Wells Fargo’s new finance subsidiary company kicks off, but it’s late in the TLAC game

By Emma Trincal

New York, May 1 – Wells Fargo & Co. created a wholly owned finance subsidiary company named Wells Fargo Finance LLC to issue debt securities, which will be “fully and unconditionally” guaranteed by parent company Wells Fargo & Co., according to a 424B2 filed on Friday with the Securities and Exchange Commission.

The name of the subsidiary is reminiscent of other big banks’ subsidiaries, which are issuing structured products at the subsidiary level rather than at the bank holding company level, with the guarantee of the parent company.

“This is purely TLAC-related. They’re doing what all the other U.S. banks did a couple of years ago. This is going to be how they will issue structured notes looking forward,” a lawyer said.

TLAC rules

In 2016, major U.S. banks indeed created or used existing finance subsidiaries to issue structured notes as a way to comply with the Federal Reserve Bank’s Total Loss Absorbing Capacity (or “TLAC”) rules governing the Global Systematically Important Banks or “G-SIBs.”

The TLAC rules were designed as part of overall capital requirements to ensure that large financial institutions had enough capital to avoid posing a threat to financial markets stability as it happened at the end of 2008.

Each G-SIB is required to meet a certain minimum of the “loss-absorbing capacity” capital in the event of a crisis or bankruptcy.

Unfortunately for the structured notes industry, the Fed did not recognize structured products as TLAC-eligible mainly due to their derivatives features.

This became an issue for issuing banks as the non-eligibility forced them to raise more debt to meet their TLAC ratios.

Loophole

“TLAC rules have certain requirements regarding the issuance of certain debts from the bank holding company,” explained this lawyer.

“Structured products are one of those instruments that are limited. They cannot exceed with other financial instruments 5% of the holding company’s risk/weighted assets.”

But the industry quickly found a way around this by setting up subsidiaries for the issuance of structured notes. It was a simple answer to a complex rule: TLAC only applies to the parent company, not to a subsidiary.

“In order to more efficiently issue structured notes banks have said: OK, you don’t want us to issue them out of the holding company? We’ll set up new subsidiaries. That’s what they did back then. And that’s what Wells Fargo is doing now,” the lawyer said.

Late-comer

Wells Fargo was the only large U.S. bank that so far was still issuing structured notes from the parent company. In that regard, Wells Fargo is two years behind its peers as banks, one after the other, switched to finance subsidiaries in 2016.

Some holding companies, for instance Citigroup, Inc. and the Goldman Sachs Group, Inc., began then to use existing subsidiaries: Citigroup Global Markets Holdings, Inc. and GS Finance Corp., respectively.

JPMorgan created JPMorgan Chase Financial Co., LLC; Morgan Stanley established Morgan Stanley Finance LLC and Bank of America ramped up BofA Finance.

As all other big U.S. banks have elected two years ago to issue structured notes from a finance subsidiary company, it remains unclear why Wells Fargo took so long to do the same thing.

“Wells Fargo Finance LLC is a newly created subsidiary,” the lawyer noted.

“They’re the last one of all U.S. banks. I imagine it relates to their own capital planning needs,” a second lawyer said.

“Some banks continue to issue at the holding company level but only for lightly structured notes, like rate-linked notes.”

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