Some Banks Have Work To Do To Comply With Volcker Rule

U.S. bank holding companies are moving at a variety of speeds when it comes to getting into compliance with the Volcker Rule.

Some banks, such as Goldman Sachs and Wells Fargo, may need to make serious changes to comply with the law. Others, such as Bank of America Corp., which has sold some private equity assets, and Credit Suisse, seem determined to keep their merchant banking businesses.

“The banks are clearly engaged in [the] process of rethinking and reconfiguring themselves” with regard to private equity, Josh Lerner, the Jacob H. Schiff Professor at Harvard Business School, told Buyouts.

Banks can sponsor private equity funds under the Volcker Rule, part of the Dodd-Frank financial reform packed signed into law last year, but they have to limit their own commitment to 3 percent of their tier 1 capital (equity capital plus disclosed reserves). And they can own no more than 3 percent of the fund. The rule requires banks to divest their direct holdings in third-party funds, but it doesn’t appear to impact the funds-of-funds and secondary pools managed by banks for other investors.

While implementation of the Volcker Rule could take as much as 12 years to fully implement, banks could well face pressure to act sooner. Principals working at merchant banks, for example, would no doubt prefer that their parent bank act sooner rather than later if they’re eventually going to be spun out. That way they can get on with the business of raising money as an independent group.

Goldman Sachs appears to be in the camp of bank holding companies that could not continue its merchant banking business, as currently funded, under the Volcker Rule. The bank reportedly contributed $9 billion to its sixth merchant banking fund, which closed in 2007 at $20.3 billion. That’s well above the roughly $2 billion it would be allowed to invest based on the $71.2 billion of Tier-1 capital it had by the end of last year. The bank has taken some action that appears partly inspired by the Volcker Rule. Last year it sold its proprietary trading desks to Kohlberg Kravis Roberts & Co., while its Urban Investment Group, which invested in inner-city companies, spun out as New MainStream Capital.

Wells Fargo, which last year divested one buyout group, Wachovia Capital Partners, has at least $2.9 billion committed across its buyout, mezzanine, and venture affiliates, known as Norwest Equity Partners, Norwest Mezzanine Partners, and Norwest Venture Partners. That would be just under $3.2 billion the bank would be allowed to invest under the 3 percent rule, considering its $109.35 billion of Tier-1 capital as of Dec. 31, 2010. But because the Norwest groups are captive, it’s likely Wells Fargo would run afoul of the Volcker Rule assuming it owns more than 3 percent of the funds.

Spokespeople for Goldman and Norwest declined to comment.

For its part, Bank of America Corp appears determined to maintain its remaining private equity businesses, including BAML Capital Partners, which invests $50 million to $200 million in buyouts (see table for the various private equity businesses at BofA and other banks). The bank, with $163.6 billion of Tier-1 Capital as of Dec. 31, 2010, would have around $4.9 billion to invest in private equity activities if the Volcker Rule applied today. In August, BofA divested Banc of America Capital Investors, another buyout group now called Ridgemont Equity Partners.

“The new requirements allow us to maintain our private equity investments business,” Jackie Fine, a spokesperson for the bank, told Buyouts. “We anticipate making some adjustments to ensure we are in compliance with the reforms, but believe our PE strategy was already moving in the direction of the new requirements over the past year.”

Credit Suisse, which operates DLJ Merchant Banking, a buyout group that’s been struggling with staff defections, isn’t planning to divest any assets and doesn’t plan to change any strategies with its various private equity activities, spokesperson Suzanne Fleming told Buyouts. (The bank also manages funds of funds and has a fund placement group.) The bank has long operated its private equity businesses with a capital-light model, meaning it has generally invested limited capital in the funds, which are primarily invested in by third parties. Still, the bank may need to lessen its investment to adhere to the Dodd-Frank capital requirements.