updated 10/8/2008 2:00:09 PM ET 2008-10-08T18:00:09

Citigroup and Wells Fargo agreed Wednesday to extend their legal standstill in the fight for Wachovia until Friday morning, giving the banks more time to work toward a mutual agreement.

After the battle for the Charlotte, North Carolina-based bank moved to both state and federal court over the weekend, the parties agreed Monday to a cease-fire at the urging of Federal Reserve officials. But that agreement expired at noon Wednesday without a resolution on the fate of Wachovia.

The Fed was engaging in talks with both Citigroup and Wells Fargo in the hope of reaching a quick resolution and avoiding a lengthy court battle, a person with knowledge of the talks said Monday.

The extension of the standstill suggests that the parties believe an agreement is reachable. It puts on hold a hearing scheduled for 3 p.m. in New York federal court. Also, while it still leaves Wachovia without a rescue plan, it thwarts a drawn-out brawl in court — at least for now.

"I think the worst thing would be a protracted legal battle," said Mike Stanfield, chief executive of VSR Financial Services in an interview Tuesday. "There is enough uncertainty in the markets right now. We certainly don't need more."

Like many banks, Wachovia has been slammed over the past year by defaulting mortgages, particularly in its portfolio of option adjustable-rate mortgages, which allowed many customers to pay less than the monthly interest owed on the loan.

Wachovia was in considerable trouble when it agreed to the Citigroup deal early last week. Wachovia disclosed in court documents that it agreed to the acquisition "with the understanding that a seizure of its banking assets later that day by the Federal Deposit Insurance Corp. would occur" unless it accepted Citigroup's proposal.

Citigroup agreed last Monday to buy Wachovia's banking operations for $2.1 billion in a deal brokered by the Federal Deposit Insurance Corp.

In addition to assuming $53 billion worth of debt, Citigroup said it would absorb up to $42 billion of losses from Wachovia's $312 billion loan portfolio, with the FDIC agreeing to cover any remaining losses. In return, Citigroup would issue $12 billion in preferred stock and warrants to the FDIC.

Four days later, San Francisco-based Wells Fargo & Co. stunned Citigroup by announcing that Wachovia's board had agreed to its $13.1 billion all-stock offer. Originally, the deal was valued at $15.1 billion, or $7 a share, but Wells Fargo stock has declined since it was announced. The Wells Fargo proposal does not include assistance from the FDIC.

The announcement by Wells Fargo sparked legal action by Citigroup, which charged violation of its exclusivity agreements with Wachovia.

According to an affidavit filed by Wachovia Chief Executive Robert Steel in federal court Sunday, Steel was approached by FDIC Chairman Sheila Bair late Thursday. Bair told the CEO that Wells Fargo was prepared to propose a merger transaction "and encouraged me to give serious consideration to that offer," the affidavit said.

One of Wachovia's attorneys then advised Bair that unless Wachovia had a signed and board-approved merger agreement from Wells Fargo, it could not consider the proposal, the affidavit said.

The FDIC said Friday it "stands behind its previously announced agreement with Citigroup." At the same time, it said it would review all proposals and work with all three institutions to resolve the tug-of-war.

According to Steel's affidavit, Wells Fargo, along with Citigroup, pored over Wachovia's books the weekend of Sept. 27. But Citigroup was the only bank left standing when, at the eleventh hour, Wells Fargo backed out of a deal to acquire the entire bank without any government assistance, according to a person familiar with the situation. The person asked not to be identified due to the sensitive nature of the matter.

"I think Citi feels like if they had not stepped in, Wachovia would have gone bankrupt," Stanfield said. "They allowed Wells to make a higher bid. That is their best argument in my view."

Wachovia, like Washington Mutual Inc., which was seized by the federal government last month, was a big originator of option adjustable-rate mortgages, which offered low introductory payments and let borrowers defer some interest payments until later years. Delinquencies and defaults on these types of mortgages have skyrocketed in recent months, causing big losses for the banks.

Still, the bank's assets would undeniably be a boon to the ultimate victor.

An acquisition would greatly expand Citigroup's retail franchise — giving it a total of more than 4,300 U.S. branches and $600 billion in deposits — and would secure its place among the U.S. banking industry's Big Three, along with Bank of America Corp. and JPMorgan Chase & Co. Citigroup would also reclaim its title as the biggest U.S. bank by total assets — $2.91 trillion.

New York-based Citigroup could certainly use the additional deposit base to boost its balance sheet. The bank has not turned a profit for three straight quarters, and lost a total of $17.4 billion during that period after writing down its assets by about $46 billion. That's the most write-downs of any U.S. bank.

On the other hand, the deal would give Wells Fargo total deposits of $713 billion and more than 6,500 locations — more than any other bank in the U.S.

While there is some overlap in states like California and Texas, the deal essentially opens up the entire East Coast to San Francisco-based Wells Fargo, giving it a footprint in new markets such as New York and Miami.

In terms of total assets, a combined Wells Fargo-Wachovia would have $1.37 trillion in estimated pro forma assets as of the end of this year.

In the event of a deal, Wells Fargo said it expects to take a $74 billion hit on Wachovia's $498 billion loan portfolio. The bank also said it expects to incur the majority of credit costs in the next two years, and for the transaction to add meaningfully to earnings after that.

Because of a new tax leeway the Internal Revenue Service has granted banks, Wells Fargo could use the $74 billion of tax losses on Wachovia's loan writedowns to offset its own income, which means the bank's taxes could be much lower for several years, according to Deutsche Bank analyst Mike Mayo.

"It's conceivable that if Wells Fargo wanted all of Wachovia, they simply could give money to Citi and allow them to step away from a transaction and still have some money as well," Stanfield said. "If Citi really wanted all of Wachovia, they could turn around and bid as well."

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