NEW YORK (
) -- The most significant part of the Volcker rule is steeped in ambiguity, but as it applies to hedge funds and private-equity investments, big banks appear overexposed.
Overall, the provision may have less of an impact on the financial industry than once feared, but several banks stand to get hit pretty hard because of the ratio of such alternative investments to their Tier 1 capital levels.
Housed within the financial reform bill, the Volcker rule seeks to prevent financial institutions from gambling with taxpayer-insured funds. Yet its language on so-called "proprietary trading" isn't entirely clear.
The rule will allow banks to continue buying and selling notes from the Treasury Department, as well as debt backed by
( FRE) and Ginnie Mae and other federal agencies. They can also use tools to hedge against risk or buy and sell instruments related to underwriting or market-making activities as long as banks don't act against the client's best interest. (The decision of whether there is a conflict of interest will be left up to regulators.)
The impact of the changes is yet to be seen, since it's hard to tell where the regulatory yardstick will land in terms of what activities fall outside of that wide net. But one element of the rule is more clear-cut: Financial firms will have to divest any private equity or hedge-fund investments beyond 3% of Tier 1 capital.
RBC Capital Markets highlights one small bank that stands to get hit pretty hard by that requirement:
The Santa Clara, Calif.-based bank had $247 million in venture capital and private equity investments as of March 31, representing about 30% of its Tier 1 capital. Perhaps not all of the items would need to be divested, but even half that amount would require significant divestitures -- or big
capital raising -- over the next one-to-seven years, depending on when the legislation is implemented and enforced.
It seems that large banks will have to do the same, albeit to a lesser degree. The data aren't strictly comparable because the banks don't report everything identically. Yet it appears that all but one of the Big Six -- with
being the exception -- will have to get rid of some alternative assets or present more cash to cover them.
will be hit hardest by the rule, since it has $10.5 billion in private-equity and hedge fund investments as of March 31. That represents 15.3% of its $68 billion in Tier 1 capital.
Bank of America
is next on the list of most exposed, outlining $13.5 billion worth of such investments, or 8.7% of its Tier 1 capital.
outlined $3 billion, or 6.1% of Tier 1, and
outlined $7.3 billion in private-equity assets alone, which represents 5.5% of Tier 1.
figures are less clear, but the bank seems to have $5.7 billion in such investments, representing 5.8% of Tier 1.
comes in at the low end of the pack -- perhaps because of its divestitures and restructuring -- holding just $1.3 billion in hedge funds and private equity., which represents 1.1% of its Tier 1.
RBC analysts noted that the timeline to adapt to the Volcker plan "offers much flexibility," especially because firms will get even more time to deal with illiquid assets. However, RBC believes most banks affected by the change will start divesting "as soon as possible."
Still, the biggest concern for large financial firms that have a big presence in the capital markets may be the definition of "proprietary," rather than how traditional their investments have to be.
Says RBC: "The most notable ambiguity lies with the delineation between proprietary trading and market making... We believe that determining these quantifications will not be that easy."
-- Written by Lauren Tara LaCapra in New York