that are in the transaction. These include cash, agency obligations, investment-grade CP and other note obligations, that sort of thing.

We have approximately a $110 billion loan portfolio consisting of drawn, high-quality diversified loans to US and international entities. The average drawn balance is $15 million, and it comprises almost 100,000 discreet individual borrowers.

We also have approximately $80 billion of residential mortgage loans. Most of this portfolio is performing loans, first liens, and they were originally originated with in-house appraisals. This portfolio at origination had a weighted average LTV of less than 80% and an average FICO score in excess of 680. The remaining assets, as I said, are very attractive, and we have obviously appropriately reserved for those as part of our loan loss reserve.

We have a significant improvement as a result of this transaction in our structural liquidity, and Vikram mentioned this briefly. So if you take the sum of our long-term debt, our deposits and our equity, it adds to approximately 71% of our total assets on a pro forma basis. As I mentioned, there is a significant portion of Wachovia’s assets that are liquid which we anticipate to be potentially salable.

If I take you down — if we now step over to chart number six, I’ll take you through a summary of what the purchase accounting looks like. So the book value of the business at the time before any of this transaction takes place is $63 billion, and then we make the following purchase accounting adjustments.

We have a write-down of goodwill and intangibles of $39 billion, an adjustment on the credit-impaired loans and securities that I just talked about — this is the same $30 billion that I talked about earlier, when I described the $312 billion in assets in the portfolio. We release, relative to these assets, $9 billion in loan loss reserve that existed against this portfolio before the transaction took place. We have other purchase accounting adjustments that we then make, and I mentioned some of this before — the restructuring expenses and so on — of a total of $4 billion. So the book value, approximately, after purchase accounting, is about $1 billion negative. As Vikram mentioned, we have purchase consideration going into the transaction of just over $2 billion, and so we have goodwill and intangibles associated with the transaction of $3 billion.

The remaining business obviously is a very strong competitive entity.

The final chart that I have here in the deck shows the number of branches that we will have as a result of this transaction. So we will have, instead of the 1019 branches, a total branch count of 4365. In terms of total deposits, as Vikram mentioned, we will have total deposits on a pro forma basis of $1.252 trillion, well in excess of the next-largest competitor. With that, I’ll turn the time back to Vikram.

Wachovia has a great management team with a proven record, a proven record of integration. This is a company that grew up over time with 106 acquisitions. Through all of that, they have built a great service culture that I just mentioned, and we expect the team that is very experienced on integration will be part of our integration as well.

On our side, Terri Dial also has a lot of experience with integration. We believe it is essential that we maintain a strong presence in Charlotte, North Carolina.

As far as this transaction is concerned, teams on both sides worked extremely hard over the last 72 hours to figure out how to put all this together. We had over 200 people from Citi working on this nonstop. That included a group of world-class risk professionals, world-class finance professionals; also, our professionals on the retail banking side and the consumer businesses.

Our plan is to fold our US retail bank, which is about a third the size of Wachovia’s retail bank, into the Wachovia platform and the team is extremely strong — the Wachovia team, Terri Dial, Marty Lippert.

Let me step back for a minute and talk about Citi’s overall mission. You know what we’re trying to do. We talked about it at Citi Day. We’re trying to create incredible operating leverage by getting fit, by repositioning our businesses and driving the synergies that come from a universal banking model.

And, while there have been questions about the model, I hope over the events of the last many weeks and months it’s absolutely clear why we continue to believe this is the right model, and today’s transaction, if nothing, strengthens that model significantly for us as a Company.

Most importantly, I want to assure you that while we are working on this transaction and we’ll work on the integration that this represents, nothing is going to take our eye off the ball on getting fit. We’re committed to the same things we talked to you about, both in terms of expense reduction, reengineering, but also in terms of asset reduction. That plan continues in full force.

In business, there are many high-return opportunities. Many of the high-return opportunities also come with high risk. There are very few that are high return with contained or manageable risk. This is one of those very few.

There are two risks in this transaction. There are risks on the asset side, but we managed that. We managed that by examining the entire $800 billion balance sheet in detail with world-class professionals, people I have a lot of confidence in, and we came up with $312 billion as risk assets that we needed help with, and we got that help and we contained that risk. Gary has talked about the rest of those assets.

So we have contained the risk on the asset side. The other side of the risk is the integration risk. I just said that Wachovia grew up over time through 106 acquisitions. We did as well, growing up over many acquisitions. We’ve got skill sets on both sides, and we will make sure that we will execute on this with a great deal of precision and great speed.

I want to end by saying, we have a great deal of confidence in our collective ability to execute on this transaction. And, when we do that, it is my belief this will turn out to be one of those rare high-return transactions with contained risk.

That’s why, when I started, I said we looked at a lot of things. They weren’t compelling. This one is extremely compelling to us.

Let me stop there and turn it over to Gary.

Gary Crittenden - Citi - CFO

So, before we finish, let me just make a few comments, if I could, about the current quarter. As you all know, this quarter has been marked by extreme market volatility and there has been continued deterioration in consumer credit, and that has had a significant negative impact on our results. On the positive side, as Vikram just said, our expenses and headcount have continued to show sequential declines and we have made progress on reducing GAAP assets and RAP assets during the course of the quarter.

The combined impact of these trends is an expected decline in net income versus last quarter, but an expected improvement versus the first quarter of this year.

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Notwithstanding these negative headwinds, our capital ratios are expected to remain strong. Now I will walk you through our current overall expectations for revenues, expenses and net losses. We have not yet closed the quarter, and especially in light of market volatility, the numbers could change meaningfully. We will be releasing our third quarter results on October 16.

As you know, third quarter revenues historically have shown seasonal weaknesses, in part driven in by lower volumes in securities and baking. In keeping with historical trends, this quarter showed that expected slowdown. However, the slowdown was exacerbated by the continued disruptions in the credit markets and numerous adverse market events which combined to produce extremely low levels of activity. Markdowns on subprime-related, leveraged finance and monoline exposures for the third quarter are expected to be substantially lower than in the second quarter. Together, we expect these marks to be in the range of $1.5 billion.

However, marks on our SIV assets have shown a very substantial increase in the third quarter over those in the second quarter. This quarter, the extreme volatility in the markets resulted in a very significant widening of the credit spreads on assets underlying our SIVs, despite the fact that the credit quality of these assets remains generally strong. We expect that the markdown on these SIV assets to be in the range of $1.7 billion for the third quarter.

Additionally, we expect to see securitization-related losses in our cards business in the range of $2 billion in the third quarter. This was given principally by three factors. First, the disruption in the credit markets, which hampered our ability to do card securitizations during the quarter, resulting in significant losses. Second, higher funding costs due to a significant widening of spreads in the asset-backed and commercial paper markets. And finally, higher losses flowing through our securitization trusts, resulting in a downward valuation of our I/O.

There are two other factors that we have already announced which remain consistent with our current expectations. First, a $500 million in pre-tax losses related to the auction-rate securities settlement. This number represents the difference between the purchase price and the market value at the time of settlement. Additionally, we will record in expenses a $50 million fine payable to the State of New York and a $50 million fine payable to other state regulatory agencies.

Second, on September 10, we announced that the quarter-to-date pre-tax impact on revenues from trading losses and write-downs of our exposures to the preferred and convertible shares of Fannie Mae and Freddie Mac was approximately $450 million.

Before moving to credit, let me remind you that our own credit spreads have been volatile during the quarter. This has resulted in large swings in our estimation of any associated gains related to the market value of those liabilities for which the fair value option was elected. Recent market events continue to have a significant impact on our credit spreads, and therefore, will be a factor affecting revenues in the quarter.

On credit we expect total credit costs for Citi to be in the range of $9 billion to $10 billion in the quarter, up from approximately $7 billion last quarter. Approximately half of the increase in the credit cost is due to building loan loss reserves, primarily in cards and mortgages, given the continued acceleration in losses. The remaining half is due primarily to higher NCLs than we had expected. I have said in the past that higher losses in our cards portfolio should persist for the remainder of this year and well into 2009 as unemployment and housing trends both continue to deteriorate.

Our current estimates point to a net credit loss ratio that is close to a 20-year high. Unemployment has been rising but is still below historical highs. If unemployment continues to climb as expected, this will further increase credit costs in the cards business.

In the mortgage portfolio, both delinquencies and losses have reached historical highs. On headcount and expenses, however, we continue to make excellent progress, continuing the positive trend of the last few quarters. Expenses are expected to decline in this quarter approximately $1 billion sequentially. So, since the end of last year, our total expenses will be down by more than $1.5 billion, which reflects our efforts to re-engineer our cost base in the current economic environment.

Our headcount is also expected to decline by approximately 10,000 during the quarter bringing our year-to-date headcount reduction to approximately 23,000. And, as I mentioned, we have continued to reduce GAAP and RAP assets during the quarter. Taking these factors into consideration, seasonally lower revenues, continued marks and losses in the ICG business, securitization issues in cards and significantly higher credit costs, we expect an increase in net losses versus last quarter but an improvement over the first quarter of this year.

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