by Calculated Risk on 11/02/2008 06:54:00 PM

The WSJ mentions the FDIC's role in Wells Fargo acquiring Wachovia: Tough Love for U.S. Banks

Here is the Wells Fargo narrative mentioned in the story from an S-4 filing with the SEC:

Background of the Merger

Wachovia’s strategy has been to build a diversified financial services company providing a wide range of financial products and services to an expanded customer base. To accomplish this objective, over the last two decades Wachovia acquired nearly 100 banks, thrifts and broker-dealers to become a leading banking franchise in the eastern, southern and western United States, as well as a nationwide retail securities brokerage business. In 2006, at a time when Wachovia’s market cap was approximately $86 billion, in furtherance of Wachovia’s objectives of expanding its banking franchise to the California markets and gaining market share in U.S. residential mortgage lending, Wachovia acquired Golden West Financial Corporation of Oakland, California for approximately $25.5 billion. Golden West added significant size to Wachovia’s then-small California retail banking presence and also added approximately $120 billion of residential mortgages to Wachovia’s balance sheet, which at the time had assets of about $553 billion. Substantially all of the Golden West mortgage portfolio has consisted of a product, referred to as “option ARMs” or adjustable rate mortgages with monthly payment options. The credit quality of this portfolio has deteriorated significantly in the current mortgage crisis.

In the spring of 2007, the U.S. housing market began experiencing increases in sub-prime home loan delinquencies and declines in housing values. Throughout the remainder of 2007, in accordance with the mark-to-market valuations required by United States generally accepted accounting principles, these declining asset values created valuation losses in certain types of securities that Wachovia held on its balance sheet, including sub-prime residential mortgage-backed securities (RMBS) and collateralized debt obligations whose underlying collateral contained sub-prime RMBS (CDOs). In addition, Wachovia began to increase its loan loss provision in response to generally deteriorating credit conditions, including in the Golden West mortgage portfolio. In the fourth quarter of 2007, Wachovia reported net income of $51 million, compared to net income of $2.3 billion in the fourth quarter of 2006.

Economic conditions, and in particular the housing market, continued to deteriorate in the first quarter of 2008.

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In light of the worsening outlook for housing prices, changing borrower behavior and mark-to-market valuation losses on Wachovia’s RMBS, CDOs and leveraged lending portfolios, Wachovia reported a loss in the first quarter of 2008 of $707 million, compared with earnings of $2.3 billion in the first quarter of 2007. In response to these developments and to create a stronger capital cushion for future credit losses, Wachovia sold $8.05 billion of common and preferred stock in mid-April 2008 and announced a 41% reduction in its quarterly common stock dividend.

Issues relating to Wachovia’s declining financial condition, including continuing credit deterioration in the Golden West mortgage portfolio and other elements of its loan portfolio, continued mark-to-market valuation losses on securities positions, and a series of other negative results that included $314 million of losses in Wachovia’s bank-owned life insurance portfolio, a $144 million regulatory settlement related to Wachovia acting as payment processor for telemarketers, and a charge of $975 million related to certain “sale-in, lease-out” leasing transactions and other factors, preceded an announcement on June 2, 2008, that Wachovia had terminated its Chief Executive Officer, G. Kennedy Thompson. Wachovia’s board of directors appointed its Chairman, Lanty L. Smith, as interim Chief Executive Officer while it searched for a permanent replacement. On July 9, Wachovia named Robert K. Steel as its Chief Executive Officer and President.

On July 22, 2008, Wachovia reported a second quarter loss of $9.1 billion, including $6.1 billion related to goodwill impairment, and a $5.6 billion loan loss provision, reflecting continuing worsened housing and economic conditions and anticipated future losses on its loan portfolio, primarily in the Golden West mortgage portfolio. At that time, Wachovia also further reduced its quarterly common stock dividend by 86% to $0.05 per share and announced a series of measures, including balance sheet adjustments, expense reductions and the possible sale of non-core assets, intended to preserve capital and enhance liquidity to secure Wachovia’s future as an independent company in light of weakening economic conditions. Wachovia pursued these initiatives aggressively — by early September, Wachovia had begun the planned elimination of close to 10,000 employee positions and Wachovia was on track for a $20 billion reduction in securities and loan balances by the end of 2008. Toward the end of July, Wachovia also announced that its Chief Financial Officer and Chief Risk Officer would be replaced. In addition, on August 15, Wachovia announced that it had been successful in reaching a global settlement with state and federal securities regulators requiring Wachovia to repurchase approximately $8.5 billion in auction rate securities, at an expense to Wachovia of $775 million (which was subsequently revised to $997 million).

In the first half of September 2008, a series of unexpected and unprecedented events occurred in rapid succession in the financial services industry that increased the uncertainty and stress in the financial markets. These events included the conservatorship of Fannie Mae and Freddie Mac on Sunday, September 7, 2008, the bankruptcy of Lehman Brothers Holdings and the acquisition of Merrill Lynch by Bank of America announced on Monday, September 15, 2008, and growing concerns about the viability of American International Group, which later culminated in a transaction in which the Federal Reserve acquired most of AIG’s equity.

These events created significant turmoil as the markets and market participants affected by such events, including Wachovia, began absorbing the enormity of their consequences in the days following the September 15 announcements regarding Lehman Brothers and Merrill Lynch. The resulting degradation in the credit markets which raised the costs of borrowing, together with the deteriorating condition of the U.S. economy and housing market, market perceptions, and rating agencies’ outlooks, led Wachovia to intensify an analysis of potential strategic options. Wachovia’s Chairman, Lanty L. Smith, scheduled a telephonic Wachovia board meeting on September 16, 2008, so that management could review these events with the board and their anticipated effect on Wachovia, including the effect on Wachovia’s strategic decision-making. At that meeting, management described Wachovia’s operations in the current financial environment and discussed the following possible strategic options: (1) exclusively pursue the strategy announced in July for preserving and protecting capital and liquidity by continuing to reduce risks and expenses and consider possible disposition of non-core assets (i.e., “stay-the-course”); (2) sell certain core assets and/or businesses; (3) raise $10 to $15 billion of capital; (4) a combination of (2) and (3); (5) an investment in Wachovia by a large strategic investor in an amount of between 20-40% of Wachovia’s voting equity; and (6) a combination with another financial services company. Acknowledging a preference for Wachovia to remain an independent company, which was achievable under options 1-4, the board and management determined to pursue seriously options 2, 3 and 4 but also determined that current conditions made it prudent to remain open to and begin exploration of options 5 and 6 as well.

In furtherance of these initiatives, Wachovia engaged Perella Weinberg and, later, Goldman Sachs for financial and strategic advice on Wachovia’s options and the law firms of Sullivan & Cromwell LLP and Simpson Thacher & Bartlett LLP to provide legal counsel for strategic alternatives. These advisors began developing the documentation necessary to raise capital. In addition, Wachovia created and populated an electronic data room to facilitate due diligence activities by potential investors and/or combination partners. As it began pursuing all five possible alternatives, Wachovia and a potential combination partner initiated contact on September 17 about a possible merger-of-equals transaction and entered confidentiality agreements and began conducting due diligence analyses on each other on September 18. Wachovia and the potential partner also discussed transaction structure and management issues.

Also during that week, Wachovia’s senior management received three separate unsolicited calls from Vikram Pandit, the Chief Executive Officer of Citigroup Inc. and two other Citigroup senior executives indicating interest in pursuing discussions regarding a possible combination with Wachovia. Mr. Pandit placed yet another call to Mr. Steel the following week on September 22, 2008, to reiterate Citigroup’s interest.

Wachovia also held telephonic meetings of its board of directors on September 18 and September 19 at which management briefed the board on developments regarding consideration of the various alternatives.

On September 20, 2008, Wachovia received a telephone call from U.S. government officials encouraging Wachovia to engage in discussions with another financial institution for the purpose of that institution acquiring Wachovia. Wachovia entered into a confidentiality agreement with this financial institution on September 21 and representatives of Wachovia traveled to New York to begin due diligence and substantive discussions regarding a possible acquisition of Wachovia on a highly accelerated time schedule. By early evening on September 21, Wachovia and this potential acquirer determined not to proceed with a transaction. [CR note: based on reports at the time, this was probably Morgan Stanely] A primary factor in the decision was the potential acquirer’s desire for a financial backstop from the federal government with regard to Wachovia’s loan portfolio, which federal regulators did not then agree to provide.

At a telephonic meeting of its board of directors in the afternoon of September 21, management and Wachovia’s legal and financial advisors updated the board on the status of discussions with both of the potential merger partners and the ongoing due diligence matters. By late evening on September 21, negotiations with both of the potential merger partners with which Wachovia had conducted negotiations over the weekend had ended and management provided a status report to the Wachovia board of directors in a telephonic meeting on September 22.

In addition to the discussions regarding the potential mergers, throughout the weekend of September 20-21, Wachovia continued to explore the other alternatives involving a capital raise, asset sales and a large investment by a strategic investor of 20-40% of Wachovia’s equity. In connection with the former alternative, the market rebound by September 19, which followed the Administration’s announcement at the end of the week of several economic rescue initiatives (its $700 billion economic stabilization proposal, the temporary guarantee of money market funds against losses up to $50 billion, and the availability of $180 billion in currency swaps), produced a more attractive environment for a capital raise and Wachovia intensified its efforts toward this alternative. Wachovia engaged in preliminary discussions with potential private investors during the period of September 19-21 in preparation for a possible public offering that would have followed a private placement to a single or small number of private investors during the week of September 22; Wachovia’s legal and financial advisors prepared drafts of documentation toward that end.

In connection with the alternative involving a large investment by a strategic investor, Wachovia signed a confidentiality agreement with another global financial institution on September 18, 2008. This financial institution began conducting due diligence on Wachovia on September 18, initially indicating to Wachovia that it could be interested in purchasing between 20 — 40% of Wachovia’s equity; however, discussions between that institution and Wachovia never progressed beyond the exploratory stages. Wachovia continued to pursue actively the alternative strategy of raising capital and selling assets.

On September 20, Mr. Steel had a brief conversation with Richard Kovacevich, Chairman of Wells Fargo, about engaging in discussions regarding a possible transaction. Mr. Steel and representatives of Perella Weinberg, Wachovia’s advisors, had two additional follow-up conversations with Mr. Kovacevich to make arrangements for due diligence work and encourage him to consider the opportunity on an accelerated basis.

Market conditions for financial institutions deteriorated precipitously the week beginning September 22, 2008. On September 21, Morgan Stanley and Goldman Sachs announced that they had been approved to convert to bank holding companies regulated by the Federal Reserve. The Administration’s economic stabilization proposal encountered difficulty in Congress and the breadth of the Federal Reserve’s assistance to AIG became evident when details were announced on September 23. On September 24, Mr. Steel attempted to contact Citigroup’s CEO, Vikram Pandit for the purpose of communicating that Wachovia was prepared to respond to Citigroup’s invitation to discuss a possible combination. Mr. Pandit was traveling and unable to speak to Mr. Steel until early in the morning of September 26, when Mr. Steel promptly responded to a 4:27 a.m. email from Mr. Pandit suggesting that he was available.

On Thursday, September 25, the Office of Thrift Supervision announced the seizure of the largest savings bank in the United States, Washington Mutual Bank, FSB, and the subsequent placement of Washington Mutual Bank into FDIC receivership, followed by a sale to JPMorgan Chase for approximately $1.9 billion. In that transaction, JPMorgan Chase did not assume any equity or debt securities of the holding company for Washington Mutual Bank or the senior and subordinated debt of Washington Mutual Bank itself. In addition, on September 25, the tentative agreement in the U.S. Congress regarding the Administration’s economic stabilization proposal had collapsed in talks that evening at the White House.

The combination of the seizure of Washington Mutual Bank and the collapse of Congressional agreement regarding the Administration’s economic stabilization proposal preceded a sharp downward turn in the financial markets. The cost to insure Wachovia debt as evidenced by credit default swap spreads increased substantially from Thursday, September 25 to Friday, September 26. On Friday, September 26, there was significant downward pressure on Wachovia’s common stock price and deposit base, and as the day progressed, liquidity pressure intensified as financial institutions began declining to conduct normal financing transactions with Wachovia. On that day, after briefing national rating agencies, Wachovia was informed that the rating agencies were likely to take negative ratings action in the very near future. In light of the deteriorating market conditions during the week of September 22, Wachovia believed it was no longer in a position to engage in the public offering and private placement transactions to raise capital that had been considered as an alternative. Liquidity continued to decline and by the end of September 26, Wachovia’s management was concerned that, without accessing the Federal Reserve’s discount borrowing window, Wachovia’s banking subsidiaries would not be able to fund normal banking activities on Monday, September 29. Wachovia had been regularly reviewing its liquidity situation with the Federal Reserve and the OCC, who on that day remained on site.

Wachovia held a telephonic board of directors meeting on Friday, September 26 during which management advised the board of directors of the status of Wachovia’s liquidity situation, the status of the various strategic alternatives, including that the capital raising alternative was no longer a viable option, and the status of discussions with regulatory authorities about Wachovia’s financial condition. Management also advised the board of directors that management had begun discussions with Citigroup and Wells Fargo regarding a possible merger and that Wachovia intended to pursue both during the weekend of September 27-28. Management informed the board of directors that if a combination with another partner could not be arranged by Monday, September 29, the FDIC would place Wachovia’s bank subsidiaries in receivership.

Wachovia entered into separate confidentiality agreements with Citigroup and Wells Fargo on September 26, related to the possible acquisition of Wachovia. Wachovia representatives traveled to New York for the weekend of September 27-28 and engaged in due diligence discussions and negotiations with Citigroup and Wells Fargo. Wachovia communicated to both parties the need to announce a merger transaction by Monday morning, September 29. Citigroup communicated to Wachovia that it was not willing to acquire Wachovia itself, but only its bank subsidiaries and further that it was not able to proceed with any transaction without government assistance in the form of a loss-sharing arrangement. Although Wachovia explained its concerns that the remaining parts of Wachovia might not, after such a proposed Citigroup transaction, be viable or solvent on their own, Citigroup indicated that it was only prepared to negotiate for the purchase of the bank subsidiaries.

On Saturday, September 27, and in an early morning meeting on September 28, Mr. Kovacevich, the Chairman of Wells Fargo, told Mr. Steel that Wells Fargo was considering an offer to purchase all of Wachovia in a stock-for-stock transaction, pending completion of due diligence activities. Mr. Kovacevich commented that Wells Fargo was working on a transaction that would not require government assistance and that he believed Wells Fargo could meet the Monday morning timetable.

On September 28, Wachovia’s counsel transmitted a draft of a merger agreement to counsel for Wells Fargo. Mr. Steel and Mr. Kovacevich held ongoing discussions throughout the day regarding the status of the due diligence. In the afternoon, Mr. Kovacevich indicated that he was concerned that the compressed timeframe Wachovia requested would not enable Wells Fargo to complete the due diligence it believed necessary and prudent and at approximately 7:00 p.m., Mr. Kovacevich informed Mr. Steel that Wells Fargo was not prepared on this timetable to offer to acquire Wachovia along the lines previously discussed. That evening, representatives of Wells Fargo proposed to, and discussed with, representatives of the FDIC and other federal bank regulators a possible transaction between Wells Fargo and Wachovia that would include a loss-sharing agreement with the FDIC whereby Wells Fargo’s exposure to losses would be limited with respect to specified Wachovia assets it would not have had an opportunity to review in depth.

Shortly after Mr. Steel spoke to Mr. Kovacevich, Sheila Bair, the Chairman of the FDIC, contacted Mr. Steel and advised him that the FDIC understood that Wachovia would be unable to find a merger partner that could accomplish a combination without government assistance. Chairman Bair confirmed that, in the FDIC’s view, the Wachovia situation posed systemic risk to the banking system and for the first time indicated that the FDIC intended to take unprecedented action by exercising its powers under Section 13 of the Federal Deposit Insurance Act to effect an “open bank assisted transaction” with another financial institution, which would be selected by the FDIC through a bidding process to be conducted over the next several hours.

Wachovia held a telephonic meeting of its board of directors at approximately 9:00 p.m. on September 28 to advise the board of the current situation and the FDIC’s position. Legal counsel discussed with the board matters regarding its fiduciary duties relative to shareholders and, in the existing context, creditors. Management indicated that it likely would need to re-convene the board in several hours for the purpose of considering an agreement with the purchaser selected by the FDIC.

At approximately 12:30 a.m. on Monday, September 29, Wachovia and its financial and legal advisors proposed an alternative transaction to the FDIC for its consideration. Wachovia proposed that it receive FDIC assistance in the form of loss-sharing on a designated loan portfolio, as well as granting the FDIC equity ownership in Wachovia and raising approximately $10 billion in capital in a public offering. Wachovia urged the FDIC to accept this proposal, believing it involved significantly less risk to the FDIC fund than the transaction it understood Citigroup to be proposing, and, based on the state of preparation for the capital raising transaction that Wachovia had considered the prior week, indicated that it was prepared to move very quickly to implement it.

During the evening and early morning hours, Wells Fargo had further conversations with representatives of the FDIC concerning the terms of a proposed acquisition of Wachovia by Wells Fargo, including the terms on which open-bank assistance might be provided by the FDIC.

At approximately 4:00 a.m. on Monday, September 29, Chairman Bair informed Mr. Steel that the FDIC had determined that Citigroup would acquire Wachovia’s banking subsidiaries, that Wachovia should proceed to negotiate terms with Citigroup, which Wachovia understood were to be signed by Citigroup, Wachovia and the FDIC, and that there would be an announcement before the start of business that day. Several hours earlier, Citigroup had delivered what was styled a draft agreement-in-principle to Wachovia, which reflected Citigroup’s proposal.

Citigroup’s proposed agreement-in-principle, which by its terms was not binding on any of the parties, provided that Citigroup would acquire the stock of Wachovia’s banking subsidiaries and other mutually agreed assets for $2.16 billion in cash and/or stock at Citigroup’s election and the assumption of approximately $53.2 billion of Wachovia’s senior and subordinated debt. Under this structure, Wachovia would attempt to continue as an ongoing business concern with its principal businesses being the Wachovia Securities retail brokerage business and the Evergreen mutual fund business. Among other material terms, the terms associated with separating the Wachovia businesses in connection with a transaction, and supporting and funding those businesses remaining with Wachovia after a transaction, were left unspecified and subject to negotiation. The FDIC would provide Citigroup with loss protection on a $312 billion loan portfolio to be identified by Citigroup, on which Citigroup would absorb the first $30 billion of losses and additionally absorb up to $4 billion a year of losses for the first three years. The non-binding agreement-in-principle also indicated that if definitive agreements were reached they would provide that, in the event the resulting transaction was not consummated, Citigroup would have an option to purchase selected Wachovia branches in California, Florida and New Jersey at fair market value. The non-binding agreement-in-principle was subject to the negotiation and execution of definitive transaction documentation, as well as Wachovia board of directors and shareholder approval. Efforts by Wachovia to negotiate a number of material terms of the Citigroup proposal and Wachovia’s request that Citigroup purchase Wachovia in its entirety, were rejected by Citigroup. The non-binding agreement-in-principle also indicated that Citigroup would have exclusivity for seven days from announcement.

Wachovia held a telephonic board of directors meeting at 6:30 a.m. on Monday, September 29 to advise the board of the events that had developed during the night. Legal counsel to Wachovia described the terms of the non-binding agreement-in-principle. Management informed the board that it was faced with two options: (1) execute the agreement-in-principle with Citigroup and the FDIC or (2) have the FDIC place Wachovia’s banking subsidiaries into receivership, which likely would require Wachovia Corporation to file a bankruptcy petition soon thereafter. Perella Weinberg and Goldman Sachs both indicated that, based on the circumstances, and subject to conducting due diligence, completing their financial analysis and reviewing definitive documentation, and provided that the definitive terms thereof were consistent with the agreement-in-principle, they believed they would be able to render an opinion that the consideration to be received in the Citigroup proposed transaction was fair, from a financial point of view, to Wachovia. The Wachovia board of directors voted in favor of proceeding with Citigroup.

Following the board of directors meeting, Citigroup provided Wachovia with what it described as the execution copy of the non-binding agreement-in-principle and also sent Wachovia a letter agreement containing certain exclusivity covenants. In addition to the agreement-in-principle, Citigroup instructed Wachovia to sign the letter agreement shortly after receiving it, rejecting Wachovia’s few suggested changes, including a suggestion that there be a provision requiring both parties to negotiate in good faith. Faced with Citigroup’s unwillingness to consider changes and the views of the regulators, Wachovia executed both the non-binding agreement-in-principle and the letter agreement.

On the afternoon of September 30, Citigroup delivered a draft acquisition agreement and other related agreements to Wachovia, and the parties proceeded to have discussions regarding the terms of that agreement and the other agreements contemplated by the non-binding agreement-in-principle. Because the transaction contemplated by the agreement-in-principle involved separating Wachovia’s banking businesses from Wachovia Corporation itself and the other functionally and operationally integrated businesses within Wachovia, the negotiations involved very complex issues. On several occasions, Wachovia urged that Citigroup reconsider the structure and acquire all of Wachovia to avoid the complexity inherent in the contemplated transaction and uncertainty about whether the remaining businesses in Wachovia would be viable, on-going concerns. After hearing these concerns, Citigroup indicated that it would pay an additional $2.16 billion in Citigroup common stock. In exchange for purchasing certain additional assets that had not been contemplated by the agreement-in-principle, Citigroup also indicated it would provide additional Citigroup shares to permit Wachovia to make a tender offer deeply discounted from par value for Wachovia’s outstanding preferred stock.

As the negotiations proceeded, however, the requirement to separate Wachovia’s businesses continued to raise difficult issues, often involving potential great cost and risk to Wachovia, as well as the fundamental question of the viability and solvency of Wachovia after the transaction. Wachovia also expressed concern that the Citigroup draft agreement and Citigroup’s position on certain issues were inconsistent with the non-binding agreement-in-principle. Nevertheless, on Wednesday, October 1, Citigroup insisted that the parties be prepared to execute the definitive agreements no later than Friday, October 3 in order for Citigroup to commence a $10 billion capital raise that was contemplated in the non-binding agreement-in-principle. However, as of the evening of Thursday, October 2, it had become apparent that there were a number of significant substantive issues of disagreement between the negotiating teams of Citigroup and Wachovia, involving potentially billions of dollars in exposure to the remaining Wachovia entity.

On Thursday, October 2, Wells Fargo had discussions internally and with its legal counsel, Wachtell, Lipton, Rosen & Katz, and its financial advisor, JPMorgan Securities, regarding Wachovia and the announcement about Wachovia and Citigroup. Noting that the announcement of Citigroup’s plans for Wachovia indicated that a definitive agreement had yet to be negotiated and that there had been no subsequent disclosure of such an agreement or indeed of all the details of the announced proposal, Wells Fargo and its advisors discussed the possibility of submitting a bid for Wachovia. Wells Fargo executives reviewed information regarding Wachovia and analyzed the financial implications of a potential transaction. Based on these discussions, and with the benefit of additional time to assess its diligence findings from the preceding weekend [CR note: and a favorable change to the IRS tax code!], Wells Fargo determined that an offer to acquire all of Wachovia in an unassisted stock-for-stock merger transaction could be undertaken on terms that were both likely to be more attractive to Wachovia and its shareholders than the terms of the Citigroup proposal, as they were understood, and that presented acceptable economics and risk levels to Wells Fargo. Wells Fargo also informed representatives of federal banking regulators concerning its thinking and its renewed consideration of a proposal and indicated that its revised proposal would involve an acquisition of all of Wachovia and would not require FDIC assistance.

In the evening of October 2, the Wells Fargo board of directors met, together with management and Wells Fargo’s legal and financial advisors, to consider the proposed transaction with Wachovia. Following extensive discussion the Wells Fargo board unanimously approved the proposed merger with Wachovia and directed management to execute a merger agreement and deliver it to representatives of Wachovia.

At approximately 7:15 p.m. on October 2, Mr. Steel received a telephone call from Chairman Bair of the FDIC, who asked if Mr. Steel had heard from Mr. Kovacevich. Mr. Steel answered that he had not spoken to Mr. Kovacevich since the initiation of negotiations with Citigroup, other than a very brief congratulatory phone call from Mr. Kovacevich regarding the Citigroup transaction on the morning of September 29. Chairman Bair advised Mr. Steel that it was her understanding that Mr. Kovacevich would be calling Mr. Steel to propose a merger transaction that would result in Wachovia shareholders receiving $7.00 per share of Wells Fargo common stock for each share of Wachovia common stock and encouraged Mr. Steel to give serious consideration to that offer. At Mr. Steel’s request, Chairman Bair next telephoned Jane Sherburne, Wachovia’s General Counsel, and provided additional details of the proposed Wells Fargo transaction, including that it would not require any government assistance, and indicating that it appeared that the Wells Fargo transaction was superior to the Citigroup transaction from the perspectives of both Wachovia and the government. Ms. Sherburne advised Chairman Bair that unless Wachovia had a signed merger agreement from Wells Fargo that had been approved by the Wells Fargo board, it would not consider this proposal. Chairman Bair indicated she would provide Mr. Kovacevich that information and subsequently reported to Ms. Sherburne that she had done so and that Mr. Kovacevich indicated a signed, Wells Fargo board-approved merger agreement would be forthcoming.

At approximately 9:00 p.m. on October 2, Mr. Steel received a telephone call from Mr. Kovacevich that he would be sending a signed, Wells Fargo board-approved merger agreement to Mr. Steel. Mr. Kovacevich informed Mr. Steel that, in view of the significance of the proposal to Wells Fargo, Wells Fargo intended to disclose its proposal publicly the following morning. Mr. Steel received that signed agreement in an e-mail at 9:04 p.m. The e-mail contained a letter outlining Wells Fargo’s proposal, which involved a stock-for-stock merger with consideration valued, based on Wells Fargo’s closing price that day, at $7.00 per Wachovia common share. The signed merger agreement also attached to the email was, with one substantive exception, in the form that had been provided to Wells Fargo by Wachovia the preceding weekend, on September 28. Wachovia promptly called a meeting of its board of directors at 11:00 p.m. on October 2.

At the Wachovia board meeting, Wachovia’s management updated the board of directors on the status of the Citigroup negotiations and the existence of significant unresolved issues. Wachovia’s management expressed serious doubts about the viability of Wachovia under the structure and terms proposed by Citigroup as they had evolved during negotiations from what had been set forth in the non-binding agreement-in-principle. Mr. Steel briefed the board on communications with Chairman Bair and Mr. Kovacevich, including that Wells Fargo would disclose its proposal publicly the following morning whether or not Wachovia acted on it that evening. Wachovia’s legal counsel provided advice to the board of directors regarding its duties in the face of the Wells Fargo proposal and the Citigroup transaction and exclusivity letter, as well as other relevant considerations. Wachovia’s board was advised that Wells Fargo’s proposal stated that its willingness to proceed with the proposed merger agreement was contingent upon it receiving a substantial voting interest via the share exchange agreement that would not be subject to prior shareholder approval in order to provide assurances to the market regarding the completion of Wachovia’s acquisition by Wells Fargo and a resulting mitigation in the uncertainty and instability then faced by Wachovia. Legal counsel described the terms of the Wells Fargo merger agreement and the conditions to closing, which included clauses regarding the receipt of regulatory and shareholder approval and the share exchange agreement and its effect on receiving shareholder approval, but excluded a “material adverse change” clause.

Wachovia management and members of the board of directors expressed the view that the Wells Fargo merger proposal appeared to be substantially superior to the Citigroup proposal in a number of ways, including value to Wachovia shareholders and certainty of completion due to a signed, definitive transaction agreement with minimal conditionality. Perella Weinberg and Goldman Sachs both indicated that, based on the circumstances and subject to completion of due diligence and final financial analysis and review of definitive documentation, they expected that they would be able to render an opinion that the exchange ratio pursuant to the Wells Fargo merger proposal was fair, from a financial point of view, to Wachovia shareholders (other than Wells Fargo and its affiliates). Management informed the board that it believed that, unless an agreement was signed by the end of the day on October 3, the FDIC was prepared to place Wachovia’s banking subsidiaries in receivership over the coming weekend.

After extensive questions, discussion and consideration by the board of directors, on motion duly made and seconded, the Wachovia board resolved unanimously that the Wells Fargo merger agreement and the merger are advisable for, fair to and in the best interest of Wachovia shareholders and voted unanimously to approve and adopt the merger agreement and the merger and recommend that Wachovia shareholders approve the plan of merger contained in the merger agreement, subject to receipt of the fairness opinions from Perella Weinberg and Goldman Sachs. Early in the morning on October 3, Perella Weinberg and Goldman Sachs orally delivered their opinions that, as of that date, and based upon and subject to the factors, limitations and assumptions to be set forth in their respective written opinions, as well as the extraordinary circumstances facing Wachovia to be described therein, the exchange ratio pursuant to the Wells Fargo merger agreement was fair, from a financial point of view, to the holders of Wachovia common stock (other than Wells Fargo and its affiliates). The opinions of Goldman Sachs and Perella Weinberg were subsequently confirmed in writing. For more information, see “Opinions of Wachovia’s Financial Advisors”, beginning on page .

Immediately following the board of directors meeting, which concluded after midnight, the Audit Committee of Wachovia’s board of directors met and determined that the delay necessary to secure Wachovia shareholder approval otherwise required by the general rules of the New York Stock Exchange prior to consummation of the transactions contemplated by the share exchange agreement would seriously jeopardize the financial viability of Wachovia. The Audit Committee expressly approved Wachovia’s decision not to seek shareholder approval for the issuance and sale of Series M Preferred Stock to Wells Fargo pursuant to the share exchange agreement in reliance on an exception contained in the New York Stock Exchange rules. The Audit Committee members were present during the board discussions described in the preceding paragraph and had the benefit of those discussions in making the determination regarding Wachovia’s financial viability.

Following receipt of the oral fairness opinions, Mr. Steel executed the merger agreement and, with Ms. Sherburne, telephoned both Mr. Kovacevich and Chairman Bair to inform them of the Wachovia board approval and execution of the merger agreement. Thereafter, Mr. Steel, Ms. Sherburne, and Chairman Bair next telephoned Vikram Pandit, Chief Executive Officer for Citigroup, to inform him that Wachovia had entered into the merger agreement with Wells Fargo. Mr. Pandit indicated he believed Wachovia was in breach of the exclusivity covenants and appealed to Chairman Bair to consider the effect of this development on systemic issues unrelated to Wachovia.

At approximately 7:00 a.m. on October 3, Wells Fargo and Wachovia issued a joint news release announcing the merger agreement.

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