Citigroup and Morgan Stanley are rolling the marriage dice. The result is a Smith Barney, Morgan Stanley Merger that will create the largest broker network.

A few months ago, Wall Street firm Morgan Stanley was scrambling to survive. Now it is rebuilding with a bang.

The New York company is pushing toward completion of a joint venture with Citigroup Inc.’s Smith Barney unit that would create the largest brokerage force in the world, toppling the former Merrill Lynch & Co., now owned by Bank of America Corp., from a perch it has held for years.

Putting together the two Wall Street rivals won’t be easy, with potential snags that range from clashing egos to divided loyalties, especially since Smith Barney brokers will likely report to bosses from Morgan Stanley, under the terms being discussed.

But with Citigroup hungry for cash and Morgan Stanley wanting to reduce its exposure to volatile trading businesses, both companies seem ready to roll the dice. Terms of the current talks call for Morgan Stanley to control 51% of the two companies’ brokerage units, with Morgan Stanley paying Citigroup about $2.5 billion.

With about 20,000 registered advisers, the Morgan Stanley-Smith Barney joint venture would nose ahead of Merrill Lynch at a time when some analysts view that firm as vulnerable following its acquisition Jan. 1 by Bank of America. James Gorman, the Morgan Stanley co-president who is expected to become chairman of the joint venture, led Merrill’s “thundering herd” of brokers before being wooed away in 2005 to turn around Morgan Stanley’s brokerage business.

Citigroup May Book $10 Billion Gain From Morgan Stanley Deal

In an interesting quirk of tax law, Citigroup May Book $10 Billion Gain from a $2.5 billion sale to Morgan Stanley.

Citigroup Inc. may book a gain of as much as $10 billion by forming a brokerage venture with Morgan Stanley, helping to replenish capital depleted by the biggest losses in the bank’s 197-year history, a person familiar with the talks said.

The pretax gain would result from writing up the value of Citigroup’s Smith Barney brokerage unit to the new price set by the deal, said the person, who declined to be identified because the talks are confidential. The gain of $5 billion to $6 billion after taxes would flow into Citigroup’s capital, a loan-loss cushion so eroded that the bank had to get $45 billion of rescue funds last year from the U.S. government.

“You’re selling out the future to get through the crisis of the present, and unfortunately they don’t have a lot of other choice,” David Trone, an analyst at Fox-Pitt Kelton Cochran Caronia Waller in New York, said in a Jan. 9 interview.

The worst banking crisis since the Great Depression forced Citigroup Chief Executive Officer Vikram Pandit to abandon his pledge not to sell Smith Barney. For the past decade, the unit has been at the center of the bank’s plan to provide bond- underwriting, savings accounts and investment advice under a single umbrella.

Breaking Up Is Hard To Do

I never bought Pandit pledge to not to sell Smith Barney. All parts of Citigroup are for sale in my opinion. For a discussion, please see Citigroup Pieces For Sale, Starting With Smith Barney.

Citigroup needs capital, and it is going to continue to need capital.

Shortly after Citigroup’s Town Hall Meeting proclamation that it was well capitalized (something no one in their right mind believed) , the Treasury, Fed Rushed to Citigroup’s Rescue injecting an additional $20 billion into Citigroup and backed up to $306 billion worth of the giant bank’s assets in a bid to help stabilize the firm.

Clearly the work is not done. The evidence is the sale of Smith Barney after a pledge by Pandit to not do so. How much credibility does Pandit have? I suggest the answer is none and he will not be long at Citigroup.

In regards to the wedding, there is bound to be huge levels of corporate overlap so look for 5,000 jobs minimum to go by the wayside.

Mike “Mish” Shedlock
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