The battle for control of troubled bank Wachovia tilted Sunday toward Wells Fargo as a state appeals court blocked a lower court's ruling that had favored rival bidder Citigroup.

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NEW YORK — The battle for control of troubled bank Wachovia tilted Sunday toward Wells Fargo as a state appeals court blocked a lower court’s ruling that had favored rival bidder Citigroup.

At stake is the $339 billion in Wachovia deposits and its network of more than 3,300 branches that would solidify the winner as being in the top tier of U.S. retail banking.

In the Sunday night ruling, the Appellate Division of the New York Supreme Court threw out an order by Justice Charles Ramos issued late Saturday at the request of Cititgroup. The order would have extended the time under which Wachovia and Citigroup had to complete their deal.

Citigroup, which announced Sept. 29 that it had federal backing to acquire the banking assets of Wachovia for $2.1 billion, or about $1 a share, said it would appeal.

The fight was also waged in federal court, where Wachovia asked U.S. District Judge John Koeltl to declare invalid part of the Citigroup deal that would have restricted Wachovia from considering competing bids.

Meanwhile, The Wall Street Journal reported Sunday night that the Federal Reserve was pushing for a compromise. The main plan under discussion would divide Wachovia’s branches, with Citigroup getting those in the Northeast and Wells Fargo those in the Southeast and California, the report said.

Analysts warned that a prolonged takeover fight carries enormous risk at a time when the nation’s financial system is under the worst stress since the Great Depression.

“I would hope there would not be a long battle because that does not bode well for Wachovia’s existing business,” said Ben Halliburton, chief investment officer at Tradition Capital Management in Summitt, N.J.

It was clear from court documents filed Sunday that Wachovia was in deep trouble. It disclosed it agreed to the deal “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.

Four days later, Wells Fargo stunned Citigroup by announcing Wachovia’s board had agreed to its $14.8 billion all-stock offer. Originally, the deal was valued at $15.1 billion, or $7 a share, but Wells Fargo stock later fell.

No FDIC aid

Wells Fargo also said it would need no FDIC assistance to complete the takeover, which would be aided by a new IRS rule designed to make it easier for banks to offset losses from loans and other bad debts held by other banks they acquire.

In its request to Ramos, Citigroup invoked an exclusivity agreement in the deal that it said barred Wachovia from considering competing bids from other potential buyers before Monday.

Wachovia responded by asking Koeltl to declare the Wachovia-Wells Fargo agreement “is valid, proper and not prohibited by a letter agreement between Wachovia and Citigroup.” Koeltl scheduled a Tuesday hearing so Citigroup could respond.

A protracted court fight raised the possibility Wachovia will further weaken.

Federal action

However, the government, which has closed and then seized failing banks, including Washington Mutual, would likely step in if the bank were in jeopardy.

Wachovia is among the banks whose billions of dollars in losses from bad mortgage bets ultimately led to the government’s $700 billion plan to buy bad assets from banks and other institutions to shore up the financial industry.

Wachovia spokeswoman Christy Phillips-Brown said Sunday the company believes its agreement with Wells Fargo is “proper, valid and … in the best interest of shareholders, employees and the American taxpayers.”

She said Citigroup is free to make a better offer under that agreement.

Wells Fargo said Sunday it has “a firm, binding merger agreement” with Wachovia.

The FDIC said Friday it “stands behind its previously announced agreement with Citigroup.” It also said it would review all proposals and work with regulators of all three institutions to resolve the tug of war.

An FDIC spokesman did not immediately return calls for comment Sunday.

Not only does a legal battle delay Wachovia’s saving, it could also be damaging to Citigroup, Halliburton said.

“I’m quite surprised that Citigroup would be agitating in this fashion, given that they themselves might need some government favors in the near future,” Halliburton said, either for recapitalization or potentially to take over some other failed institution.

“I can see why Citigroup wants it. I’m just surprised they don’t recognize in all likelihood it’s over,” he said.

Option ARMs

Wachovia was a big originator of what are called option adjustable-rate mortgages, which offered very low introductory payments and let borrowers defer some interest payments until later years.

Delinquencies and defaults on these types of mortgages have skyrocketed.

Wachovia and Citigroup are among the companies that have been forced to take billions of dollars in write-downs because of failed mortgages and mortgage-backed securities that have also plunged in value.

Despite its escalating loan losses, Wachovia is still worth far more than either Citigroup or Wells Fargo is offering, said Herb Sandler, the former co-CEO of Golden West Financial.

Wachovia picked up about $122 billion in option ARMs when it bought the California company and its thrift, World Savings in 2006 for $24.3 billion.

Arguing the projected losses on the World Savings loan portfolio have been grossly exaggerated, Sandler believes Wachovia is still worth at least $60 billion.

“This is still a viable company,” said Sandler, who declined to disclose how many shares he owns.

Once hailed for running their savings-and-loan company like an endearing mom-and-pop shop, Sandler and his wife, Marion, are now being vilified as ruthless home lenders who helped destroy Wachovia and contributed to the financial decay that led to the federal rescue plan.

After deflecting the media for months, Herb Sandler defended his lending record Sunday

Sandler, 77, spoke the morning after NBC’s “Saturday Night Live” broadcast a skit deriding the Sandlers as predatory lenders who had duped unsophisticated borrowers and Wachovia, too. A caption shown during the sketch skewered them as “people who should be shot.”

Public ridicule

The public ridicule represents a 180-degree turn for the Sandlers, who were considered the voices of reason while they steered Golden West and World Savings through a period of financial recklessness that led to the failure of thousands of other S&Ls in the 1980s and 1990s.

Golden West never strayed from its staid lending approach while the Sandlers scolded others for their risky investments in commercial real estate.

Herb Sandler agrees with his critics on one point: He and his wife, Golden West’s co-chief executives for more than 40 years, couldn’t have picked a better time to sell the company than when they closed their $24.3 billion deal with Wachovia in October 2006.

Home prices began to crumble once Wachovia took over, and now the bank is in such deep trouble that it has agreed to be sold to Wells Fargo for nearly 90 percent below the company’s stock price at the time of the Golden West takeover.