Citi prices first deal through its TLAC-related issuing subsidiary, joining a growing club

By Emma Trincal

New York, March 30 – Lining up to comply with capital regulations, most issuers have recently amended their shelves or created new subsidiaries in order to issue structured notes in accordance with the so-called total loss-absorbing capacity requirements, also known as TLAC.

The last to date was Citigroup Inc., which earlier this month added a new issuing subsidiary to its shelf.

Citigroup Global Markets Holdings Inc. priced $68.7 million of floating-rate notes due May 5, 2017 linked to the performance of the Citi Commodity Spread Index – Bloomberg Commodity Index 3 Month Forward Sub-Indices versus Bloomberg Commodity Index Sub-Indices, according to a 424B2 filing with the Securities and Exchange Commission. The deal priced on March 24. The notes are guaranteed by Citigroup.

It was the first registered structured note to price under this issuing entity.

A Posar filing was made earlier in March allowing Citigroup Global Markets Holdings to issue debt under the Citigroup shelf and to enable Citigroup to be the guarantor. The new issuing entity is a wholly owned subsidiary of Citigroup.

This pattern of issuance is now the “new normal” on Wall Street, sources said, as Citigroup is merely following the lead of many other large banks on Wall Street that have set up or are in the process of setting up new finance companies. Those are created to issue structured notes in a bid to comply with new rules designed to avoid “too big to fail.”

TLAC

In October, the Federal Reserve Board proposed rules asking the 30 banks that pose systemic risk to hold a minimum amount of assets deemed to absorb losses – the TLAC – in case of insolvency.

The purpose of the rule, following Financial Stability Board’s recommendations, is to avoid another too-big-to-fail scenario.

Banks will be required in future years to hold at least 18% of their risk-weighted assets in TLAC. Failure to do so would represent a violation of their capital requirements.

Unfortunately, structured notes do not count toward TLAC, according to lawyers’ interpretations, partly because of their embedded derivatives.

“The fact that structured notes are not eligible is a negative. If you were to issue structured notes that don’t count as TLAC, you’d still have to meet your TLAC requirements and long-term debt requirements, so you’d have to raise a lot more debt. It would be inefficient. It’s not even an option. If you’re an issuer, why would you want to issue a debt that doesn’t work for you?” explained a lawyer.

The subsidiary solution

Fortunately, the Fed imposes those restrictions on bank holding companies only. Very quickly last year, Goldman Sachs Group, Inc. took the lead by boosting issuance volume through its GS Finance Corp. subsidiary.

GS Finance was not a new company. It had issued two small structured note offerings in 2008 totaling $28 million, according to data compiled by Prospect News. Starting last year, however, the subsidiary began to operate full speed. GS Finance has issued $1.74 billion in 171 offerings since July, according the data.

Finance companies

If issuers are using the subsidiary route to issue notes, it is because TLAC is only valid on a consolidated level, not on the subsidiary level.

Issuers could also use operating companies instead of finance subsidiaries, but it would be “more complex” and would have to include audited financials, said Anna Pinedo, a partner at Morrison & Foerster, during a presentation at a conference held in March and hosted by the Structured Products Association.

“Most issuers have decided to issue from a finance subsidiary company. They established these finance companies as issuers,” Pinedo said at the conference.

The structured notes issued by the subsidiary are guaranteed by the bank holding company, which enables the securities of the finance company to be registered on an S-3 filing using the shelf registration process.

JPMorgan

JPMorgan Chase & Co. on Feb. 24 made an S-3 filing with the SEC to announce that its subsidiary JPMorgan Chase Financial Co. LLC will issue debt, which JPMorgan will fully guarantee.

No structured notes have yet priced, but sources said it is pending.

Morgan Stanley

A week before, Morgan Stanley amended its registration statements on Form S-3 as well to add Morgan Stanley Finance LLC to its shelf. The finance company is a subsidiary of Morgan Stanley. Its debt will be guaranteed by the holding company.

Morgan Stanley Finance priced its first deal late last week. It was $2.1 million of leveraged notes due Sept. 30, 2019 linked to the Euro Stoxx 50 index.

“Wells Fargo is considering doing the same thing,” according to a market participant.

“They’re looking into it. They’re all looking into it.”

Some markets participants on the distribution side who are less familiar with the regulation remain puzzled.

“I don’t know. It looks like a loophole to me. Is that so easy to comply with TLAC rules? You just create a subsidiary?” asked a distributor.

Cost of doing business

A lawyer explained.

“It’s not a game. This is what they have to do,” he said.

Based on a set of rules proposed by the Fed, which include TLAC but also a so-called “clean holding” regulation, bank holding companies are subject to limitations when it comes to non-eligible TLAC, which is the category under which structured products fall into. The excluded liabilities cannot exceed 5% of their TLAC capital.

“It’s a very small bucket,” he said given that TLAC itself represents a fraction of the risk-weighted assets.

“It’s obviously not enough.”

But TLAC is an obligation of the parent holding.

“All the losses will be passed on to the parent holding company. If the finance company fails, the losses will be absorbed by the bank holding company, not by the debtholders. All the people who had business with the subsidiary will go on with their business. At least, that’s the idea.

“This is why you have the guarantee. It’s as if the parent company invested money in the bank itself. If the finance company becomes insolvent, the parent company absorbs the losses, allowing the subsidiary to continue to do business because the losses have been absorbed by the parent.

“In theory, the parent that has issued TLAC will have enough ‘absorbing capital’ to absorb those losses.

“That’s the theory.

“This is the structure people are going into. Are they happy? It doesn’t matter. That’s reality. They don’t really have the choice.”

© 2015 Prospect News.
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