Banks have relied heavily on the conversion of trust assets and the "redirection" of maturing certificates of deposits to grow their mutual fund groups. Those channels are starting to dry up, forcing banks to seek alternatives.

Banks are beginning to exhibit a sense of urgency to build fund assets, and rightly so. Bank-managed funds are well below the industry average in assets per fund across all fund categories. For example, the average size for bank-managed taxable fixed-income mutual funds is around one-third the industry average for the same category.

Increasingly, banks are looking to acquisitions of mutual fund sponsors and institutional money managers as a way to bring assets into their fold. Not all of these acquisitions are pure asset plays, however. Strategic considerations are also a motivation.

For example, acquisitions may allow banks to augment product offerings, bring management expertise in-house, access distribution channels, or gain brand name recognition.

There are a number of ways to value M&A transactions involving investment management firms. Two common ones are the percentage of assets method and the revenue multiple method.

Valuation based on percentage of assets provides a rough benchmark, but does not give any real intelligence about the profit potential of the transaction. The revenue-multiple method compares the annual management fees from the assets managed to the purchase price. This brings significantly more intelligence to the analysis.

The majority of recent M&A transactions have fallen within a band of 2% to 4% of assets and two to five times revenue.

Chase Manhattan Corp. was a pioneer in the bank M&A arena with its March 1993 purchase of six funds, with $130 million of assets, managed by Olympus Asset Management Co. The deal was modest, but it opened the doors for other banks to follow suit.

First Union Corp. followed with its October 1993 purchase of Leiber & Co., adviser to the $3.4 billion Evergreen Funds. The acquisition doubled the bank's mutual fund asset base.

First Union paid $142 million, roughly 3.9% the funds' assets. But looked at another way, First Union paid somewhere between 4.2 times revenue, based on management fees from the Evergreen Funds, and 5.6 times revenue, based on the funds' revenues plus those on pension and private accounts.

This is at the high end of the range. However, the Evergreen Funds provided First Union with additional fixed income and equity funds that had considerable retail appeal.

The granddaddy of all recent bank M&A activity is Mellon Bank Corp.'s acquisition last September of Dreyfus Corp., with $80 billion under management.

Dreyfus' fund performance has been middle-tier and its product line is weighted towards less profitable fixed-income and money market funds, but Dreyfus gives Mellon instant brand-name recognition. Valuation experts have yet to quantify the value of the Dreyfus name. Dreyfus, on the other hand, may be cashing out at or near the top of an extended bull run for mutual fund companies.

Mr. Cerulli is a principal and Mr. Casey is a consultant with Cerulli Associates, a Boston-based consulting firm that caters to the financial services industry. Part 2 of this article will appear shortly.

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