NEW YORK (Dow Jones)--President Barack Obama's proposal to rein
in banks contains a number of provisions that could have a serious
impact on the private equity arms of banks, as well as the private
equity industry overall, depending on how the vague outlines
unveiled Thursday are filled in.
Obama said in his remarks on the proposal that "banks will no
longer be allowed to own, invest in or sponsor hedge funds,
private-equity funds or proprietary trading operations for their
own profit, unrelated to serving their customers."
Some say the clause at the end of that statement about serving
customers may provide a loophole, as most banks would argue that
their PE investments do just that. But the proposal nonetheless
could mean any private equity or venture capital firm run by a bank
would need to spin out on its own or wind down.
The number of such firms has decreased in recent years, as many
banks have spun out their merchant banking operations, but there
are still a number of financial institutions with significant
private equity operations.
The most notable is Goldman Sachs Group Inc. (GS), which has
some $145 billion in alternative assets under management as of
Sept. 30. Goldman Sachs runs some of the biggest private equity
funds around, including the $20.3 billion GS Capital Partners VI
and the $13 billion GS Mezzanine Partners V. The bank has been a
big investor in its own funds, with close to half of the capital in
its sixth main fund, for instance, coming from the parent company
and its employees.
Many market participants believe Goldman Sachs will be the
hardest hit by the proposal as it is currently phrased. "[The
proposal] is a big deal," said a senior executive at one
bulge-bracket firm. "It hurts Goldman Sachs the worst because of
its reliance on proprietary trading."
During a conference call with analysts Thursday, Goldman Sachs
Chief Financial Officer David Viniar said the firm's private-equity
business is "important" and "very integrated" with the rest of its
businesses. "There are a lot of our very important clients invested
in our private-equity business," he said, according to a
transcript. "We invest alongside other clients of the firm, and we
invest in clients to help them grow."
But Goldman Sachs is far from the only bank that might be
impacted. The fate of Morgan Stanley's (MS) direct buyout arm, for
instance, is up in the air. That unit is still trying to raise a
multi-billion dollar fund, which held a first closing on around
$2.5 billion in 2008. A person familiar with the matter said the
fund is still open, though it isn't clear how much capital it has
collected. Morgan Stanley also has a fund of hedge funds business,
with about $16 billion in asset under management. It owns stakes in
several hedge fund managers, including Avenue Capital Group, and
has real estate investments and a small proprietary trading
desk.
The co-heads of Morgan Stanley Private Equity, Stephen Trevor
and Alan Jones, weren't available for comment.
J.P. Morgan Chase & Co. (JPM), which spun out its larger
buyout arm a few years ago, retains a smaller buyout unit, One
Equity Partners. A person familiar with the situation said One
Equity would have to be divested, while the bank's asset-management
business, which manages assets on behalf of third-party clients,
probably wouldn't be affected. Tasha Pelio, a spokeswoman for One
Equity, wasn't available for comment.
It isn't clear what will happen to Merrill Lynch, now part of
Bank of America Corp. (BAC), or to a multi-billion-dollar private
equity fund that it may or may not still be trying to raise. The
fund originally had a target of $6 billion, with roughly half of
the money to come from Merrill Lynch itself.
Other banks with private equity operations include Citigroup
Inc. (C), which owns Metalmark Capital; Credit Suisse Group's (CS)
DLJ Merchant Banking Partners, and Wells Fargo & Co. (WFC),
which is the sole or main LP in a number of funds carrying the
Norwest name. A spokeswoman for Citigroup declined to comment,
while spokespersons for Bank of America, Credit Suisse and Wells
Fargo weren't available for comment.
More broadly, the proposal as worded could shut down banks'
capital commitments to any private equity firms--not just their own
PE arms--making fund-raising harder for many in the industry.
Banks aren't huge investors in private equity funds--in 2008
they accounted for only 10.3% of overall U.S. fund-raising,
according to the Private Equity Analyst Sources of Capital survey,
and that percentage likely declined in 2009 as banks tend to pull
back from PE during down periods. But in what is already a tough
fund-raising environment, their removal from the capital pool
wouldn't help, especially for the few firms that still do count
banks as big investors.
"If banks can't invest--if insurance companies can't also--if
endowments and pension funds have less money to put to work, it's
going to be difficult to raise money for funds," said Antoine
Drean, chairman of placement agent Triago.
Depending on how the administration's proposal is enacted, it
could also force banks to sell existing fund stakes on the
secondary market. If this were to happen en masse, it could result
in a real logjam on the secondary market and major headaches for
firms that count banks among their LPs. That has secondary firms
salivating already.
"The regulations may cause some wholesale spinoffs," said Kelly
DePonte, a partner at placement agent Probitas Partners. "This is
good news for the secondary market as attractive partnerships will
be offloaded."
However, one key legislator acknowledged the problems with that
scenario, as House Financial Services Committee Chairman Barney
Frank (D., Mass.) said in an interview on CNBC that any banking
curbs should be implemented over a longer time frame of three to
five years. "To order this to be all done all at once, it would be
a fire sale and I would be opposed to that happening," he told
CNBC.
In the end, industry participants said it is difficult to tell
from Obama's brief statement just what the administration's
proposals will look like in more fleshed-out form. They also don't
know how the proposals might change as they make their way through
Congress.
One guidepost might be similar proposals on Securities and
Exchange Commission registration. When the administration
originally proposed SEC registration in early 2009, it was intended
to apply to all private equity, venture capital and hedge funds,
but after heavy lobbying by the National Venture Capital
Association, the version of legislation that eventually made it
through the House of Representatives omitted venture funds from
registration. And the version still pending in the Senate omits
both venture and private equity funds.
Whatever happens, those affected in the private equity industry
are hoping for more clarity soon, as they say the uncertainty this
proposal has created--like others from this administration on
topics like health-care reform--makes it difficult to go about
their daily lives.
"These are prognostications that aren't actionable," said one
executive at a private equity firm that used to be part of a
bank.