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Federated Investors, Inc. (NYSE:FII)

Q4 2008 Earnings Call

January 23, 2009 9:00 am ET

Executives

Raymond Hanley - President of IR

Chris Donahue - CEO

Tom Donahue - CFO

Debbie Cunningham - CIO, Money Market

Analysts

Craig Siegenthaler - Credit Suisse

Ken Worthington - JPMorgan

Marc Irizarry - Goldman Sachs.

Cynthia Mayer - Bank of America

John Fox - Fenimore Asset Management

Robert Lee - KBW

William Katz - Buckingham Research

Operator

Greetings and welcome to the Federated Investors fourth quarter Earnings Call.(Operator Instructions). As a reminder this conference is being recorded.

It is now my pleasure to introduce your host Mr. Raymond J. Hanley, President of Federated Investors Management Company. Thank you Mr. Hanley, you may begin.

Raymond Hanley

Good morning and welcome. Today we have planned some brief remarks before opening up for your questions. Leading today’s discussion will be Chris Donahue, Federated’s CEO; Tom Donahue, Chief Financial Officer and with us today are Dennis McCauley, Lori Hensler and Stacey Friday. From the Corporate Finance Group. And we are also joined today by Debbie Cunningham, our Chief Investment Officer for the Money Market area who will also participate in the Q&A as well.

Let me state that certain statements in this presentation including those related to money levels, investment and financial performance, constitute forward-looking statements, which involve known and unknown risks that may cause the actual results to differ from any future results implied by such forward-looking statements. For a discussion of the risk factors see Federated’s SEC filings and no assurance can be given as to future results and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future.

And with that, I will turn it over to Chris.

Chris Donahue

Thank you Ray and good morning. I will begin by reviewing Federated’s recent business performance before turning the call over to Tom to discuss our financials.

Starting with the cash management business: Money market assets grew by $68 billion, or 24% from the prior quarter, an increase by $119 or 50% for the full year 2008. The Q4 growth came in mutual funds, while the money market separate accounts were a lot flat for the quarter. We continue to see a money fund growth in January with assets averaging about $334 billion, excluding our separate accounts.

Money fund asset growth has been strongest in the wealth management and trust channel, with solid growth in the broker-dealer channel. We peg our market share at about 8.5% at year-end, up from just under 7% at the end of 2007.

Market conditions in the fourth quarter continue to drive demand for government money funds and treasury funds in particular. At year-end, Federated’s money market mutual funds by type were $92 billion in treasuries, $122 billion in government agencies, $78 billion in prime, and $35 billion in municipal funds.

During the fourth quarter, treasury funds grew by $22 billion, about 30%. Government agency funds added $34 billion, just under 40%., prime funds prime funds gained $7 billion, 10% and muni funds added $6 billion, a little over 20%. Now so far in January prime funds have led asset growth. Prime funds have added about $6 billion, treasuries are roughly flat. Agencies are up $3 billion and the munis are up $1 billion.

Market conditions remain challenging and our investment managers and traders continue to do an excellent job for our client. We are managing our funds with the focus on providing daily liquidity at par, as we continue to provide high quality cash management for our customers.

Reflecting demand and the resulting yields available in the market, treasury securities and thereby treasury fund yield have decreased to record lows. In certain products, the growth yield is not sufficient to cover all of the fund’s normal operating expenses. And so fee waivers have been used to maintain positive or even zero net yield.

During the fourth quarter, the impact of these waivers to Federated was $1.5 million in reduced operating income. The 11 classes of shares affected in the fourth quarter had $15 billion in assets at year-end. Now so far, through January 21st we have had about $560,000 of operating income impact from these waivers, generated from 20 classes of shares with approximately $29 billion in assets.

We expect these waivers to increase going forward. Now we cannot predict the impact of the waivers due to the number of variable and the range of potential outcome. Variables include yield levels available in the marketplace; changes in assets within the funds; actions by the fed; changes in expenses of the fund; the mix of customer asset; and our willingness to continue the waivers.

It is important to remember that while waivers reduced income from what it would have been without the waivers, the growth of money market assets and related growth in money market revenues net of waivers has made it possible for federated to perform well and to continue to grow, during the period of extremely difficult market conditions.

Money market funds continue to be a critical part of the capital market and we continue to see strong demand from investors with balances now, well in excess of the insured amounts from mid September.

Going forward, we believe that the core structure of the money market mutual fund will remain intact and it is important to their ongoing use by investors. Core features include amortized cost, which is how dollar-in dollar-out daily liquidity for work, diligent, independent, credit work to avoid securities do not meet the minimal standards of minimal credit risk, and inherence to other key components of Rule 2a-7 that are essential to the success of these products.

Investors understand that money market funds are investment products and that investment product involves risk. Money market funds operate within a strict regulatory framework designed to reduced risk. Investors continue to increase their uses of this product, because they want to benefit that money funds provide, including the affirmation, daily liquidity at par, diversification, credit analysis, competitive yields and convenience. These are the core value proposition of the money market mutual funds and they have been so for over three decade. And we believe that it will transcend the difficult market conditions that we are experiencing now.

Turning to equities; assets decreased about 16% or $5 billion during the quarter on a net basis and this includes the $2.7 billion added from Prudent Bear and Clover Capital acquisition. The decline was largely due to market depreciation and to a lesser extent, net redemption. About half of the net redemption in equity mutual funds occurred in October, consistent with industry results. We saw outflows in many of our equity funds.

However, we did see net inflows in to our capital appreciation, strategic value, Kaufmann large cap funds as well as the uncertain MDT funds. Our equity mutual fund flows are about flat for the first couple of weeks of January. Though, as always, we caution about drawing conclusions from this limited data. Within our equity separate account, outflows were driven by net redemption in our SMA product.

And turning to the fixed income side, our investment performance remain solid as our investment personnel continue to navigate difficult market condition successfully. Fund flows turned modestly negative in the fourth quarter reflecting market conditions and industry result. Most of the net outflows occurred in October with flows back to positive in December.

Our flagship total return Bond funds continue to produce positive flows. We also saw inflows net of expected asset sales in a previously discussed distressed asset portfolio in our institutional separate account. We have recently won six fixed income separate account mandate totaling approximately $500 million that have not yet funded.

Fixed income fund flows are positive for the first weeks of January. As of January 21st, our managed assets were approximately $419 billion including $368 billion in the money market area, $25 billion in equities and $26 billion in fixed income. Now, our money market mutual fund assets included in these figures obviously stand at about $337 billion.

Looking at investment performance and using the quarter end Lipper rankings for our equity assets our competitive performance results are solid with 87% of the rated assets in the first or second quartile over the last year. 88% over three years, 86% over five years and 77% over 10 years. For the Bond fund assets the comparable first and second quartile percentages are 64% for one year, 75% for three years, 83% for five years and 70% for 10 years.

On the distribution side in the wealth and trust markets, combined net sales of equity and bond funds were positive. We continue to have success with the total recurrent bond fund in this channel and money market products continue to increase.

The broker dealer channel, money market assets increased $5 billion. In the global institutional channel, we are having success with institutional fixed income accounts, including the new business I just mentioned.

On the acquisition front, we closed three deals in the fourth quarter, adding nearly $ billion from Prudent Bear, Clover Capital and Fifth Third transactions, and we continue to pursue acquisition opportunities.

At this point, I would turn it over to Tom to talk about the financials.

Tom Donahue

Thank you Chris. Federated’s revenue increased 8.5% in 2008 from 2007. For Q4, revenues decreased 1% compared to the prior quarter. The growth for the full year was due mainly to higher money market assets, partially reduced by lower equity assets largely from market declines. The decrease from the prior quarter was primarily due to the decrease in average equity assets partially offset by higher average money market assets.

Money market waivers to support positive or dealer yields in certain products impacted revenue by $.4 million in the fourth quarter. These waivers were partially offset by $1.9 million in related lower marketing and distribution expense, which made the operating income reduction from these waivers $1.5 million.

Compensation and related expense decreased from the prior quarter, due mainly to revised estimates of 2008 incentive compensation expense. The prior quarter also included $1.6 million of compensation expense related to this special dividend payment.

Marketing and distribution expense increased from the prior quarters due mainly to higher average money market fund asset. Amortization of deferred sales commission decreased due to lower B share asset.

Nonoperating expense increased from the prior quarter due mainly to lower interest and dividend and to higher recourse debt expense with Q4 as the first full quarter of our term loan facilities started in mid August. The tax rate was lower in Q4 due to lower deferred tax expense from an adjustment to the deferred tax liability from certain fully amortized B share deferred sales commission asset. For the full year 2009, we expect our tax rate to be between 37% and 38%.

On the balance sheet cash and short-term investments were $59 million at the end of the year and recourse debt was $177 million. We continue to generate strong free cash flow and expect that we will continue to use cash and our revolver to fund acquisitions, dividends, share repurchase, capital expenditures and debt repayment.

We would now like to open the call up for questions.

Question-and-Answer session

Operator

Thank you. We will now be conducting the question-and-answer session. (Operator Instructions)

Our first question comes from Craig Siegenthaler with Credit Suisse. Please state your question.

Craig Siegenthaler - Credit Suisse

Thanks and good morning. First question, I just want to touch on the fee waivers with Debbie, which is still quite minimum in the fourth quarter, which short-term treasuries now yielding around zero and if this yielding flattering goes down a little bit. I am just wondering, what the rest of revenues assuming, because there are a few variables that are assuming AUM more or less stays flat.

Debbie Cunningham

I think as Chris mentioned in the prepared remark, our waivers definitely have increased during the first several weeks of January compared to the end of December. Having said that, the market for treasuries is actually become a little bit more, a little less punitive let us call it in the last week and half. Just to give you some information that, that you can extrapolate that from.

During the second half of December and into the first week of January, treasury yield were in the negative [four to two] basis point range, for the majority of treasury securities that we will be purchasing and certainly our non-repo treasury fund and even to some degree in our repo treasury fund. The negative four to two basis point for the latter part in December and into the first week in January.

Treasury backed repo rates during that time period were also at zero. There are few days that were positive, but for the most part there were at zero during that time period. Last week the Fed actually had a collateral back into the system, which was what caused the office of the Feds, when they took collateral out of the system in the beginning parts of December what caused us very, very low a negative rate to a curve, they reverse that last week.

They didn't do it with any, number one, informational content associated with it to get it to going or whether was done intentionally nor they do it or follow-up with any kind of informational content that will give us an ideas to whether it was done purposely and the results were as accepted. But effectively what happened last week, when they added that collateral was, the treasury security that we said has been offered. I won't say that we've been buying, but have been offered into the marketplace at minus four to two basis point are now in a range that’s more like 4 to 14 basis point. And this shows up from the one-week to the three-month sector of the treasury curve.

Repo backed by treasuries went from zero to 20 to 30 basis points. So, there is a vast difference in what we are seeing reflected in purchasable yields in the marketplace today, than was even the case in the first week in January. I cannot give you any, I do not have any good information as to whether that going to hold or not. What we are looking at right now with the target rate of zero to 25 basis points is number one, something that unprecedented in that is that range, so you don’t even have a real number to peg it off out, you can pick a number in that range, pick half way 12.5 basis points.

We were certainly operating way under it for a period of time. We now seems to be operating over it, is the target really 25 now. I do not know the answer to that. So, that is one thing that is historic. Secondly, is the fact that ultimate rates themselves are at levels that we have not seen in many decades. So, I cannot give you robust prediction that based on some of that information maybe you can extrapolate from there.

Craig Siegenthaler - Credit Suisse

Well, Debbie, I think here is an easy way to think about it. What was the run rate of fee waivers maybe on a weekly basis or if you want to say a monthly basis over the last few weeks?

Chris Donahue

Well, Craig, that was the number we gave you for the months the day that approximately $560,000. So, that was three weeks worth of data.

Craig Siegenthaler - Credit Suisse

And that was net or is that notional? There has been getting sense now there.

Chris Donahue

That net of the reduction in the related marketing and distribution expense. So, that is the net impact reductions operating income to Federated.

Craig Siegenthaler - Credit Suisse

Got it, okay.

Chris Donahue

And we see daily fluctuation in that number and that is why we went through the factors that influence it because it truly is, you have got five or six variables that work.

Craig Siegenthaler - Credit Suisse

Got it. And then my second question was more strategy question. I’m just thinking about reserving our capital requirements in the money market industry because it seems to be a little bit of disagreement between some competitors in the space and I’m just wondering maybe timing wise, when the insurance policy the government provided goes away. I think its September, October of next year. How likely do you think it is policies we put in place for charges here? And then, what your thoughts on the level of this capital charge, maybe as a percentage of AUM?

Chris Donahue

I would not assume that there is going to be a capital charge. It is still a very justifiable or debatable issue. Let us try to break this into several questions. First of all, what about the insurance? No one can tell right now, whether its going to continue, what they know that this insurance program can’t continue because of statues, of pools that they are using at the treasury, and on that date of September 19th. So, someone is going to have to do some statutory work to have new insurance.

It is interesting that in the industry and for us too, there have been substantial tens of billions of dollars for us, and hundreds of billions of dollars in the industry that have come in, that are in fact not insured because the insurance is limited to certain funds and certain asset. There have also been some people, who have declined to re-up the insurance on some of their funds, and that certainly considerations of all us are looking at.

So, the insurance has its own way of looking at it and our clients at least have looked more at the, by confidence and the product as appose to the insurance. And when this was first put in, a lot of the industry comments at the time were, well we do not know that we really need this. We do not really know that we want this, and what about paying for it, etcetera. So there is a healthy debate on the insurance.

Now, on the issue of potential capital, various numbers are thrown out, various concepts are thrown out. At the end of it, the mutual funds industry in money market funds of $3.8 trillion is not in a position to guarantee the investment and never has been and will not be. And this is the reality.

That’s why I make the comment that these are investment products, and you heard me also say, they are cash management products as well, plus they are also investment products, which means they are going to have risk and which means that you have to evaluate the expertise and confidence and your commitment to the work that’s being done, and not just ho-hum, there’s somebody at the end of the day who will take care of this.

So a lot of people are brainstorming a lot of ideas, which is certainly fine; but remember that we’ve been through this for more than three decades with all sorts of opinions about, how these business ought to be structured, going all the way back to the 70s, and it was some of the same players then I might add.

Craig Siegenthaler - Credit Suisse

Got it. Thanks a lot for the color.

Operator

Thank you. Our next question comes from Ken Worthington with JPMorgan. Please state your question.

Ken Worthington - JPMorgan

Hi, good morning. So to talk on Chris’s first one. If the world sees the scene in terms of yield as it is today, and assets in your funds today as they are today, for the next 12 months or 13 months, so everything gets reinvested at today’s rates, how big are fee waivers in that scenario? Like you know the world seems to be getting a little bit better from the yield perspective, and Debbie pointed that out and that makes sense, but if things stay the same. How big are they?

Chris Donahue

One of the reasons we gave that figure for the first several weeks was to give you a way to deal with that. And so it is really tough for us to calculate that one. We see clients already moving and I know you are saying, well assume everything stays the same. But it is still a pretty tough calculation when you do not know all of the different variables. And that is why we gave you, if everything stays the same as it was in the first several weeks, and then you can take that number and multiply it and that everything staying the same.

Ken Worthington - JPMorgan

Yes, but the problem with that is everything is being reinvested now at much lower rates and you’ve got securities that were purchased 12 months ago at a 5% yield been reinvested at 40 basis points. So that is why I was trying to setup a different scenario?

Chris Donahue

I know, you are now talking about the variables. I will let Debbie comment on a little bit on the comment about the maturities, which is a true factor.

Debbie Cunningham

I think Ken, from a maturity perspective that are reinvested at this point, the only troubling sector, if you will, from a low rate of side of the equation for reinvestment of maturities into the portfolios, is the treasury sector. It is less troubling than it was two weeks ago but it is still a problematic sector in the context of the ultimate rate there. But if you go out beyond that to government agency products, if you go beyond that to prime products, even in the context of the tax free world and municipal products, there is not a problem from a rate perspective on a reinvest and being unable with that reinvest in the current market environment and cover the core cost of the product.

Ken Worthington - JPMorgan

Okay.

Tom Donahue

And this Tom, if you just say, take our $90 billion or so in treasuries and then start dealing with -- think of it in that way and try to model it out, you can model it out any different way you want and we just don't want to do that. I mean, there is so many different variables where our customers are going to go? What is going to happen? How we are going to be able to reinvest it? For how long, for how long, for how long?

Ken Worthington - JPMorgan

Okay. No, no, you comments, your comments help. So I appreciate that all. I will move on to number two. You mentioned in the release, I think in the comments about fee waivers to maintain the competitiveness of money market fund products. And I think you have indicated that those types of waivers increased for the quarter, which is kind of surprising given the challenges that money fund business is having on the fee waiver side for the rate. But anyway, can you tell us a little bit more about the nature of those fee waivers and what the outlook is? Are those really going to continue in this kind of environment or is that competitiveness going to fall off?

Raymond Hanley

Ken, its Ray here. We separated the waiver into two components in the press release, mainly because of the interest in the number and that is for maintaining zero or positive yield. The rest is the number that typically occurs, occurs every quarter and it is more a function of the volume of assets that go into a particular product than it is active price management. We say it for competitive reasons because by definition you could say that the waiver of any fees for competitive reasons that has to have your yield and your expense ratio where you think you can sell the products in the market.

I would not tell you that there had been any particular change. The new entrant of course is the waiver for zero or positive yield. But otherwise I would say there really has not been any particular pricing or competitive change. It is a more of the question of the demand for a particular product and what does that result in, terms of the waiver levels. They are more or less built into those products to some degree.

Ken Worthington - JPMorgan

Got it, okay. Thank you very much.

Operator

Our next question comes from Marc Irizarry with Goldman Sachs. Please state your question.

Marc Irizarry - Goldman Sachs.

Okay, can you just clarify the $560,000 average of debts cumulative? That is cumulative for the period so far through January?

Chris Donahue

Yes, its for the first three weeks of January. We literally see this on a daily basis.

Marc Irizarry - Goldman Sachs.

Okay and then, maybe because you can talk a little bit about the consolidation opportunities that you’re seeing out there, you continue to see, some others trying to get out of the money from business, money market fund business, saying that as you were non-core or just profitable not enough, I mean, how do you sort of view, as a consolidation in the business going forward.

Chris Donahue

The consolidation will be and is an ongoing trend and it is not – sometimes consolidation is always viewed, if O, A, has to buy B. Well sometimes B can leave the field and in the absence and then come to a collection of A, C & D. And so you have some of that as well and you end up maybe by the substraction method with consolidation as well.

And we are seeing both types, where we are looking at various opportunities, for money market fund asset and we are seeing other players leave the field for exactly the reasons you are talking about. We have felt for a long, long time that many of these players, were, did not had sufficient assets for devotion of resources to play in this game, the way the major players have played in this game. And so this is a natural order of cleansing of this kind of a market and we would expect it to continue.

Marc Irizarry - Goldman Sachs.

Okay. And then just in terms of the fee waivers. And if you just look at the expense ratio, I guess there is a, obviously fees were just borne by the distribution side versus the investor and management side. Is that relationship fixed, is meaning that, is the distribution channel going to, is there going to be a point, where the investor manager ends up taking the brunt of the fee waivers, where is right now, maybe the distribution side taking a little bit more?

Chris Donahue

What we have done is developed a pro-rata relationship with our intermediaries. But that pro-rata relationship is different for every customer in terms of the arrangements make with each of them. So, the sharing of the decline moves in last step each between us and that between our investment advisory fee and the moneys that they share. Now, Ray may put some additional color on that as well.

Raymond Hanley

When you see the 560, that of course is net of the sharing and as Chris mentioned it varies by customer. When you aggregate all of that as a product level, it varies by fund and then if you pull that all the way up to the complex level, the guidance we would give you would be that you would see waivers approximately three quarter to the intermediary and one quarter to the Federated, but that can fluctuate again based on individual products and how the assets move between products.

Marc Irizarry - Goldman Sachs

Okay. Great, thanks.

Operator

Our next question comes from Cynthia Mayer with Bank of America. Please state your question.

Cynthia Mayer - Bank of America

Hi, good morning. Just one more fee waivers if you can attend it, which is I know they change everyday, but I’m wondering if you can give us a sense of what they were, the worst run rate, maybe right at the start of the year?

Tom Donahue

They would have been actually not that much difference in late December and early January, because again the assets have already shifted around a bit. So, I would say, we have not really seen that much of a fluctuation in the daily rates.

Cynthia Mayer - Bank of America

Okay. You mean by shifted around, there was already some money going into prime funds?

Tom Donahue

Yes.

Cynthia Mayer - Bank of America

Right; okay. And in your earnings release you mentioned that one of the factors affecting the fee waivers is just your willingness to do them. What is the alternative to that? Were you implying at some point if it reverted and it got worse you would close the funds, or allow the yields to go negative or something like that?

Chris Donahue

There are an enormous range of potential alternatives that could be brainstormed. The willingness is a way to underscore the voluntary nature of what goes on. One of the traps, we wish to avoid is the trap of ‘no good deed goes unpunished’; in other words, our willingness on a voluntary basis to do certain things now does not imply that, that is some future situation or some in terms of the revenues that we receive.

So, we always like to underscore that. But we also could look at a lot of other alternatives. Others have closed funds, create new funds, and there are a lot of other ideas that people have been kicking around that are all part of the brainstorming on this subject.

Cynthia Mayer - Bank of America

Okay and just a follow-up on the question on consolidation. Does the fact that some are just voluntarily quitting the business make you less likely to go out and buy the assets? And what is happening to the pricing of the assets?

Chris Donahue

Well, in terms I would like to comment on the pricing, but in terms of our willingness either structure depends as it does in all of the acquisitions we do on the mutual fund side on a precise look at the content to the asset, how they got there, what they are? And what is in the portfolio.

So, the fact that some people would be leaving the field does not negatively impact our willingness to, for example, do a platinum type transaction. And so those two do not relate, what really matters is the hardcore work of looking at the shareholders, how they got in? Who they are? What‘s their characteristics are? And looking at the portfolio and what is in it and how we think about it. And I will let Tom comment on the pricing.

Tom Donahue

Cynthia, from a pricing point of view, we have not changed really our views on this. Go back to, when we did the Alliance transaction, which is the money market asset can leave everyday. So, how are you going to pay for this and how does somebody want to get paid for it. And we continue to look at it as an over time payment if we get revenue out it and then the negotiation is, what is the sharing arrangement? And has it really changed.

Cynthia Mayer - Bank of America

Okay, makes sense. Just one last one, the Fed insurance program of September 18th, I’m just curious whether will that make those assets more sticky than usual and would there be any danger, when that expire that those assets would leave. It sounds like you think those clients are not there for the insurance, they are for the quality of the management, but I’m just curious about that.

Tom Donahue

Well, certainly we cannot predict the future on that. But our institutional clients by their actions would indicate that they are willing to put more money in, they absolutely know for certain are not insured. And so that shows the willingness to own the portfolio in an uninsured environment. And so that's why some people have decided to not re-up the insurance on their treasury fund and while that's the consideration that I’m sure others are going through as well.

Cynthia Mayer - Bank of America

Great, okay, thanks.

Operator

Our next question comes from John Fox with Fenimore Asset Management. Please state your question.

John Fox - Fenimore Asset Management

Hey, good morning everyone.

Chris Donahue

Hi, John.

John Fox - Fenimore Asset Management

I have a number of questions. Number one, I am going to ask about an equity fund. Could you talk about the reception in your plan for the Prudent Bear Fund at this point?

Chris Donahue

The reception for the Prudent Bear Fund has been rather as safe and gain.

John Fox - Fenimore Asset Management

I would think so.

Chris Donahue

As a general rule, sales forces in the mutual fund area like to focus on positive up-sloping environment. However, one of the reasons we started talking to these guys a long time ago before all of this really crated was because of the underlying efficacy of having a portion of your investment in products that are managed by the Prudent Bear people.

So, the performance has been outstanding and we are in the middle of launching and talking and developing with clients. We see positive flows in those funds right now. But I am not going to give you a whole bunch of numbers, because we are right in the middle of the launch and the discussion with everybody on them. But they went through the same sequence that we have gone through with our other areas of excellence, in terms of bringing their story to our clients, to allow our clients to build their clients portfolios including the Prudent Bear product.

John Fox - Fenimore Asset Management

Okay. Thank you. You mentioned that figure of 170 or so and the figure on the balance sheet is like 120. So, is there a piece in the credit line stuck in current liabilities?

Tom Donahue

Yes.

John Fox - Fenimore Asset Management

Okay. And as a general rule, as people move from treasury and say, agency or prime because they just get sick of 0% interest, does that behavior helps the fee waiver situation.

Chris Donahue

Yes it does.

John Fox - Fenimore Asset Management

Okay. And it seems like in the January figures that you gave, that behavior has occurred.

Chris Donahue

Yes it did.

John Fox - Fenimore Asset Management

Great. And since we have a good fortune to have Debbie on the call, I wonder if she could expand, she can comment on the treasury market, may be going into some of the other categories, agency commercial paper, munis and just kind of talk about the health of the fixed income market that she thinks in 2009.

Debbie Cunningham

Certainly. Government agency backed repo at this point, which is large component of many of our product in that phase. Generally in the last week and a half again going back to sort of change when the Fed had a collateral, has been trading in the 25 to may be 35 to 40 basis point range. So it is above fund target. We don’t think that’s sustainable, I mean, even if you look at the range of 0 to 25 basis points, 35 and 40 is way above that and so that’s too high. We think it will come back down again. But that is where it stayed in the last week and half.

Direct government agency securities depending upon the maturity that you’re looking at across the money market yield spectrum, generally are about maybe 9 basis points in the very shortest and all the way out to about 80 basis points, if we go further out the money market yield curve. From a prime fund perspective, generally you are looking at either CDs, bank product of some sorts or commercial paper or asset-backed commercial paper. Here we’re looking at yields that started on a over 9 basis and add about 35 basis points and go out to the end of the money market yield spectrum and sort of the 1.5 to a 175 range depending upon what’s – are very issuer specific for names out in that spectrum.

John Fox - Fenimore Asset Management

Okay.

Debbie Cunningham

Munis, the overnight or the weekly rate has been holding right around 50 basis points, I think it was 45, but we can have to go 48, so its a little bit above that before -- that’s down from the end of the year, it was above 1%, which was just basically reflective of year end demands pressures in that sector, but since the beginning of January its been holding right around the 50 basis point level and that’s a reflection of probably about 70% of the asset, roughly on average that are in our muni money market funds are in some way tied to that weekly rate, but spread above that, but that’s sort of the basis of which they trade.

John Fox - Fenimore Asset Management

Okay. Probably just as a followup. How would you characterize the tenor of the market. Now not the rate levels but just in terms of liquidity, peer level, has the fixed income market gotten better, you feel they are the same they are worse. How would you just categorize that?

Debbie Cunningham

I think definitely some liquidity in the primary market, its much, much better. There will be an interesting test that occurs next week. One of the facilities that, if this is a Federal Reserve Bank in New York put in place during the fourth quarter the kind of show of confidence in liquidity in the market place but they really weren’t any market makers at that point of time. If the facility called the commercial paper funding facility, it was one whereby issuers of commercial paper who were unable to sell their CP into the market place in the normal fashion.

John Fox - Fenimore Asset Management

Right.

Debbie Cunningham

But could go to the fed and sell their paper to the fed at a pre-described 90-day rate. That is the first maturities of that paper occurring next week. So what we have seen since October when it came out through next week is just simply an increase in that program outstanding. Its been increasing at a lesser amount very week but nonetheless it has been an increasing number, which it had to be, because it didn’t have to be increasing or stay the same since nothing was maturing at.

The maturity starts next week, and I think it will be a test to see whether those issuers are now able to more effectively go back to the direct market as normal participants in the marketplace and place their paper in that fashion rather than utilizing the CP accessibility. We access them, but that facility’s usage will go down in the weeks and months to come. Based on what we think right now as I said is, on a primary issuance basis, a lot better liquidity and market acceptance from most issuers.

John Fox - Fenimore Asset Management

Okay. Thank you very much.

Operator

Thank you. Our next question comes from Robert Lee with KBW. Please state your question.

Robert Lee - KBW

Hey, good morning everyone.

Chris Donahue

Hey Robert.

Robert Lee - KBW

Couple of quick questions and the back to the money funds and this is not a fee waiver question, but if you look historically, ultra-low rates that is clearly unprecedented. At some point, it has resulted in some amount of outflow from certain types of investors and I think Chris in the past in your presentations you’ve broken down the money funds to different kind of buckets, and to give investors a sense of that bucket of assets that may be at risk and for some reason $20 billion is what sticks to my mind, if I look say, back a year or so ago. Is it at all possible to kind of size the pieces of money fund pot that you think may be most susceptible to kind of when things calm down, kind of moving because of rates?

Chris Donahue

Yes. Rob just referring to our charts that are on page 8 that are on the website if anybody is interested. But what we do is put the various slices of parts of assets, and we have done it that both in terms of circles and highs and in terms of a regular line chart. And we have divided it into bank trust, capital market, broker-dealer and corporate others. And number that Rob is referring to of $20 billion was basically the number of those assets that we had in corporate other at year-end Q4 ‘07.

That number today is about $28 billion and what I have said historically about those clients is that they are more attentive to the yield, the net yield than perhaps the other clients because they are not in it as much for the customer service part of it. And therefore we have seen more volatility in that section than in the other sections of our business. Meaning the bank trust, capital markets and broker-dealers. And so if you were to look at that section of assets it was $11 billion at the end of ‘06, $18 billion in the end of ‘07 and $28 billion today.

However, given the low rate I do not know the exact same motif necessarily applies in the near-term Rob. Because right now, the people who are in cash or encashed, if they wanted to be in a higher rate situation they would have to move out the credit curve, if you will, in order to get there. So at this point I really do not see that kicking in but that’s -- you are right on with the number in our corporate and other category.

Robert Lee - KBW

All right, great, that is helpful. And I guess another question going back to acquisitions, obviously you had a busy Q4. You mentioned that you are obviously still looking but in the past you have talked about one of the buckets you wanted to fill was value, which I guess to some extent you filled. Can you maybe update us on where, if you are going, to use your words, power shopping, where you kind of see the holes that you are looking at now?

Chris Donahue

Well, as of now, we think that more than just all how we sort of feel, the Clover Capital has done our value space that we're very happy with that acquisition and in terms of the expertise that was acquired up in Rochester. So we are not doing any more power shopping in the value space and we are really not looking in with the power shopping motivations for other areas. We think that with the Prudent Bear, with the Clover and with the other acquisitions we have done, we have more or less scored on the streets we wanted to score. Now this is not to say that we would not add sections here and there if we found opportunities. But the focus is more on roll up in money market assets at this time.

Robert Lee - KBW

Okay. And one last question maybe one on the fixed income business on the fund side. You talked a little bit that you are starting to see increased demand for short duration products. I think you may have mentioned you have seen some on prior call. But, are you actually seeing some investors trying to go out the yield curve a little bit more and if not, you would assume at some point that is going happen. Any sense that you are getting more inquiry about it?

Chris Donahue

Well, in terms of the flows we are seeing more flows on the short intermediate side. In the fourth quarter we had pretty strong flows. So far this year we are seeing more money come into those funds. And in total those assets are up from year-end.

Tom Donahue

Yes, we’ve seen the Ultrashort product in particular Rob, if you breakdown the short and immediate buckets to the piece, you’ll probably would see people gravitate, say two-thirds will be the Ultrashort Fund bond and I think you’ve seen over the years, we’ve had at times, significant inflows into those product and then outflows in it, and it really does relate to the yield environment, but they have been more positive in the first couple of weeks of Q1 than they were even in Q4.

Chris Donahue

I think, Rob we talked to the sale people in our budgeting process, they are not expecting the same level of growth that they had in ‘08 as in ‘09 in the Ultrashort short. So, you get both the answers.

Robert Lee - KBW

I appreciate it. Thanks guys.

Operator

Our next question comes from William Katz with Buckingham Research. Please state your question.

William Katz - Buckingham Research

Yes, thank you. Good morning. Just a feel that of course here on the fee waivers, I just want to understand that the math here, if $560,000 for the first three weeks, if you annualize that, you’re talking about less than $10 million if the world didn’t change, is that exactly to understand it and if that’s the case that makes no adjustment for mix and the fact advice continues to amount. Is that correct?

Chris Donahue

Yes, but you cannot really do that because as we have talked about before and somebody else mentioned, you are going to have maturities of securities that were high yielding. That is why in the press release and why Chris’ currently say we expected to increase as we said right here today.

William Katz - Buckingham Research

Okay. All right so in that regards, are there any hedging strategies that you are considering as a potential economic offset?

Tom Donahue

No, from what we’re seeing obviously the growth in the assets, we continue to have net revenue growth and in particular within the money market that we strip out the decline in equity then we are clearly winning the rate verse volume push forward and we would see that continuing that mean is going to continue forever and you that you can’t pay in a scenario, where that doesn’t happen.

But given that push forward between rate and volume no, I don’t think you certainly wouldn’t do anything along the lines of hedging at the fund level, and at the complex level, we see this as a market situation with the yields, we are very happy, where the business is, and what the demand and how we have been able to perform in that environment. So, there would not been any operational hedge necessary even.

Chris Donahue

Bill, my thought on answer to that question is, that is what our firm is, is a diversified firm. We got our equity funds and we gone through the performance and that’s looking pretty good and the fixed income, is looking pretty good, and we sure have benefited from our money fund complex to a great extend and we are going to continue to fight on that everyday. That kind of how we look at our firm is it a hedged firm.

William Katz - Buckingham Research

Okay. Just one more small picture question that two of you conceptual question. On the run-off portfolio it is in the institutional business. Can you size that in terms of asset and management also the impact in Q4?

Tom Donahue

I believe it is around $500 million or $600 million at this point. We had a couple of hundred million of run-off in each of the two quarters that we have managed and then its distrusted assets and its designed to be sold, when and at we can. And I think we gave the numbers, maybe we did not give the number is about $180 million in Q4.

William Katz - Buckingham Research

Okay. That is helpful. And then Chris, just two big picture questions. When you compared as earlier this week talked about the fact that clients are demanding greater pools of liquidity generally. Is that a factor in your outsized market share gain in money markets?

Chris Donahue

What do you mean demanding greater pools? You mean, they want to be in bigger funds?

William Katz - Buckingham Research

I think that is exactly the concept, right.

Chris Donahue

From our point of view, our clients have always felt that way, because when you have big clients, what they are really telling you is, they want to know that they can get their $400 million or $600 million or $2 billion out of a fund without blowing up the repo position.

So, they look at the size of the complex and the size of the fund they are in, as important ingredients. And this is nothing new; this maybe new to some players in this business, but our clients have been on this before, and many of our clients have their machinery built in where they will only be so much in a given fund, so much of a percent, and things like that. So, I agree with fees this year advancing, and say that the clients we are dealing with it on that for many moons.

William Katz - Buckingham Research

Okay. The other question is, given the success and stability of the money market business, and what they did has been more of a nascent push into the fixed income of the equity side. Are you seeing any visible signs of cross-sell? In other words, is the success of the money market business advancing the cause here on some of the fixed income mandates or equity mandates otherwise now gotten?

Chris Donahue

I would love to be able to track and chart and say with great confidence that, this money from the money funds and then be moved over into our other products. But I cannot track it, and I cannot say it with as much enthusiasm and confidence as I would like. However, I would mention that our performance in this space has enabled us to gain, continue our brand, our recognition in the marketplace for being a good player with good credit work and good response to clients.

So, in that sense it is very helpful, but dealing with the intermediates, we could not even see the money directly move from pot A to pot B anyway because of the mechanic. And having been in this for three decades it is very difficult for us to make that speech although it would be one, I would love to give.

William Katz - Buckingham Research

Okay. Just last question, you did buyback a modicum of stock, it has probably given the timing of the deals etcetera, but it is modicum versus, where many of the peers have been flat to flat to hunkering down. How do you think about allocation as you lookout into this year between buyback particular, where the stock is trading right now versus power shopping, to use your vernacular or even sizable dividend like you did last year.

Tom Donahue

Well, I do not know about the sizable dividend, but we would continue to score on all streets namely dividends and if we saw acquisition opportunities we would do those. And we remain open to doing the share buyback. But as with answers we’ve given on this before Bill, it’s really tough to say, oh well, we are definitely going to do more of thing A or thing B, because we really truly do it. If you look at our chart, look at how we do it on an opportunistic basis during the year. So, it is really hard to say, how exactly we are going to allocate those dollars.

William Katz - Buckingham Research

Okay. Thanks for taking all my questions.

Operator

Thank you. Ladies and gentlemen, there are no further questions at this time. I will turn the conference back to management for closing comments.

Raymond Hanley

So that concludes our call. And we thank you for joining us today.

Operator

Thank you. Ladies and gentlemen, you may disconnect your line at this time. Thank you all for your participation.

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Source: Federated Investors, Inc. Q4 2008 Earnings Call Transcript
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