1st Interstate in Talks With Wells on Buyout

First Interstate Bancorp appears ready to give up its three-month battle to avoid a takeover by Wells Fargo & Co.

The Los Angeles-based banking company opened talks with Wells over the weekend in reaction to a Securities and Exchange Commission decision that may have sunk its friendly deal with First Bank System Inc., Minneapolis.

In the decision, issued on Friday, the SEC said First Bank would have to suspend a share repurchase for two years once a transaction was completed.

"As a company, we are always mindful of our responsibilities to our shareholders, employees, customers, and the numerous communities of which we are an integral part," First Interstate chairman William E.B. Siart said in announcing new talks with San Francisco-based Wells.

In a prepared statement, First Interstate warned that there is no assurance that the discussions will result in a merger. Nor has the company yet terminated its friendly merger agreement with First Bank System.

But all signs point to the striking of a deal soon. For example, First Interstate gave some guidance about what to expect if a deal is reached.

A merger, the bank said, "is not expected to be at a price higher than Wells Fargo's current exchange ratio of 0.667 shares." Mr. Siart said in letters to customers and employees that he expects to report further developments in the merger talks "very shortly."

A source close to Wells Fargo, speaking on the condition that he not be named, said that First Interstate is not making any demands that Wells finds unacceptable.

The source added that he expects an agreement to be announced within "a couple of days," after the completion of due diligence work and the ironing out of details.

This means that Wells could file a revised proxy statement with the SEC next week. Shareholders of the two companies then could vote on a merger in late February or early March, the source said. A merger could be consummated in the second quarter, pending approvals by state and federal regulators.

Among the items Wells still needs to negotiate is the size of its operations in Los Angeles, the source said. Politicians and business executives have expressed concern about the economic impact in Southern California of an in-market merger. To alleviate the concerns, Wells officials have said they would be willing to operate dual headquarters in Los Angeles and San Francisco.

Wells also is interested in retaining some key First Interstate executives. Furthermore, Wells may want to negotiate a modest reduction in the $200 million breakup fee First Bank is entitled to if its friendly deal is terminated.

The SEC, rather than the markets, ultimately was responsible for bringing First Interstate to the negotiating table, according to another source familiar with the deal.

This source said that First Interstate officials were not overly concerned about the fact that Wells Fargo's offer has been valued at more than a billion dollars over First Bank's for at least the past month.

The source said that First Interstate had been seriously considering asking First Bank to increase its exchange ratio above the current offer of 2.6 shares. The source added that First Interstate officials did not believe that First Bank's stock would decline and offset the benefit of a ratio increase because there would be a large earnings accretion from a merger.

But the SEC ruling, in which the agency said First Bank could only use the pooling method of accounting if it refrained from stock buybacks for two years, was a "real zinger" that put a damper on the deal, this source said.

First Bank had planned to commence stock buybacks 90 days after a merger. Analysts said the buybacks were responsible for a third to half of the expected earnings accretion. The delay in the stock buybacks thus took away much of the value of the First Bank offer.

Many observers said that this resolution to the deal seemed fair to shareholders of all three companies. "In hindsight, I can't take potshots at anyone or their advisers," said Cary H. Thompson, a managing director with Natwest Markets.

Brent B. Erensel, of UBS Securities, said that by striking a friendly deal with First Bank, First Interstate managed to get Wells to increase its exchange offer above a previous offer of 0.625 per share.

This gained First Interstate about $600 million, more than compensating for the breakup fee due to First Bank. He also noted that the fee is expected to more than cover First Bank's costs as a white knight.

Daniel Kaplan contributed to this story.

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