Friday, January 22, 2010

Private Equity Cos Awaiting Specifics On Obama's Bank Proposal

The following news could be the reason for the recent selldown. Bearish market could have commenced. I would probably sell some on rebound.


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.

By Shasha Dai

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