Citi and Morgan to merge brokerages

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Morgan Stanley chief John Mack (left) and Citigroup CEO Vikram Pandit will now be partners as a result of Tuesday's merger of the two companies' brokerage units.

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NEW YORK (CNNMoney.com) -- Citigroup confirmed speculation Tuesday that it plans to merge its Smith Barney brokerage division with that of peer Morgan Stanley, a move that is expected to mark the beginning of a break-up of the troubled banking giant.

Under the terms of the agreement, Morgan Stanley (MS, Fortune 500) will take a 51-percent stake in the joint venture and pay Citigroup (C, Fortune 500) $2.7 billion for the stake.

In a statement released by both companies, Morgan Stanley said it reserves the right to raise its stake in the joint venture over the next three to five years, before ultimately assuming control after five years.

The combined entity, which would be called Morgan Stanley Smith Barney, would be one of the nation's largest brokerages, with more than 20,000 financial advisors and $1.7 trillion in client assets.

"We are creating a new industry-leading wealth management franchise," said John Mack, Morgan Stanley's chairman and CEO, in a statement.

While the deal is expected to save the two firms a combined $1.1 billion, both appear poised to gain from the joint venture. Morgan Stanley would position itself to build its wealth management business, while Citigroup would generate some quick cash, and still maintain a sizeable stake in its reliable Smith Barney unit.

In a conference call following the announcement, Morgan Stanley co-president James Gorman, who will serve as chairman of the joint venture, and Mike Corbat, CEO of Citi's global wealth management division, said it was too early to tell how many jobs could be lost as a result of the tie-up.

They hinted that some of the top performers might receive retention bonuses to stay on, but could not indicate what it would cost the two firms.

Tuesday's action, however, represents what some consider to be the first step by Citigroup to dismantle its so-called "universal banking" business model, offering all types of financial products to consumers and businesses.

A source close to the matter indicated that the company will unveil a reorganization plan in the coming weeks. The Wall Street Journal reported that the company could time the announcement to coincide with its fourth-quarter results on Jan. 22.

A company spokesman declined to comment on the matter.

Citigroup observers have speculated that any number of its different units could be shed as part of a restructuring plan, including international operations such as Banamex, one of Mexico's largest commercial banks.

Others have speculated that Citigroup might pursue a bolder approach by trying to sell other divisions, including its massive credit card unit.

Some analysts previously suggested that the company's transaction services business, which helps finance trade for large corporations, might also be on the block. However, a source close to the matter said that the company has no plans to sell that business.

A breakup of Citigroup, however, would represent a major departure from the company's so-called "universal bank" business model, which has been in place for more than a decade following the merger between Citicorp and insurance company Travelers in 1998.

Citigroup CEO Vikram Pandit had maintained his commitment to the company's position as a one-stop financial shop for businesses and individuals as recently as last fall.

But the New York City-based bank has come under increasing pressure to take drastic action in recent weeks.

Next week, analysts expect the company to book its fifth-consecutive loss, this time hemorrhaging close to $3.8 billion, or $1.14 a share, according to Thomson Reuters.

And 2009 doesn't look much better. Analysts widely expect the banking giant to finish this year in the red as well.

At the same time, regulators are anxious for Citigroup to get its affairs in order. The government brought the bank back from the brink of collapse in November by agreeing to absorb a portion of its future losses tied to more than $300 billion in assets.

In addition, Citigroup has received an investment of $45 billion from the Treasury Department as part of the government's controversial bank bailout program.

Citigroup (C, Fortune 500) shares gained more than 5% Tuesday on the New York Stock Exchange following a 17% stock plunge just a day earlier. Morgan Stanley (MS, Fortune 500) shares edged slightly higher.