(Bloomberg) -- As Larry Fink predicts bouts of volatility in bond markets in the coming years, his firm is leading a push among mutual fund firms to reinforce their defenses.
Fink’s BlackRock has increased the amount its mutual funds can collectively borrow to meet withdrawals to $2.1 billion as of November from $500 million in early 2013, regulatory filings show. Eaton Vance, Goldman Sachs Group and Guggenheim Partners are among the firms that have also arranged new borrowing agreements or bolstered existing ones in the past year.
The funds are boosting credit lines, an emergency tool used to bridge short-term funding gaps that can occur when many investors sell a fund at the same time, after investment banks reduced trading in response to new legislation. Fink, BlackRock’s chief executive officer, has warned the retreat of banks as counterparties will create severe volatility. Regulators are preparing new rules for mutual funds to ensure that a sudden stampede out of funds won’t result in a downward price spiral that threatens the financial system.
“What regulators are most concerned about is when problems in one fund become a problem for the rest of the world,” said Coryann Stefansson, a managing director in the financial- services regulatory practice at PricewaterhouseCoopers, adding that her comments didn’t pertain to any specific management firm. “These committed lines of credit are like having an airbag and a seatbelt.”
New York-based BlackRock ranks as the world’s largest money manager, overseeing some $4.65 trillion that clients have invested in institutional accounts, its iShares exchange-traded funds, and mutual funds. The shares rose 0.7 % to $349.10 each at 10:31 a.m. in New York.
DEFENSE LINES
Mutual funds traditionally hold cash and easy-to-sell securities, such as short-term Treasuries, to comply with U.S. laws requiring them to pay shareholders within seven days of getting a redemption request. Funds increased such holdings last year, according to Chicago-based Morningstar Inc. The portion of net assets at taxable bond funds stashed in cash and securities maturing in less than a year rose to 9.61 % as of Sept. 30 from 8.84% at the same point in 2013.
The credit lines offer another line of defense for funds, which typically want to limit the amount of cash holdings because they can drag down returns.
BOOSTING CREDIT
BlackRock for many years maintained a $500 million credit line to back up the liquidity of its mutual funds, Ed Sweeney, a company spokesman, said in an e-mailed response to questions. That changed in April 2013, when the firm raised the borrowing capacity to $800 million.
During 2014, BlackRock increased the maximum its funds could borrow to $1.1 billion when their credit line matured again in April, then revised it in November to $2.1 billion, according to SEC filings. BlackRock can ask the banks to raise the borrowing ceiling to $2.6 billion under the November agreement, compared with $1.35 billion under the prior contract.
“Regulators need to admit that we have changed the ecosystem of bonds,” Fink said in an interview last month. “I am absolutely convinced we will have a day, a week, two weeks where we will have a dysfunctional market” in the next year or two. “It’s going to create some sort of panic, create uncertainty again.”
BlackRock’s credit line supports its entire retail mutual fund business, where assets under management grew more than 32 % in the past two years to $534.3 billion. Within the retail fund group, fixed income assets under management rose 37% to $189.8 billion.
SEC PUSH
“BlackRock uses a number of tools and investment processes to pro-actively manage liquidity risk across all sectors and asset classes of its family of mutual funds,” Sweeney said. “We continually review our third-party credit facility agreements and in light of growth in assets under management and other market considerations we have increased the size of those agreements over the past 18 months.”
With the U.S. Federal Reserve poised to raise interest rates in the next several years, the U.S. Securities and Exchange Commission has been pushing bond funds to prepare for an abrupt investor exodus from fixed-income markets. The agency’s division of investment management suggested in January 2014 that funds ensure they can handle redemptions lasting for periods such as a week or a month, and review their sources of liquidity.
SEC Chair Mary Jo White in a speech last month previewed agency plans to update the regulatory code for mutual and exchange-traded funds, in part by proposing new liquidity requirements.
MORE DEMAND
The two biggest custody banks are reporting more demand for the credit lines. Bank of New York Mellon Corp. has “seen a significant increase in the requests for new redemption facilities,” said spokesman Mike Dunn, adding that much of it came from funds specializing in bank loans. State Street has witnessed an “uptick” in demand, said Anne McNally, a spokeswoman for the Boston-based company.
Depending on how they’re used, redemption lines of credit can either help a fund company manage risk or exacerbate dangers, the Treasury Department’s Office of Financial Research said in a September 2013 report. By providing managers with the flexibility to hold less cash, the report said, the credit lines could create “potential liquidity risks” during a decline.
A fund that relies on a bank line to fund redemptions for a few days, while waiting to receive the proceeds of asset sales, is taking a safer course than one that borrows against it to avoid selling securities in a depressed market, said Christopher Remington, director and institutional money manager for Eaton Vance’s floating-rate loan group.
INCREASING LEVERAGE’
“If you used it in an aggressive manner, you could increase risk,” Remington said. “You would be increasing leverage at a time there is market stress.”
One area prone to liquidity mismatches are leveraged loans, because sales take longer to settle than securities such as stocks and bonds. A mutual fund must meet redemption requests in either three or seven days, depending on whether the sale of the fund shares was handled through a broker.
Starting in 2013, the mutual fund industry ramped up its investments in leveraged loans to corporations and other borrowers, both through funds dedicated to the asset class and those that own various financial instruments. By March 2014, U.S. funds geared toward ordinary investors held 25 % of the $712 billion of bank loans available, up from 18 % in 2012, according to S&P Capital IQ. Mutual funds’ holdings have since declined again to the 2012 levels.
REDEMPTION READINESS'
Eaton Vance almost doubled the borrowing ceiling on a credit line that serves three of its funds, including the Eaton Vance Floating-Rate Fund, to $1.4 billion as of April 30 from $750 million six months earlier, regulatory filings show. The revised line equaled 10 % of the $14 billion of assets in the funds at the end of 2014, compared with 5% under the previous borrowing facility, Remington said.
“Rightsizing the line is part of our ongoing assessment of redemption readiness,” he said.
Guggenheim funds replaced a $50 million credit line provided by Bank of America Corp. by entering into a $275 million credit facility with Citigroup, the firm disclosed in June. The agreements had similar terms, according to filings, and were both “reserved for emergency or temporary purposes.”
RELUCTANT BANKS
The push by funds to boost credit lines comes as some banks scale back lending to reduce the cost of complying with new regulations.
Bank of America, the second-largest U.S. lender, terminated a $1.15 billion credit line in November that it had provided to the DoubleLine Income Solutions Fund to acquire securities, according to regulatory filings and a person familiar with the situation, who asked for anonymity because some of the information is private. DoubleLine Income Solutions, a closed- end fund with $1.8 billion in assets, obtained a replacement line with similar terms on the same day from BNY Mellon and HSBC Holdings Plc, the filings show. Zia Ahmed, a spokesman for Charlotte, North Carolina-based Bank of America, declined to comment on the credit line.
Bank of America ended the DoubleLine facility before the Jan. 1 effectiveness date for rules that can make it more expensive for banks to provide committed credit lines. The rules, establishing what are known as liquidity coverage ratios, impose the strictest requirements on the nation’s six largest banks, providing an opportunity for smaller lenders to grab business.
“Clearly there are banks exiting this space because of capital requirements,” said Matthew D’Amico, the leader of the fund finance team at law firm Bryan Cave. “Some banks who don’t have the same capital requirements have come into the market and sought business with low bidding,” said D’Amico, who works in Bryan Cave’s New York office.
