In a year of spectacular losses in mutual funds, few fund bailouts have caused more of a sat than the $67.9 million BankAmerica Corp. injected into two of its money market funds. In congressional testimony earlier this month, BankAmerica risk-management executive Lewis Teel explained what happened. Excerpts follow.
At various points from 1992 to October 1993, the [Pacific Horizon] Prime and Government Funds acquired variable and floating rate notes issued by U.S. government agencies. These notes met all objective purchase criteria and were permissible investments. The notes did not amount to more than 10% of each of the fund's respective portfolios at the time they were purchased.
Assets in the funds fluctuated from month to month. But when the Federal Reserve instituted a series of interest rate increases, [assets] began to decline sharply. Within a 90-day period the Prime Fund experienced redemptions of over $7 billion.
Rather than permit the net asset value of the fund's shares to fall, BankAmerica elected to make a capital addition to the [Prime] Fund of $17.4 million on May 6.
In June, [Securities and Exchange Commission] warnings about the use of structured notes by money market funds, and the continuing references to these instruments as "derivatives," led to an increase in redemptions.
During the third week of June, these problems also began to spill over into the Government Fund.
In light of market conditions and concerns, Bank of America proceeded to sell the structured notes. The losses amounted to 2% to 4% of the face value of the securities.
BankAmerica had no legal obligation to maintain the net asset value of the funds
[But] in the end, we felt that the bank's clients had invested in part due to the bank's respected reputation.
This experience has led us to improve our policies and procedures, with an emphasis of risk control.
In addition, the bank is placing greater emphasis on understanding its client base.
Many of the shareholders in the Prime Fund were clients of the distributor [Concord Financial Group]. The bank did not have a direct relationship with these shareholders. Consequently we did not have full appreciation for the degree to which these shareholders were sensitive to slight changes in short [-term interest rates].
We do not believe that this episode was essentially related to derivatives, or that it demonstrates the need for derivatives legislation.
Fundamentally, the problem came about because the investment decisions were mismatched to the highly interest-rate-sensitive client base.
Structured notes contributed to our problem.
But the problem could just as easily have arisen without such notes, depending on the weighted average maturity of the fund.
It is also important to put BankAmerica's capital contribution to the Pacific Horizon Funds in perspective.
We are in the business of managing all kinds of risks.
Bank of America sustained $525 million in credit losses from our lending activities in the first half of 1994, even though our lending activities contributed substantially to our bottom line.
Similarly, our risk management, investment advisory, and trading activities are profitable.
Losses in some activities are to be expected, but they are generally balanced out by gains elsewhere.
Management and the risk-control process must insure that exposure to loss is appropriate in light of the resources -- capital and earnings -- available to absorb them.
We have approximately $2 billion of earnings and $17 billion of shareholder capital available to absorb such risks.
