To most banks, mutual fund companies are formidable rivals in the contest to capture savings dollars. But to a handful of big banks, fund companies have become an important new cluster of borrowers.
The mutual fund industry's extraordinary growth - assets have doubled to $2.7 trillion in five years - has been accompanied by a surge in its financing needs.
The industry's basic borrowing needs, once negligible, are expected to hit $2 billion this year - and that does not include the hefty sums involved in financing mergers.
Banks, which have long supplied fund companies with short-term lines of credit, increasingly are being called upon to meet more elaborate demands for both loans and structured financing.
It's easy to see why the fund industry's appetite for financing is on the rise.
Mutual fund assets are soaring, triggering a burst of spending on the technology needed to respond to a growing customer base. Mergers are accelerating, pushing up demand for large sums of capital. And fund companies increasingly are financing their customers' purchases of fund shares, creating unaccustomed cash-flow needs.
In short, the fund industry of the 1990s has an unquenched thirst for capital.
"For a lender, that's where the opportunity is," said John A. Ketchum, who heads Bank of Boston Corp.'s financial institutions division.
Bank of Boston, based in a city known as the birthplace of the mutual fund, has emerged as one of the fund industry's chief financiers. Others in its league include Citicorp, Chemical Banking Corp., NationsBank Corp., and Deutsche Bank.
If there's a leader in the bunch, it may well be Citicorp. In addition to acting as lender, the nation's largest banking company has begun purchasing the future revenue streams of fund complexes with an eye toward securitizing them. A private placement of these revenues is expected in the coming months, according to a well-placed source.
Citicorp is carefully guarding the details of its plan. "We are doing some things in that area," said William Henson, a Citicorp executive involved in securitization activities. But, he added, "we don't need to get it out there in the marketplace, which includes a number of our competitors."
Mutual fund companies are clearly viewed as a good risk from a lender's standpoint.
"Fund companies produce strong cash flow, which has held up under a variety of conditions," said Richard H. Klein, managing director of Chemical Securities, a subsidiary of Chemical Banking Corp.
Just who are the fund companies that bankers are calling on? Most of the nearly 400 companies that manage mutual funds have borrowing needs at least occasionally. But the steadiest borrowers are stand-alone companies, and those that are part of a larger company but cannot routinely tap their parent for financing.
Some of the most frequently mentioned borrowers include Eaton Vance Corp., Van Kampen American Capital, AIM Management Group, Keystone Group, and Oppenheimer Management Group.
While fund companies need financing for everyday needs, such as financing share redemptions or payments to brokers, their funding needs soar when they enter the acquisition fray.
For example, when Van Kampen Merritt needed financing in 1994 to buy American Capital, Chemical Bank Corp. was there as the lead agent of a $460 million bank loan.
Two years earlier, Chemical also led a group of banks that provided $360 million in financing when Franklin Resources purchased Templeton, Galbraith, & Hansberger, creating the fifth-largest mutual fund complex in the country.
With close to 400 fund companies managing some 5,000 funds, there is little doubt that mergers and acquisitions will gather speed in coming years. But while banks see this M&A financing as a juicy opportunity, they are more focused on meeting the bread-and-butter financing needs of mutual fund firms.
Right now, one source of steady business is in the unglamorous but fast- growing area of financing the sale of mutual funds that carry a deferred payment option.
Traditionally, fund companies that market their wares through brokers have charged customers a sales commission, ranging as high as 8% of assets, at the time of sale. These fees, known as front-end loads, come out of the principal that a customer invests.
To satisfy customers who want to put their entire investment to work immediately, fund companies increasingly have been offering other payment options, including deferred payments, or back-end loads. But even though fund companies put off the collection of fees, they still have to pay brokers for the sales.
To fill this gap, fund companies have been tapping banks to finance the sale of mutual funds with back-end loads - dubbed "B-shares" in contrast to the "A-shares" that carry up-front fees.
Over the last five years, assets in back-end load mutual fund shares have almost tripled, to $194 billion as of June 30, according to Lipper Analytical Services, Summit, N.J.
Bank of Boston projects that banks will provide between $400 to $750 million in B-share financing over the next year. Fund companies repay the lender from marketing fees and other revenues.
Examples of back-end load financings abound:
*NationsBank is the lead agent for a $200 million line of credit - much of it for back-end loads - for Alliance Capital Management, which manages $36 billion in funds.
*Bank of Boston is the lead bank of a $45 million line of credit with Pioneer Group, a fund house with $12 billion under management. So far, Pioneer has used $15 million to compensate brokers for selling back-end load funds.
*Citicorp has agreed to provide $75 million in funding over two-years to Houston-based AIM Management Group to help the fund firm finance its B shares.
It's clear that B-share funds are developing a following with consumers.
Until April 1994, when Pioneer began offering its first back-end load shares, 100% of the company's sales came through sales of front-end load shares. Today, about 45% of the company's 1995 sales came through back-end loads.
As for Oppenheimer, about 40% of the company's sales in 1995 came from B shares, up from zero three years ago.
"Despite the growing popularity of no-load funds, there will always be a segment of investors that will go through brokers or some intermediary," said George-Ann "Tykie" Tobin-Dew, who heads Deutsche Bank's efforts to lend to U.S. financial institutions.
"Back-end loads are gaining in popularity for those who buy through brokers," she added.
Bank and fund company executives expect that growth in B shares will continue throughout the remainder of the 1990s as investors in broker-sold funds elect to avoid an up-front sales charge.
Says Robert K. Grunewald, a senior vice president with NationsBank: "B shares are one of the primary topics with our customers."
Fund executives aren't necessarily thrilled about the growth of back-end loads, which have clearly created financing headaches.
"Much to the chagrin of the fund industry, B shares are here to stay," says Kenneth C. Eich, chief financial officer with Oppenheimer Management Company. Adds William Keough, Pioneer's chief financial officer: "Shareholders simply want to have the pricing alternative."
Like his other mutual fund colleagues, Robert Graham, president of AIM Management Group, has watched B shares grow to become a sizable part of his firm's sales. Last year, he found his firm in need of additional B-share financing.
But Mr. Graham faced a problem. AIM had leveraged itself to the hilt two years ago to buy out a group of investors. The fund firm couldn't afford to load up its balance sheet with more conventional bank financing.
This problem proved to be no obstacle for Citicorp. The banking company, instead of lending money to the fund firm, purchased the revenue streams generated by AIM's funds, thereby removing the transaction from the fund company's balance sheet.
"What we are getting from this deal is the ability to remove the financing from our balance sheet and eliminate the risk that the revenue streams won't come through," said Mr. Graham.
Bankers expects to see more deals like this in the future.
"Increasingly, fund companies are demanding off-balance-sheet financing," Chemical's Mr. Klein said. "They want to preserve their debt capacity for future needs, such as acquisition financing."