GLOBAL SECURITIES SERVICES - Hedge Fund Heaven

Citigroup’s acquisition of Bisys strengthens its hand in the lucrative fund-services business.

A busy year for deal making in the custody and funds services industry just got busier. Last month Citigroup announced the $1.47 billion acquisition of Roseland, New Jerseybased Bisys Group, which had been exploring a sale in the wake of a series of regulatory snafus. Many recent deals have been driven by the push for economies of scale and the potential to wring proÞts from cost-cutting. But this acquisition is different: It enables Citigroup to build on its strength in traditional custody and clearing by adding Bisys’ lucrative and fast-growing back-ofÞce services for mutual funds, hedge funds and private equity Þrms.

“This is one of those rare cases where the two Þrms are almost a perfect Þt with little redundancy,” says Fred Naddaff, who runs Bisys’ fund services division.

The deal is expected to close in the second half of the year. Citigroup plans to sell Bisys’ retirement and insurance services units to private equity Þrm J.C. Flowers & Co. for roughly $645 million, reducing its acquisition cost to about $800 million.

With $10.7 trillion in assets under custody and operations in 49 markets worldwide, Citigroup’s global transaction services operation is the fourth-biggest provider in the world, according to custody research Þrm globalcustody.net. Citi ranks No. 1 in cross-border asset servicing.

Over the years, the bank has made a number of small, bolt-on acquisitions to shore up its U.S. mutual fund and global hedge fund servicing capabilities but has never achieved scale in those segments. Citi currently ranks as the 15th-biggest administrator of U.S. mutual fund assets and the 22nd-biggest for hedge funds worldwide.

By absorbing Bisys’ $815 billion in assets under administration, however, Citi will become a top-three player in transfer agency, fund administration and accounting for U.S. mutual funds, with roughly $518 billion. The bank also vaults to No. 4 globally in hedge fund services, with $284 billion in total assets. And it gains Bisys’ $63 billion in private equity assets under administration, and will be able to offer back-ofÞce processing for the Þrst time.

In hedge funds the acquisition positions Citi to compete against top custodians Bank of New York Mellon Corp., State Street Corp. and JPMorgan Worldwide Securities Services. Neeraj Sahai, global head of Citi’s securities and funds services unit, says that pairing the bank’s prime brokerage and capital markets businesses with hedge fund administration is a powerful differentiator.

Scott Schubert, managing director at Putnam Lovell NBF Securities, agrees. “Citi will be one of the only global custodians with that combination of services at signiÞcant scale,” he says.

The Citi-Bisys pairing could also reshape the mutual fund market. Only State Street and PNC Financial Services Group’s PFPC subsidiary have heft in transfer agency and administration. State Street serves large fund companies with more than $50 billion in assets, whereas Bisys handles middle market funds. But the newly enlarged Citi, backed by its formidable balance sheet, is likely to take aim at State Street’s territory.

The Citigroup-Bisys deal is not without risks, however. Citi acquired the company on the cheap, paying a premium of just 4 percent to Bisys’ share price at the time the deal was announced, largely because of regulatory violations that discouraged rival bidders. Last year Bisys paid $21.4 million to the Securities and Exchange Commission to settle charges that it diverted a portion of the administrative fees it earned from 27 different mutual fund Þrms back to those Þrms to pay for marketing expenses. The scandal followed a separate SEC investigation of earnings restatements at Bisys that resulted in a $25 million settlement with the agency and a preliminary $66.5 million settlement in a related class-action lawsuit. Those issues have been cleared up, but the SEC is still investigating the fund Þrms -- so far, JPMorgan Chase & Co. and AmSouth Bancorp have acknowledged that they are cooperating -- and any legal action could erode Bisys’ client base.

Meanwhile, the competition is intensifying. JPMorgan recently bought a small mutual fund services provider, marking a renewed commitment to the business. And other top players could look to snap up second-tier providers.

For now, the lack of duplication and the fact that Citi and Bisys use the same underlying software system mean that integration should be fairly simple. Given today’s appetite for deal making, however, that advantage could prove to be short-lived.

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