With apologies for not writing this up in more detail on Friday (it was a slightly hectic day), here is a fuller write up of the idea.

I posted on Friday because I thought the arbitrage would go away very quickly. It turns out that the arbitrage actually got wider on Friday and for better or worse it is a better idea now than it was when I tersely posted it.

The wb preferred j’s which trade as WB S closed Friday at $15. They are an 8 percent yield piece of paper and upon the closure of the Wells Fargo merger will become an obligation of Wells Fargo. Unlike similar pieces of Wells paper they are not cumulative and they are hold co level, although on the latter point there are a swath of Wachovia Trust preferred’s that one could use in the arbitrage instead. My guess is that the market will not see a difference.

At $15, the paper yields 13.3%. The Wells Fargo 8 5/8 cumulative paper closed at 24.60, which is about an 8.7 percent yield. At a 9 percent yield the WB S’s would trade at 22.22, which is a 48 percent return. At a 10 percent yield they would trade at $20, which is 33 percent return. The Wells Fargo paper trades at WCO pref. I cannot manage to borrow it.

On the close of Friday, Wachovia common traded at 5.15 and Wells Fargo common traded at 28.31. The conversion ratio is .1991 shares of Wells Fargo for Wachovia so the deal close price would be 5.63 per Wachovia share. That is 9.3 percent up.

If a deal does not close, then there is a chance that both the WB S’s and the common are zeros. In his affidavit Robert Steel testified that Wachovia had planned to cut the dividend and then offer 11.25 per share in an exchange offer if the Citigroup deal had closed. See http://dealbook.blogs.nytimes.... paragraph 21.

No doubt from current prices the preferreds will not fall further than the common.

For people worried about deal risk and about Wells Fargo paper risk, I suggest the following trade:

1. Long 1 share WB S pref
2. Short 3 shares WB common
3. Long .4 shares Wells Fargo

The total outlay for this trade is $10.87.

If the deal breaks then one is long 1 share of WB S pref and short three shares of common, which I think will be no worse than a wash. For 10.87 assuming the common and prefs cancel at 0 one will have bought .4 shares of WFC for 27.18 a share, which may not be great but is far from a disaster.

If the deal goes through January 1, one will have collected 50 cents in dividends from the WB S pref, another 13 cents from the WFC and given up 15 cents from WB, which is a net 48 cents. One will then be long one share of a Wells Fargo 8 percent non cumulative preferred and short .1973 shares of WFC common. If everything stays status quo the paper should be worth 22, the stock is a debit of 5.56 and the dividend is 48 cents for a total of 16.92 on a $10.87 outlay or a 55 percent 3 month return.

If Wells paper is trading worse than Wells stock probably is too so suppose the paper yields 10 percent and the stock is 20. Then the return is 20 – 3.95 plus 48 cents in dividends which is 16.53 which is a 52 percent return.

If Wells is trading at 40, the paper is probably trading around 24, which is 24- 7.89 + .48, which is 16.59 or a 53 percent return.

The only situation where the trade should turn out badly would be a total end of the world scenario (and people worried about this can simply take a lighter Wells position) or if there were an overbid. Given that Wells now has 40 percent of the vote and there will be no shareholder vote and Citi has walked away, this seems unlikely.

Apologies again for posting so tersely on Friday. I felt that this was an obvious opportunity that would not last the day.