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Opportunistic Wells Fargo now in deal-making penalty box

Wells Fargo & Co. has been opportunistic when it comes to making specialty finance acquisitions, but regulators have sent the company to the deal-making penalty box.

The Federal Reserve and FDIC said Wells Fargo failed to address deficiencies in its resolution plan, or so-called living will, and imposed restrictions that include a prohibition on acquiring nonbank subsidiaries. Wells Fargo is expected to submit another plan by March 31, 2017, and if that one is rejected, the regulators said they would also prohibit the company from growing its nonbank assets beyond levels reported Sept. 30.

The limitations from the living will rejection are the latest setback for Wells Fargo, which has been embroiled in a cross-selling controversy stemming from the company creating unauthorized customer accounts. Given the troubles from the sales fiasco, Sandler O'Neill & Partners LP analyst Scott Siefers said it is unlikely that Wells Fargo was planning on executing a large nonbank transaction.

Still, the living will restrictions prevent the company from taking advantage of situations that may arise, and Wells Fargo has been acquisitive in the nonbank space. For instance, in October, Wells Fargo closed its purchase of asset manager Analytic Investors LLC, which offers quantitatively based equity products, and the acquisition was the company's first move toward planning a launch of exchange-traded funds, Bloomberg News reported.

Acquisitions are also part of the reason Wells Fargo has grown its nonbank assets. As of Sept. 30, the company reported nonbank assets of $199.7 billion, up 55.8% from year-end 2013, according to regulatory filings. During that same time period, the percentage of nonbank assets to total assets increased to 10.28% from 8.41%, according to regulatory and SEC filings.

Wells Fargo has been an active acquirer in the specialty finance space. Since 2011, the company executed 15 acquisitions of specialty finance portfolios and businesses, according to S&P Global Market Intelligence data. Some of Wells Fargo's largest specialty finance deals came through GE Capital's efforts to reduce its financial services exposure.

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GE Capital's first announced deal from the divestiture process came in April 2015 with the sale of its real estate assets, and Wells Fargo was one of the buyers, purchasing performing first mortgage commercial real estate loans valued at $9.0 billion. Later in 2015, Wells Fargo announced other deals with GE Capital, including the purchase of the company's commercial lending and leasing businesses. Through the transaction, Wells Fargo acquired $31.1 billion in assets, including $25.6 billion of loans and capital leases, according to Wells Fargo's Form 10-Q filed Nov. 3.

Many banks are turning to specialty finance types of deals in an effort to add assets in the current slow-growth environment, said David O'Connell, a senior analyst for Aite Group LLC. He noted that those deals can help banks boost risk-adjusted returns on capital, in part because specialty finance products often have more fees than traditional bank loans. For instance, he said equipment finance or lease deals involve more administration than more typical bank loans.

"So there are more administrative fees," he said.

O'Connell added that when banks buy nonbanking operations they diversify their lending by adding exposure to different offerings such as factoring or equipment finance.

"It's a good way to acquire institutional knowledge in some fairly gritty lines of business," he said. "I actually think these acquisitions are good for a bank like Wells."

Wells Fargo has touted some of the benefits from the GE Capital deals. For instance, Wells Fargo reported that through the first nine months of 2016, the GE Capital business acquisitions helped drive a $1.1 billion, or 10%, year-over-year increase in net interest income. Through the same time period, noninterest income increased $1.0 billion, or 11%, related in part to the GE Capital business acquisitions.

Siefers said that the GE deals are not transformational transactions for Wells Fargo, but they did represent attractive opportunities. "It's just very infrequently that you are able to get a good deal with high-quality assets from a compelled seller," Siefers said.

Initially, Wells Fargo was brought into the GE Capital discussions because it was one of the few potential buyers in good financial and regulatory standing that could also digest the assets, Siefers said. But much has changed since then.

"It feels like that was a long time ago," Siefers said. "[The Wells Fargo] story was much different when those deals were announced."