Bank of America Corp. cut ties with about 150 hedge funds last year in its prime brokerage group because new regulatory requirements designed to make the financial system safer are forcing lenders to reduce costs.
The second-largest US bank made the decisions based on which relationships were profitable enough to keep amid new capital and liquidity rules, according to two people familiar with the bank’s strategy, who asked not to be named because details are private. The cuts included the majority of its quantitative hedge fund customers, or those that use computer programs to trade, one of the people said, Bloomberg reported.
Prime brokerage, or the business of lending to and servicing hedge funds, has become less profitable as measured by return on equity under new rules known as Basel III, which are being put in place to prevent a repeat of the 2008 financial crisis. The regulations have prompted the biggest banks to trim relationships or increase fees for clients that don’t meet profitability targets. Last year, Goldman Sachs Group Inc. pushed some customers to move cash from the bank and cut back on some forms of client lending.
“Hedge fund managers should expect banks to become more discerning in their allocation of equity to support new and existing business -- redirecting resources away from businesses that are expected to earn low returns on equity,” JPMorgan Chase & Co. wrote in a report last year on hedge funds and prime brokers.
Rationing Credit
Bank of America is pulling back from a push into prime brokerage after buying Merrill Lynch & Co. in 2009. After the acquisition, the lender focused on expanding the business globally, building its management ranks by hiring several senior executives from competitors, including Nomura Holdings Inc., Morgan Stanley and UBS AG.
It’s curtailing some of those efforts as higher capital rules mean banks have to profit more on each loan to get the same return they once earned. Certain hedge fund strategies require more financing, such as credit and quantitative funds.
The rationing on Wall Street comes as many smaller hedge funds struggle to survive amid lackluster returns and investors increasingly allocate money to large brand-name managers. A Hedge Fund Research Inc. report this week showed 661 funds shut down in the first three quarters of 2014. There are 8,362 hedge funds globally with $2.9 trillion in assets, according to the data provider.
Banks have cut trading inventories, shed businesses such as insurance subsidiaries and canceled some derivative contracts in an effort to comply with the new rules. Still, the regulations have forced many of the biggest lenders to boost their shareholders’ equity by more than 50 percent since the crisis by issuing new stock and retaining a greater portion of earnings.
