Time Short for Goldman, Morgan Stanley to Exit Billions in Funds

  • Firms must shed private equity, hedge funds under Volcker
  • Fed granted banks final one-year extension to July 2017

U.S. banks got a reprieve last week when the Federal Reserve gave them one more year to comply with a Volcker Rule ban on investing in private equity and hedge funds.

For Goldman Sachs Group Inc. and Morgan Stanley, now comes the hard part: Exiting billions of dollars of holdings in a short time without selling some at a loss.

The industry has until July 21, 2017, to sever most ties with private funds after the Fed signed off on the last of three 12-month extensions it was permitted to grant under the Dodd-Frank Act. That means the clock is winding down for Goldman Sachs to shed as much as $7.2 billion of investments and for Morgan Stanley to unload as much as $3.4 billion. Regulatory filings for other big banks don’t provide as much detail on investments they might have to exit to satisfy Volcker.

“For the most part, there isn’t a sense of panic,” said Kevin Petrasic, who runs the financial-services practice at White & Case and has been advising banks on complying with the prohibition on private funds. “There’s more sort of a sense of inevitability.”

Volcker -- one of the toughest restrictions in Dodd-Frank -- aimed to rein in excessive risk taking after the 2008 financial crisis, partly due to concerns that it wasn’t appropriate for banks with government-backed deposits to make speculative market bets. In addition to banning lenders from trading with their own capital, it restricted investments in funds.

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Goldman Sachs has $5 billion in private equity, $1.2 billion in real estate funds and a remaining billion split between hedge funds and credit funds, according to a May filing. Two years ago, the bank had $14.2 billion of fund holdings. It has cut that in half, and the New York-based firm said it expects to be able to exit the majority of what’s left without much difficulty before the deadline.

But the bank said it can’t pull its money from certain investments, including some private equity and real estate funds, until the underlying assets are sold. So adhering to Volcker may force Goldman Sachs to sell its stakes to other investors, a process the bank said could trigger losses.

Tough Sell

“There could be a limited secondary market for these investments and the firm may be unable to sell in orderly transactions,” the bank said in the filing.

Morgan Stanley’s investment stockpile includes $1.8 billion in private equity, according to a May filing, along with $346 million in hedge funds and $1.3 billion in real estate funds.

Many of the real estate funds Goldman Sachs and Morgan Stanley invest in may not be prohibited by Volcker depending on how they’re legally set up, but the banks didn’t provide details on how much of their holdings they think they can hold on to.

Spokesmen for Goldman Sachs and Morgan Stanley declined to comment on their Volcker compliance, as did spokesmen for other big banks, including Citigroup Inc., JPMorgan Chase & Co., Bank of America Corp. and Deutsche Bank AG.

‘Snooze Button’

Marianne Lake, chief financial officer of JPMorgan, the largest U.S. bank by assets, said in an earnings call last year that the lender had “reshaped our business through time to be compliant in substance and in form with Volcker.” As of March 31, the bank had investments in private equity funds, hedge funds, real estate funds and other funds that it valued at $1 billion, an April filing shows.

The banks have had plenty of warning, and they’ve had a good market to sell their holdings, said Marcus Stanley, policy director for Americans for Financial Reform.

“They just kind of want to hit the snooze button again over and over with the Fed,” Stanley said, and he says bank lobbyists have meanwhile been trying to talk Congress into helping them on Volcker compliance. “The regulators have to be prepared to say, ‘Time’s up.’ ”

The Fed has so far given banks as much of a leash as Dodd-Frank allowed, granting all three of the single-year extensions permitted in the law.

‘Highly Illiquid’

Still, there is an avenue for banks to secure another kind of extension -- a lengthier pass that regulators can grant on a case-by-case basis for investments that are the hardest to get out of. Banks such as Goldman Sachs and Morgan Stanley would have to submit an application for each individual fund. While the Fed hasn’t laid out how it would handle what could amount to thousands of applications, it did note last week that it will have more to say on the topic “in the near term.”

Industry groups have argued that more time is warranted, claiming that forced sales could have negative impacts on portfolio companies owned by private-equity funds and hurt other fund investors.

“A number of the remaining legacy fund positions held by banking entities are highly illiquid and thus extremely difficult to sell,” the American Bankers Association and the Securities Industry and Financial Markets Association wrote in a March letter to the Fed.

The industry also has the backing of several Democrat senators, according to a May 24 letter to the Fed from four lawmakers including Banking Committee members Mark Warner of Virginia and Jon Tester of Montana. The letter urged the regulator to “grant an extended conformance period to banking entities that have been acting in good faith.”

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