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Exclusive: Goldman finds a way past Volcker with new credit fund

Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall July 16, 2010. REUTERS/Brendan McDermid
Traders work on the floor of the New York Stock Exchange near the Goldman Sachs stall July 16, 2010. REUTERS/Brendan McDermid

By Matthew Goldstein and Emily Flitter

NEW YORK (Reuters) - Goldman Sachs Group is looking to raise up to $600 million from its wealthy customers for a publicly traded credit fund that will provide loans to mid-sized companies - believed to be the first fund of its kind for the Wall Street bank.

The new fund, in which Goldman could invest another $150 million of its own money, is being structured as a business development company, an investment vehicle that is specifically exempt from the so-called Volcker Rule that puts limits on some activities by Wall Street firms.

A January marketing brochure for the fund, reviewed by Reuters, said the fund will provide loans to "underserved middle market public and private companies" that commercial banks have largely refrained lending to since the financial crisis began.

The fund is a way for Goldman to keep a hand in the credit business despite new constraints on trading credit products that are expected to come with the finalization of the Volcker Rule. The rule that would ban proprietary trading carries exemptions in its current form for lending and small business development.

A spokesman for Goldman's asset management group, which is sponsoring the Goldman Sachs Liberty Harbor Capital fund, declined to comment.

The fund's portfolio, valued at around $50 million, already includes an average stake of about $8.5 million in six companies, with a weighted average yield of roughly 11 percent, according to the brochure. The investments are in both senior secured loans and unsecured high-yield debt.

The new fund comes at a time that Wall Street firms are looking to find new ways to entice their best brokerage customers into new products. While business development companies are not a new innovation, the Goldman fund could be a sign of things to comes from Wall Street firms as they adjust to prospect of lesser trading dollars because of the Volcker rule.

The Volcker rule is named after former Federal Reserve Chairman Paul Volcker.

The rule, which is still being hashed out by regulators, would limit the kind of activities Wall Street banks can engage in, including capping the amount of money firms like Goldman can invest in their own hedge funds and private equity funds and preventing them from trading certain kinds of financial products for their own accounts.

Changes banks including Goldman have made in anticipation of the Volcker Rule's prop-trading ban have already altered the competitive landscape noticeably in the credit space. Last fall a managing director at the private equity firm Blackstone Group took a jab at Goldman and other Wall Street banks, thanking Volcker for taking away its largest competitor in the credit space.

And while it is unlikely that funds that extend loans to businesses will be impacted by the Volcker rule, Goldman is one of several Wall Street firms that has lobbied regulators to make clear that loans made by credit funds are no different from traditional bank loans.

Jaret Seiberg, senior policy analyst at Guggenheim Partners, said it would make sense for Wall Street's biggest banks to follow Goldman's lead.

"Lending is outside the scope of the Volcker Rule, so investing in loans seems like a smart strategy going forward," Seiberg said.

In its current form, the Volcker Rule also exempts investments that are designed primarily to help develop small businesses and, as the rule puts it, "promote the public welfare."

"'We like small business,' is the historical background," said Rick Carnell, a professor at Fordham Law School who focuses on regulation. "Banking law contains various exemptions for financing small business which go back decades."

The managers of the Goldman fund are the same group of portfolio managers that have oversee group of credit hedge funds for Goldman's asset management group, some of which also make business loans.

The Liberty Harbor group is led by Gregg Felton, who joined Goldman in 2006 for the now defunct hedge fund Amaranth Advisors.

Business development companies function much like real estate investment trusts and pay out 90 percent of the ordinary income they generate by way of dividends. Publicly traded business development companies provide an opportunity for investors to easily move in and out of the fund by buying or selling shares.

According to the marketing materials, if Goldman takes the fund public, it expects to do so by July 1, 2015.

As opposed to a traditional credit fund, business development companies offer investors greater transparency into investments because the funds must comply with all Securities and Exchange Commission regulatory filing requirements.

(Reporting by Matthew Goldstein and Emily Flitter; Editing by Richard Chang)

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