Goldman grabs prime brokerage business
Credit crunch, Bear debacle, triggers flight to quality among hedge
funds
By Alistair Barr, MarketWatch
Last update: 1:56 p.m. EDT July 2, 2008SAN FRANCISCO (MarketWatch) --
The credit crunch and near-collapse of Bear Stearns has triggered
a "flight to quality" in the prime brokerage business as hedge funds
shift assets to the largest, most financially stable investment and
commercial banks, experts said this week.
Prime brokers lend money and securities to hedge funds, process and
clear their trades, take care of their assets and provide many other
backup services to managers, including risk management, reporting and
technology support.
It's a lucrative business that was dominated by Morgan Stanley
(MSmorgan stanley com new
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MS) , Goldman Sachs (GSGoldman Sachs Group, Inc
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GS) and Bear Stearns.
But when Bear almost collapsed and had to be saved by J.P. Morgan
Chase (JPMJPMorgan Chase & Co
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JPM) in March that changed. Many hedge funds worried they might not
be able to get their assets back quickly if Bear went bust. So
managers moved assets away from the struggling brokerage firm to
rival firms.
Goldman may have been the main beneficiary of this shift, while
Morgan Stanley and Deutsche Bank (DBdeutsche bank ag namen akt
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DB) also probably grabbed new clients and assets.
Goldman's Securities Services business, which includes the firm's
prime brokerage unit, generated record net revenue of $985 million
during its fiscal second quarter. That was up 36% from a year
earlier.
"That's amazing," said Josh Galper, managing principal of Vodia Group
LLC, a consulting firm focused on prime brokerage and securities
lending. "There's been a flight to quality in prime brokerage because
of a general concern about the credit quality and stability of
brokers following the collapse of Bear Stearns."
"Many, but not all, hedge funds have had multiple prime brokerage
relationships for years. When one prime broker appears to be in
trouble, it's not difficult for clients to move their accounts to
another prime broker," he explained. The revenue growth in Goldman's
Securities Services division reflects this clearly."
Vodia estimated in late June that Goldman became the largest prime
broker by assets under custody and leverage extended to hedge fund
clients, taking over from Morgan Stanley.
Still, Morgan Stanley's prime brokerage business also had a
successful fiscal second quarter, with strong revenue and average
customer balances up slightly from the previous quarter, Chief
Financial Officer Colm Kelleher told analysts during a conference
call in June.
Deutsche Bank also benefited, partly because it's a commercial bank
with access to more stable customer deposits, according to Galper.
In the past year, Deutsche's prime brokerage business has won more
than 150 new clients and is generating record revenue in 2008,
according to a spokesperson for the German bank.
However, all is not lost for J.P. Morgan, which was attracted to Bear
partly because of the firm's large prime brokerage business, Galper
said.
Some hedge funds probably kept their accounts at Bear Stearns, but
shifted all their assets and money to rival prime brokers, he
explained.
"The fact that Goldman had a spectacular quarter does not mean that
clients of Bear have closed their accounts," Galper said. "If J.P.
Morgan can show good customer service and stability some customers
may move some of their balances back."
Mini-prime brokers
Even if some hedge funds do return to Bear, the credit crunch has
encouraged most managers to set up accounts with more prime brokers.
The average hedge fund has 1.7 prime brokers currently, but that's
expected to increase to three in coming years, according to Jack
McDonald, chief executive of Conifer Securities, which provides back-
office services and other support to hedge funds.
Big prime brokers are also "squeezing the tails" of their client
rosters, eliminating accounts of some hedge funds that don't generate
enough revenue, McDonald said.
That's creating a booming market for so-called mini-prime brokers,
which service small to medium-sized hedge funds that are increasingly
being shunned by the largest firms.
Shoreline Trading Group, Merlin Securities, BTIG and Acceleration
Capital Group are some of the smaller prime brokers that have
sprouted in recent years. Conifer is also considering entering the
mini-prime brokerage business.
For Goldman, this trend doesn't mean it loses out on all the revenue
opportunities from serving smaller hedge funds though.
Most of the mini-prime brokers clear their clients' trades through
Goldman, McDonald noted.
Alistair Barr is a reporter for MarketWatch in San Francisco.