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Federated Investors, Inc. (NYSE:FII)

Q2 2009 Earnings Call

July 24, 2009 9:00 am ET

Executives

Christopher Donahue – CEO

Thomas Donahue – CFO

Raymond Hanley – President

Analysts

Robert Lee - Keefe, Bruyette & Woods

Ken Worthington - JPMorgan

Mike Carrier - Deutsche Bank

William Katz - Buckingham Research Group

Craig Siegenthaler - Credit Suisse

Michael Kim – Sandler O’Neill

Keith Walsh - Citigroup

Cynthia Mayer – BAS-ML

Mike Holton – The Boston Company

[Steven Morton] – JPMorgan

Roger Smith - Fox-Pitt, Kelton

Operator

Greetings and welcome to the Federated Investors Q2 2009 earnings conference call. (Operator Instructions) It is now my pleasure to introduce your host, Mr. Raymond Hanley, President, Federated Investors Management for Federated Investors.

Raymond Hanley

Good morning and welcome. Thank you for joining us today. Today we plan some brief remarks on the second quarter before getting to your questions. Leading today's call will be Christopher Donahue, Federated's CEO and Thomas Donahue, Chief Financial Officer. Also joining us are Debbie Cunningham, the Chief Investment Officer for money market operations, Dennis McCauley, Laurie Hensler and Stacy Friday from the Corporate Finance group.

Let me say that certain statements in this presentation including those related to asset levels, sales and financial performance will constitute forward-looking statements which involve known and unknown risks that may cause the actual results to be materially different from future results implied by such forward-looking statements.

For a discussion of the risk factors, please see Federated's SEC filings. 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. With that, I will turn it over to Christopher to talk about the quarter.

Christopher Donahue

Thank you Raymond and good morning. I will begin by reviewing Federated’s recent business performance before turning the call over to Thomas to discuss our financials. Starting with the cash management business, overall money market assets decreased by $14 billion from the prior quarter though the average assets were essentially flat.

Money market funds decreased about $16 billion or 5% from the prior quarter and were up more than $72 billion or 30% from the second quarter of 2008. So far in July our money fund assets have ranged between $308 and $318 billion and have averaged about $312 billion.

The second quarter has some seasonality that effects money fund flows. In addition to the April 15 tax statements June 15 is a corporate tax payment date which impacts many of our institutional clients.

Also certain customers have used cash for other transactional purposes. Improved market conditions for stocks and bonds likely led to lower money fund balances at Federated and across the industry.

Better markets and solid investment performance across a wide array of fixed income and equity products helped Federated sales force to achieve strong results this quarter. Money market separate account assets increased reversing the difficult Q2 tax related seasonal pattern.

Results in this area included the previously announced [sub] advisory win from a major insurance company that added about $6 billion in April. Our money market fund share was about 8.5% at quarter end.

Within money fund categories we are seeing migration from treasury and government agency funds into prime funds. Muni funds have also added assets. At quarter end Federated’s money market funds by type were: $52 billion in treasuries, $114 billion in government agency funds, $108 billion in prime funds, and $38 billion in municipal funds.

During the second quarter treasury funds decreased by $15 billion. Agency funds decreased by $17 billion. Prime funds increased by $14 billion and muni funds increased by $2 billion. Low market interest rates continue to impact yields and fee waivers for money funds.

Thomas will provide more color and depth on these waivers in his remarks. In terms of money market regulation and enhancement, the NCC recently announced proposed changes designed to strengthen money funds. The administration also put forth considerations that seek to strengthen liquidity, lessen risk and increase transparency.

We welcome a careful consideration of these items many of which are in line with the way we have always operated our business at Federated. Turning to equities, assets increased about $3 billion or 12% during the second quarter. While most of the increase was due to market appreciation, we were pleased to produce a quarter of positive net equity fund flows.

We are seeing good sales levels in a variety of funds including alternative strategies offered in the Prudent Bear and market opportunity funds, our capital appreciation core equity fund, and the dividend oriented strategic value fund.

Our equity mutual fund flows continue to be positive for the first couple of weeks of July, though as always we caution about drawing conclusions from limited data. Within equity separate accounts outflows were largely due to net redemptions in SMA products while the institutional equity accounts saw modest inflows.

On the fixed income side fund flows were strong with sharp increases in both gross and net sales. Gross bond fund sales increased 46% from the prior quarter while redemptions decreased slightly. Positive net sales were achieved in all bond fund categories including corporate, global, government, mortgage backed high yield municipals, and multi sector.

Our flagship total return bond fund gross and net sales continued to increase. We also saw strong inflows into ultrashort bond funds. We continue to have success winning new fixed income institutional business.

In the second quarter we won a series of mandates some of which went into mutual funds rather than separate accounts. We have about $170 million in wins yet to be funded into separate accounts going into the third quarter.

Solid investment performance across multiple styles in both equities and fixed income is enhancing sales growth. Looking at the quarter end [LIPOR] rankings for Federated’s equity funds, 82% of rated assets are in the first or second quartile over the last year, 74% over three years, 89% over five years and 70% over 10 years.

For bond fund assets the comparable first and second quartile percentages are 65% one year, 69% three years, 68% for five years and 74% for 10 years.

As of July 22 our managed assets were approximately $400 billion including $343 billion in money market assets, $27 billion in equity assets, and $30 billion in fixed income. Money market mutual fund assets stand at about $309 billion.

Turning to distribution our sales force produced outstanding results again in second quarter. Building from strong growth in 2008 and the first quarter of 2009 the second quarter saw another step in the pace of our fund sales results.

For the full year 2008 gross sales of equity and fixed income mutual funds increased 32% from the prior year. These sales exceeded $13 billion and averaged about $1.1 billion per month. In the first quarter sales averaged $1.5 billion per month up over 30% from the 2008 pace.

In the second quarter stock and bond fund sales averaged $1.9 billion per month, up 27% from the first quarter and up 73% from the average in 2008. Finally a brief comment on acquisitions, we continue to make good progress on the full integration of Prudent Bear and Clover Capital.

While further center of excellence deals always remain possible, we are not actively seeking to add any specific styles. We continue to evaluate multiple acquisition opportunities to add further assets including money market consolidation deals. As always, we cannot predict the probability or timing of any potential deals.

Thomas Donahue

Thank you Christopher, Federated’s revenues decreased about 1% in Q2 from the prior quarter and from Q2 2008. Compared to the prior quarter low revenues from money market funds were partially offset by higher revenues from fixed income and equity.

The Q2 revenue impact of money fund waivers to keep deals positive or zero was $17 million, partially offset by $11.4 million in related lower marketing and distribution expense. The impact to operating income from these waivers was $5.6 million compared to $5.1 million in the first quarter.

The recent run rate of these waivers has increased. Based on current market conditions and current assets we expect the impact to Q3 operating income to be approximately $8.5 million to $9 million.

The increase from the second quarter rate is due mainly to the decline in yields for government agency funds. The Q4 run rate could be higher than Q3 based on current conditions and current asset levels. Waivers could reach $11 to $12 million of operating income impact with the increase due to prime funds where yields have also come in meaningfully.

I want to emphasize that there remains a wider spectrum of potential outcomes given the multiple variables involved including yield levels available in the market, changes in assets within the funds, actions by the Fed and Treasury, changes in expenses of the funds, mix of customer assets, and our willingness to continue the waivers.

On the expense side we continue to be diligent in our efforts to properly manage expenses at Federated. We are on track to realize substantial savings in our operating expenses which were down substantially from the prior quarter even factoring in the impairment expenses from Q1.

Expenses were down slightly compared to Q2 2008 even though we completed two acquisitions in Q4 2008 that added about 50 new employees to Federated. On the balance sheet cash and short-term investments were $64 million at the end of the quarter and recourse debt was $155 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

(Operator Instructions) Your first question comes from the line of Robert Lee - Keefe, Bruyette & Woods

Robert Lee - Keefe, Bruyette & Woods

Real quickly in the fixed income business, clearly sales have picked up as you said very noticeably but the redemption rate which tends to run high in the business has also picked up and it seems like its kind of remained high, would you attribute that predominately towards just an increasing mix towards the ultrashort products and maybe if we can get some color as to what proportion of either sales or assets that’s kind of running at. My sense is those assets can be a little more flighty over time.

Christopher Donahue

Over time you’re exactly right. During the quarter the sales of ultrashort funds were a little over $2 billion and the redemptions were just under $500 million. So you can figure out what the net was there of positive sales that contributed to the 2.6. This money when it comes in tends to come in and then when it goes out it tends to go out.

So the 500 against the $2 billion is really not as meaningful as when people want to buy the ultrashorts, they really want to buy the ultrashorts.

Robert Lee - Keefe, Bruyette & Woods

And maybe follow-up on the institutional business, you talked about the successes you’re seeing in the institutional fixed income business, can we just a little bit more about what, you mentioned $170 million mandates to fund, can you talk a little bit more about the RFP pipeline, what you’re hearing from potential clients out there, if you see the RFP pipeline actually building at this point.

Raymond Hanley

The RFP pipeline has built during 2009. Its probably up about 33% and it has shifted over the last four quarters from being two thirds equity and one third fixed to just about the opposite now. So the fixed income RFP pipeline in particular has built up and its very active. We’re in more finals, we’re winning more business.

As we mentioned a number of the wins actually end up billing into institutional fixed income products but we’re certainly seeing increased activity there and the investment performance has been a key factor there and we’ve added resources to the institutional sales operation at Federated and its another example of how we’ve been able to invest in the business and grow over a period where many other companies were pulling back resources.

We’ve been able to add some very talented experienced people into that part of the operation and we see it paying dividends.

Robert Lee - Keefe, Bruyette & Woods

I guess you recently announced that you won from, I can’t remember the name of the German Bank but I guess a portfolio to manage down for them, is it possible to give a sense of when you expect that to fund and maybe some sense of the size or kind of fee structure on it.

Christopher Donahue

On this one, due to the privacy and the importance of our relationship with our partner, we’re just going to stick with what we said in the press release last week.

Robert Lee - Keefe, Bruyette & Woods

Will we see that show up in the AUM or that going to be, kind of not show up and just sort of revenues flow through.

Christopher Donahue

We haven’t determined that yet. It is money that we’re managing but we haven’t figured out how we’re going to report it this quarter.

Operator

Your next question comes from the line of Ken Worthington - JPMorgan

Ken Worthington - JPMorgan

A couple of questions on a few areas, you gave guidance which is great but I just want to understand some things behind it, in the first quarter I think you paid about 50% of the lower fee waivers to distribution and the second quarter you passed almost all the incremental fee waivers on to distribution, why did that dynamic change.

Raymond Hanley

It has to do really with the mix of products and the fraction in terms of the distributor share varies by product. I think we’ve been through the numbers in the past and on average we have about half of the revenue that we book is paid back out through marketing and distribution expense.

But the proportion vary by product and so the numbers that you’re pointing to will move around a bit.

Ken Worthington - JPMorgan

And are you in terms of passing on the fee waivers to the distribution are you doing, following industry practice, are you deviating any way from what the competition is doing in terms of passing those waivers on.

Christopher Donahue

I’m not really cognizant of how exactly others are doing their fee waivers, so I wouldn’t be able to say how we’re doing compared to others. Our basic theory of doing this is that after you add up the core expenses which includes the administrative fee and the third quarter party expenses, then we share the waivers based on a pro rata relationship with our intermediaries based on what the sharing was.

And I’m just not aware of what others in the industry have done or how they do it.

Ken Worthington - JPMorgan

And then separately you mentioned that fee waivers not associated with low fund yields fell $4.2 million this quarter, what led to that decline. Did someone in the industry kind of exit the business or what are the competitive dynamics that led to that benefit for Federated.

Thomas Donahue

Basically we meet every month on all the products at Federated and review expenses and fund projections for the year and all the funds have, or many of the funds have different year ends so its kind of the ebb and flows of managing our whole complex and you can’t grab on to any one thing and say this is what’s going to happen and we just were able to, that was the result of a couple of quarters of meetings.

Raymond Hanley

And I’d add to that, if you look in our filings we talk about literally each year we have hundreds of millions of dollars of waivers. There’s a lot of attention on the portion that has recently been for money funds yield related but against the backdrop of the size of waivers that we have as a regular part of our business that change is not particularly significant.

Ken Worthington - JPMorgan

And then you mentioned seeing SMA redemptions this quarter, I think you said that last quarter as well and there’s definitely reasons why, but do you know, did redemptions kind of pick up or did they fall off in SMA first quarter to second quarter.

Christopher Donahue

They went down meaningfully second quarter compared to first quarter.

Raymond Hanley

And one other thing that’s happening within SMA’s is that the comments from last quarter and the answer relates mostly to the equity SMA’s but we’re actually beginning to get some traction on the fixed income side with SMA’s as well.

Operator

Your next question comes from the line of Mike Carrier - Deutsche Bank

Mike Carrier - Deutsche Bank

One other question just on the fee waivers, in terms of the guidance when you look at the third quarter and fourth quarter, given where you expect some of the pressure to come by product, do you have some expectation in terms of what you’re going to be able to pass on to the distributors or maybe put another way, what the operating income impact will be versus the revenue impact.

Thomas Donahue

The first thing is guidance, its where rates are today and assets are today and run that out. So that would be the route, what we gave was the result of a set of assumptions that we don’t really expect to happen, we know won’t happen. Assets are going to change and rates are going to change but we wanted to give some feel for what happened if things carried on exactly as they are today.

Now in terms of which funds and how that happens, as we’ve talked about its pro rata sharing as Christopher went over.

Mike Carrier - Deutsche Bank

And I understand, things are going to change every day. And then just on the long-term products, fixed income is definitely seeing very good traction on the sale side, on the equity side the performances there and you have gotten in deposit [to territory] on the fund side, anything I guess its inline with the industry, meaning the industry is still over weighted towards fixed income flows, but I guess from your guidance perspective what you’re learning from the traction that you’re gaining on the fixed income side, anything else that you need to do on the equity side in terms of resources, distribution channels, or platforms to get on or is it just industry [flows] need to pick up and to be able to maintain the performance.

Christopher Donahue

What it really is is repeat the sounding joy, repeat the sounding joy, repeat the sounding joy. So in football terms its basic blocking and tackling and telling the story and telling the story. So that’s what it is. Getting on platforms that you mentioned is very, very important. And we have been increasing the numbers of platforms we’ve been on over the last month and quarters and that’s starting to show itself but we have to continue to do that as well.

There are no magic things or magic resources or whatever the need to be added to the pot. We’ve reorganized the sales force, they’re performing beautifully. A lot of enthusiasm and the performance is excellent and now its just repeat the sounding joy.

Operator

Your next question comes from the line of William Katz - Buckingham Research Group

William Katz - Buckingham Research Group

The SEC has been reaching out with some new rules out for comment, pretty much have embraced much of the ICI, working group initiatives if you will, just sort of wondering if you could talk a little bit about how you see if any change in the industry over the next couple of years and how Federated is positioned there.

Christopher Donahue

We think that the SEC proposals are very good, heading in the right direction. And we are working vigorously on our comment letter as is I assume the others in the industry to include the ICI working group.

The main thing that’s going on here is the strengthening of the resiliency of money funds. And so within that context we can have a little ebb and flow on questions or comments. I don’t think you are going to see any serious changes or harm or whatever to money market funds because the directive from the White House was specifically to be careful not to harm money funds and the statements in the document that the SEC produced, specifically says their goal was to strengthen money funds.

Now if you want to talk about some of the specific ones, the specific provisions we certainly can but that’s an overall answer.

William Katz - Buckingham Research Group

I would actually be curious of two aspects, one is one of your competitors is continuing to sound the drum beat for capital, so I wanted to get your updated views there and then I guess the one area out for comment remaining with the SEC is [shipping] from a fixed to a variable NAV, sort of wondering if maybe you could provide some comments on both.

Christopher Donahue

Sure, on the idea of capital some people just continually talk about this but I don’t think its all that real at this point. If you’re talking about real capital for money market funds, think of somebody else. Think of JPMorgan. They have $400 billion of assets. That would require $40 billion to have real capital, 10%. Oh someone will say 5%. There is no $40 billion or $30 billion or $20 billion of capital.

Next point, there’s no economic model that I’m aware of that enables money market funds with $10, $20, $30, or $40 billion worth of capital for $400 billion to have an economic model that has it make any sense. The ideas of having one or one and a half basis points of capital, which is a completely different idea, would be fine. That’s not even a big issue and if that works to satisfy things, then that would be okay.

And don’t forget that there has been some directive from the White House to work on a liquidity feature that is being worked on that we’re not prepared to talk about what that’s like but that’s another angle in this whole discussion. So we don’t think that’s real.

You also notice that in none of the proposals going all the way back to Mary Shapiro, Geitner, Bernanke, the White House, there are no proposals for capital requirements on money funds. So now let’s talk about the fixed NAV so-called or the amortized cost, variable NAV, however you want to phrase it.

The way the SEC put this was not in terms of the rules that they are proposing but in terms of questions. The way the White House put it was, well let’s look at the liquidity feature that we’ve directed you to work on in comparison with a change in net asset value. From our point of view changing that asset value is very, very, very, very bad for money funds.

And the idea that you’re going to say in one breath that money funds should be protected, and then say they’re going to have a changing NAV, a money fund is a daily liquidity at par event. And that’s the product, that’s the product that people want. And they are also investment products as we discovered.

So the SEC we don’t believe is going to go to a variable net asset value or restrain the use of amortized cost. We of course will comment to this effect in response to their proposals. So these are two of the issues that we have to deal with of course, but we think they’re both very much under control.

William Katz - Buckingham Research Group

I’m sort of curious, I looked into your guidance here on waivers in the scheme of things not far off of where I am in terms of my own thoughts as it relates to the model of the company, but any thought to and maybe I’ve asked in the past so I apologize not remembering the answer, but any thought of hedging some of this risk on a taxable basis here. Obviously if rates are going to stay low there’s certain ways I guess you could get some economics elsewhere in the business. What are your thoughts there.

Christopher Donahue

No hedging on that.

William Katz - Buckingham Research Group

Is it just accounting economic reasons or is it just practical reasons, what’s the [gate] what’s the [gate] in here.

Thomas Donahue

It would be us betting on interest rates and we are happy to be in the business that we are in, manage our clients’ money and deal with the consequences and Debbie bets on interest rates every day in order to manage the portfolio properly for our clients and we’re happy to do that but then taking the capital of the firm and choosing to do that, we think people, our shareholders and the people, the executives at Federated are happy to have our ups and downs live on how we do in the marketplace on managing the money and not our decisions on betting on interest rates.

William Katz - Buckingham Research Group

You mentioned that you continue to identify cost savings, could you quantify what in terms of opportunities you’re seeing in the second half of this year.

Thomas Donahue

We, for the second half of the year, when we went through our budget process we were trying to look and see what we’re going to go based on each quarter and how things were going to play out and we’re trying to as we, words we use, trying to manage it diligently. We have slowed down or not, taken our time on hiring replacement and we spent a lot of time through a whole process of a lot of other initiatives on saving money.

We are still swinging away at those things and we don’t see loosening up right now certainly through the rest of the year. So we’re going to remain diligent. In terms of predicting numbers we’re not going to do that.

Operator

Your next question comes from the line of Craig Siegenthaler - Credit Suisse

Craig Siegenthaler - Credit Suisse

First just to hit back on the fee waivers, kind of a follow-up to Ken’s question, previous guidance for pretax after expense impact from fee waivers is about kind of $5 to $6 million range, I’m wondering did you requantify that number today, I may have missed it. I’m just wondering where we stand now following the language in the press release in the third and the fourth quarter and also can you talk about where the run rate is for fee waivers in July.

Raymond Hanley

We did quantify it, we said that the impact in Q3 based on the current level of assets, mix of assets, and present interest rates would be between $8.5 to $9 million as compared to the $5.6. For July we’re at around $2 million month to date so we’ll be somewhere around $2.5 million for the full month.

And what’s changed over the last couple of weeks and months since we gave the last round of guidance has been that the rates have come in, in particular on the agency side, obviously the volume of assets swelled there though during the quarter they receded a bit. So its always a question of both the rate of the market yields essentially and the volume of assets moving between categories.

The number we used for Q4 was $11 to $12 million and again that’s math based on the portfolios and the yields as they exist today and the asset levels and at that point I think everything will have reset and it will turn into a pure volume of asset analysis.

Craig Siegenthaler - Credit Suisse

And just to clarify that is pretax after expense right.

Raymond Hanley

It’s the operating income effect, it’s the reduction in revenue offset partially by the reduction in related expenses.

Craig Siegenthaler - Credit Suisse

And the new SEC amendment that one I guess was proposed a month ago, is the impact from that essentially lower net yields and higher fee waivers, could you maybe talk about the impact from that.

Raymond Hanley

We’ll ask Debbie to comment on it, obviously the regulations they put things out for comment but we haven’t had changes for today. Debbie do you want to comment on what you think those regulations might do to yields of anything.

Debbie Cunningham

Basically if you look at the proposals for Rule 2A7 changes that came about a month ago at this point, they center around five areas; credit risk reduction, interest rate reduction, diversification increase, liquidity increase and then reporting and disclosure. Four of those five topics actually do effect the investment portfolio.

Reporting and disclosure is necessarily not the case but the other four do. Overall right now though looking at where yields are and where they are in general given that we’re in that zero to 0.25 range [inaudible] and don’t expect to be there forever, we’re saying that the impact on the overall portfolios will be minimal.

It will increase as you go out the credit risk spectrum so to the extent that there is minimal to no impact on the treasury funds there will be more impact on the prime funds and government agencies will fall somewhere in between with muni funds on the prime fund side also.

But again not looking at this as extremely problematic from an industry perspective and just a few basis points in yield on an impact analysis.

Craig Siegenthaler - Credit Suisse

Another way to just ask this, based on the amendments would maybe Federated and even other money market managers, would they have to lower duration and increase liquidity just based on how those are positioned today or do you largely believe funds are already positioned for the amendment today.

Debbie Cunningham

Largely the funds are well positioned in the context of the proposals as they stand today.

Operator

Your next question comes from the line of Michael Kim – Sandler O’Neill

Michael Kim – Sandler O’Neill

First when the treasury’s insurance program ended in September do you expect that to potentially serve as somewhat of a catalyst to driving a step up in consolidation across the industry and if not, maybe if you could give us your thoughts on where you think we currently stand in kind of that whole process.

Christopher Donahue

In terms of consolidation I don’t think that particular event will be a triggering device. I think the consolidation move is already underway and will continue and that may be a nice little additive or a point to look at but it really isn’t going to be a catalytic event in my opinion because the people who should get out and who are looking at their economics have already come to those conclusions.

So I think the consolidation theme will simply continue right through the end of that treasury program.

Michael Kim – Sandler O’Neill

And then on the long-term part of the business, clearly you’ve taken market share on the fixed income side, despite maybe not being one of the biggest players out there, just aside from stand out investment performance I’d be curious to get your thoughts on what some of the other drivers have been in terms of the rapid step up in flows.

Christopher Donahue

Well it is the way it always has been. Its not unlike the stories I always tell about what is Federated from Pittsburg, its two rivers coming together and when you have investment performance and strong sales which are the two rivers, then you can form the Ohio and go west young man, go west. And that’s about what it boils down to.

Now there’s a lot of work on the banks of those rivers that has to go on in order to make it flow, service, clients, etc. But the main issue is getting the excellent performance and having the sales individuals with the relationships and the knowledge to as I said before repeat the sounding joy.

Michael Kim – Sandler O’Neill

And then just more of a broader kind of a question here, thinking about earnings contribution mix as well as kind of the revenue mix, where do you see that evolving over time assuming the equity markets continue to trend higher.

Christopher Donahue

We would love to see the equity mix increase our revenues from equities increase even to the point where they are more than half of our overall revenues. However when I always mention that or go over that slide from our various analyst presentations I will always mention that we do not really manage our acquisitions or the receiving of money from our customers to try and arrive at that fraction.

But you’re on the right point that with the increase in the equity market and should that continue I think we could see some rather strong increases in equity revenues as a percent of our total revenues and perhaps even get back to the interesting days of yesteryear like the first quarter of 2005 where the equity revenues in that quarter exceeded the revenues from the money market funds.

Operator

Your next question comes from the line of Keith Walsh - Citigroup

Keith Walsh - Citigroup

Quick question, assuming the current rate environment and the money mix holds through 2010, describe to us how the fee waiver loss curve works as it moves into 2010.

Thomas Donahue

I’m not, Debbie’s going to predict interest rates.

Keith Walsh - Citigroup

Well look, I’m trying to get some sensitivity here, I don’t know why that’s not a question you can answer.

Thomas Donahue

Assuming that rates stay where they are, and what’s our waiver situation going to look like in 2010 based on, let’s see, by then all the current holdings in the money funds will be reset to whatever the rates are and—

Debbie Cunningham

It should be the same as what it is in the fourth quarter at that point.

Raymond Hanley

We made the comment earlier that by then everything would have reset and so the fourth quarter [mass] answer of $11 to $12 million would be about what the run rate would be.

Thomas Donahue

Really, if rates stay down low where they are and that’s what’s happening, if it happens in the fourth quarter and continues to stay down where they are then the prime funds are going to come into play in terms of the rates being down and if it stays down there we will still experience waivers and what we said, $11 to $12 million is our guess and so it should continue, until rates go back up.

Keith Walsh - Citigroup

Okay I just wanted to just see if when we reach that plateau, and then just as we see money market deposit account yields from banks sort of more competitive or much more competitive versus money market mutual fund, is there a risk of disintermediation losing these assets to banks.

Christopher Donahue

Historically and I’m now talking we’re in our fourth decade of looking at this phenomenon we have in our business model attracted those customers who are interested in a cash management service where yield does not drive the truck. And so we have not historically found that whatever the yields are on MMDAs has impacted seriously our money market fund business and that is true today as well.

This is not to say that some players don’t decide to use MMDAs for various purposes but we’re looking at our assets, our clients, our market share and looking at it over various cycles historically and the MMDA rates just haven’t been the main issue. Part of the reason for that is that when you’re looking at a cash management service from an intermediary or large institutional client with a lot of underlying accounts, they want the services, the availability to switch among various money funds and they like the idea of the daily liquidity at par through the systems that we have set up.

And don’t alter those mechanisms based on whatever the MMDA yields happen to be week to week or whatever.

Operator

Your next question comes from the line of Cynthia Mayer – BAS-ML

Cynthia Mayer – BAS-ML

Just another quick follow-up on the fee waivers if you don’t mind, it sounds like you’re not assuming in your projections any further shift from government to prime, and I’m just wondering that trend stands, do you think it will continue and to what extent could that offset some of the waivers.

Thomas Donahue

We’ve seen lots of money over the last year go in to treasuries and we’ve seen money go into governments, now we’ve seen money go into the prime fund and based on what’s going on in the marketplace we’re happy to try to accommodate all the clients. What do we think is going to happen, seems like as the economy may be improved, people will go out further on the rate spectrum and so that’s prime now, but will that change around, I don’t know. Debbie do you know.

Debbie Cunningham

I think its really hard to predict where client movement is. We’ve had many, many discussions with clients about the potential, their potential of moving out of treasury product and into other government agency or prime products. A lot of that has come to fruition during the first half of 2009. You’ve seen that shift occur. To try to predict the continued shift of that going forward though is very, very difficult so our assumptions are based on current mix as it stands.

You could, if you assume that more is going to go back down into the treasury and government agency and leave prime, you would increase those waivers. If you assume that the mix changes toward the prime side where prime continues to gain versus their treasury or government agency counterparts, you could reduce that waiver. But that’s not something that we’re just comfortable predicting based on the ability of clients to know exactly what our clients are going to do.

Cynthia Mayer – BAS-ML

And as you look around for the money market consolidation deals you mentioned, what are the main impediments to getting those done now and how much are you seeing available and how much competition are you seeing.

Christopher Donahue

In terms of impediment it isn’t like an impediment. It’s the purveyor of the other money fund coming to the view that now is the time to make a transaction. As I’ve discussed on these calls before the extent to which some of these players control or have great influence over the redemption process that’s the extent to which they don’t have to make a move.

So there is no catalyst in the hands of the other players other than the long-term understanding that they may be don’t want to be in this business. So its very, very difficult to say what timing will be used. And in terms of how much money, well what we do is look at all of the lists of players of which there are hundreds, and basically call on all of them and these can be sizable ones and very small ones.

So we look at it as a very large field of opportunity.

Cynthia Mayer – BAS-ML

Do you see the proposed regulations at all as influencing people one way or another, maybe tipping them toward getting out of money markets or not particularly.

Christopher Donahue

The regulations since we know that they’re just proposals and they haven’t been implemented will add to the same kinds of features that people are thinking about in terms of whether they’re really committed to this business. To give you just one example, the need both from a regulatory standpoint and an investment standpoint, to do credit work is critical. But people now see the beauty of this.

And the rules underscore this but the rules are always there requiring it anyway. So yes, it accelerates, underscores, and reemphasizes the things that were necessary in order to run a money market fund and if you’re not prepared to do that then you’re going to get tripped up and maybe the SEC is going to [inaudible] an inspection and maybe that does accelerate people’s desires because they’ve got to say, hey do I really want to commit to have a proper credit analysis staff given whatever assets I have and how are they going to play it.

So I think it is a modest help in the overall consolidation effort.

Cynthia Mayer – BAS-ML

You mentioned the seasonality inherent in Q2 with the June 15 tax payment, is there anything in Q3 we should be on the lookout for, September 15 or anything else as we watch the money market flows.

Thomas Donahue

September 15 is another tax date, beyond that nothing comes to mind in Q3.

Operator

Your next question comes from the line of Mike Holton – The Boston Company

Mike Holton – The Boston Company

I just missed a number earlier, when you said managed assets total as of July 22, did you say it was $400 billion.

Thomas Donahue

Yes.

Mike Holton – The Boston Company

Okay so just down a little bit from the end of the quarter and I imagine that’s all money market.

Thomas Donahue

Yes.

Operator

Your next question comes from the line of [Steven Morton] – JPMorgan

[Steven Morton] – JPMorgan

I just wanted to know if I could get a headcount update and the number of employees as of this quarter, the end of last quarter and the year ago quarter.

Thomas Donahue

The 1,370 at the end of June and at the end of March 1,379.

[Steven Morton] – JPMorgan

And the year ago quarter.

Raymond Hanley

We don’t have that number in front of us but it would have been at least 50 less due to the acquisitions we did in Q4.

Operator

Your next question comes from the line of Roger Smith - Fox-Pitt, Kelton

Roger Smith - Fox-Pitt, Kelton

I just want to go back to the acquisition story I guess on the money market side and is there a capacity constraint at Federated right now or how much assets do you think you could bring over on the money market side through acquisitions, how many types of, could this be multiple deals at, done in a short period of time.

Christopher Donahue

We don’t look at ourselves as having a capacity constraint at this time. Our market share of 8.5% we think there’s plenty more to go. So I don’t have a cap on it and wouldn’t even start to address some kind of theoretical issue there.

Thomas Donahue

From an integration standpoint is dependant on what transaction we were talking about. We would not try to sink ourselves in taking on too much from an integration standpoint.

Roger Smith - Fox-Pitt, Kelton

But when you do that on the money market side is it really just transferring the assets from someone else’s platform onto your platform or is there more integration risk that we should be thinking about.

Christopher Donahue

Depending on what the structure is of the money coming in there is integration issues that have to be addressed. For example, what are the funds, what are structure of the funds inside their portfolios, who are the customers, how did they get there, why are they there and how does that all work. Those things are critical. For example, when we did the Alliance transaction which was $19 to $20 billion. We brought over some of the actual funds and began running them here as well.

Others we merged or moved assets into our other funds. So every one of these questions has to be answered if you have a large money fund deal and they are important questions.

Roger Smith - Fox-Pitt, Kelton

And then when I sort of think about the costs associated with doing these type of deals, should we think about it more similar to what was done with the Alliance transaction which I believe my understanding there is that a lot of the fee for the deal was on more of an earn out structure. Is that what we should think about.

Christopher Donahue

Yes, that pattern was very strong then and remains strong from our point of view in looking at money fund deals that because its daily liquidity at par, it doesn’t take a wizard to figure out that paying over time might be a smart idea.

Roger Smith - Fox-Pitt, Kelton

So then that’s really how most of the deals end up getting talked about from a capital point of view, doing acquisitions, having capital on hand isn’t overly [inaudible].

Christopher Donahue

No its not, in doing those kinds of deals although in the Alliance deal there was an up front payment and then over time and certainly that’s, given a certainly deal that’s a worthy structure as well.

Operator

There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Raymond Hanley

Thank you for joining us today. That concludes our call.

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Source: Federated Investors, Inc. Q2 2009 Earnings Call Transcript
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