Constellation Financial Management Co., the company that pioneered the mutual fund fee sector, is expecting to announce a deal in the upcoming weeks that will definitely be "bigger than the last one," said Pat McAllister, a principal with the company.
The five-year old New York-based company was founded by Tom Mann and Mark Garbin for the purpose of providing off-balance-sheet finance to mutual fund companies and insurance companies to pay for back-end loan distribution expenses.
"An example of this would be a mutual fund B share where the mutual fund company pays the brokerage fee as opposed to the consumer paying the fee," explained McAllister.
"The mutual fund company gets additional fees from the fund to compensate for having upfronted that money. We are providing financing against those back-end fees."
Constellation had its first groundbreaking deal last May with a $200 million mutual fund fee-backed securitization. This deal is one of the largest 12b-1 securitizations on record, and the first to receive a double-A rating. (ASR 5/17/99)
The company's last securitization, which priced in September, was a $175 million multi-tranche structure backed by the fees collected from underlying assets in approximately 250 mutual funds.
"We structured the deal to include only investment grade notes," said McAllister. "The effective subordination on that deal was structured in the form of a derivative trade with a triple-A-rated institution. Effectively we swapped what would have been double-B rated notes and sold triple-B rated notes instead."
But what made them venture off into this market?
"Until 1998 we were a buy-and-hold investor in this asset class," said managing director Joseph D'Anna. "As we grew and added clients, we began to feel that the diversity we created on our asset side should be matched by a greater diversity on the liability side. The asset-backed securities market is a very efficient and interested holder of the risk and rewards of our asset class. Notes backed by 12b-1 fees and insurance asset related fees are very attractive to ABS investors."
"The only thing that our company does is buy, manage and securitize these distribution fees," stated McAllister.
Bright Lights For 2000?
Examining the market of mutual fund fees, McAllister feels that "there is good value in the right deals and little to no value in the wrong deals."
"A lot of what we do is very closely related to equity markets," he added. "People might be a little concerned about over-valuation in equity markets right now, but we don't think that's an issue for a long term investor who is engaged in a program of buying assets steadily over time. People should develop the right relationship with us and become a consistent long-term investor. The market is actually very attractive for an investor in this position."
The company has experienced a tremendous growth increase since its first deal in May. Its volume of asset flows into the company has increased by 50%, and it expects to at least double the amount of deals that it issued last year.
Looking into the year 2000, Constellation hopes to issue at least one deal each quarter, and forecasts an increase in the size of the deals as well. The company anticipates that it will be selling "approximately a billion dollars plus of asset-backed notes."
"We're trying to expand the depth of the market to accommodate deals in the $300 million to $500 million range," McAllister said. "We expect our asset flow to support about four of these deals per year."
McAllister predicts that the market will begin a rapid development this year. "Our competitors have, to some extent, responded to the initiatives that we have brought. The volume of assets coming into the market should be increasing quite dramatically. Hopefully that will mean the market will grow more efficient and people will have better deals to choose from."
A System That Works
The founders of the company and the outside investors are all extremely committed to furthering the understanding of the assets in general and furthering the communication of that understanding to both the buyers and the sellers.
Constellation follows a few key strategies when approaching a new deal. One of them is to structure its deals not only to maximize what it can get out of a particular deal but to create a program of attractive deals that investors can get into and invest in again and again, over time.
"We try to optimize the structure of each deal so an investor can buy a sequence of deals and build an optimally diverse portfolio of mutual fund fee-backed notes," explained McAllister.
"Today and anytime in the future we're going to have a sizable and diversified balance of fee assets on our books," added D'Anna. "Each time we do a securitization it becomes an interesting portfolio selection problem to create a diversified and attractive pool to securitize while maintaining the quality of our balance sheet and maintaining the ability to repeat the securitization process over and over again in the future."
In terms of strategy, Constellation is also looking to get more information on these mutual funds and insurance assets out into the public because up until now its deals as well as its competitors' deals have been strictly private.
"We think that there is a lot of market inefficiency that we can help remove by disseminating information more widely," said McAllister.
A Shining Star
McAllister feels that Constellation's most important distinguishing characteristic is the "extensive asset data and the analytical rigor that [it] brings to [its] asset securitization and underwriting process."
"We spend far more resources than our competitors in collecting and analyzing data that helps to predict the performance of this asset class," said McAllister.
"We can therefore support both higher ratings and provide better underwriting qualities in the bonds that we sell and can work with investors to help them understand the risk and return characteristics of their bonds much more completely than any of our competitors," he said.
D'Anna added, "Our investment in data collection and analysis has been a long-term ongoing one that has resulted in us having developed an enormous database of mutual fund investor and asset behavior. There is no parallel in the industry. Nobody else has the amount of information that we have."
Looking at the mutual funds fee market, D'Anna describes the transactions of Constellation's competitors as being "smaller and much more private."
"Prior to our entry, they did little to expand the market," he said of his competitors. "With every transaction that we've done we've added a number of new investors that we've introduced to the attractive nature of this asset class. Already with two deals, we have expanded the market significantly. We expect to continue to do that in the future."
Constellation attributes its success to "strict underwriting that is driven by the fact that the management of this company has a very strong financial investment in its success."
The company is committed to the long term and making partnerships with its investors as well as its creditors.
"One of the main structural considerations in our deals is to continue to build a program that is appealing to institutional investors so, that we're not just doing one deal with them," said D'Anna. "We want them to be our partner for the long term, buying our notes regularly."
