Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Federal Investors, Inc (NYSE:FII)

Q1 2010 Earnings Call

April 23, 2010 9:00 a.m. ET

Executives

Raymond J. Hanley - President for Federated Investors

J. Christopher Donahue - President, Chief Executive Officer & Director

Thomas R. Donahue - Chief Financial Officer, Vice President, Treasure & President FII Holdings, Inc

Susan R. Hill - Senior Vice President, Senior Portfolio Manager

Analysts

Roger Freeman - Barclays Capital

Michael Carrier - Deutsche Bank Securities

Craig Siegenthaler - Credit Suisse

Michael Kin - Sandler O'Neill

Cynthia Mayer - Banc of America - Merrill Lynch

Ken Worthington - JP Morgan Chase

William Katz - Citigroup

Robert Lee - Keefe, Bruyette & Woods

Marc Irrizary - Goldman Sachs

Operator

Greetings and welcome to the Federated Investors first quarter 2010 quarterly earnings call and webcast. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Raymond J. Hanley, President for Federated Investors. Thank you. Mr. Hanley, you may begin.

Raymond J. Hanley

Good morning and welcome. Today we've planned some brief remarks before opening up for your questions. Leading today’s call will be Chris Donahue, Federated’s President and Chief Executive Officer; Tom Donahue, Chief Financial Officer.

Also with us are Denis McAuley, Lori Hensler and Stacey Friday from the Corporate Finance Group and Sue Hill, Senior VP and Senior Portfolio Manager from our Money Market Group will participate in the Q&A as well.

To start, let me say that certain statements in the presentation constitute forward-looking statements that involve known and unknown risk that may cause actual results to be materially different from future results implied by such forward-looking statements. For a discussion of the risk factors please see our 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’ll turn it over to Chris to talk about the quarter.

J. Christopher Donahue

Thank you, Ray, and good morning. I will start with a brief review of Federated’s recent business performance before turning the call over to Tom to discuss our financials. Looking first at the cash management portion of our business, money market assets decreased by $41 billion or 13% from the prior quarter. The decrease came from money market funds as cash separate account assets increased slightly.

We noted in our January call that money fund assets were down about $22 billion. Assets were relatively stable in February before decreasing in March and we have seen the expected tax related outflows here in April.

Unprecedented market conditions and short-term interest rates have led to unprecedented changes in client money fund balances over the last three years. In this period our clients added about $173 billion to their money fund balances in '07 and '08.

In '09 and through mid April of '10 we've seen about $100 billion leave our money funds. Money fund withdrawals have included certain assets that came in late in '09 with an intended short stay, draws outs of cash by corporations beginning to increase investment spending and increased use of certain high-yielding investments including direct market investments and bank deposit products by some investors who are more yield sensitive.

Throughout this period, including in 2010, our client relationships have remained strong, stable and, in fact, growing. Our clients have appreciated the strength and stability of our products and our willingness to keep funds open during periods when other providers closed funds, even as we waived most or, in some cases, all of our advisory fees in some of the funds.

We are confident that looking beyond the unprecedented market and interest rate environment of recent years our cash management business continues to be very well positioned. We expect this business to continue to grow over time with higher highs and higher lows during particular cycles.

Although low rates continue to impact yields and fee waivers for money funds in Q1, we believe that we saw the high water mark for these waivers in January and February. As we expected, there was some upward movement in certain rates within the current zero to 25 basis point Fed funds target range in March.

We believe that we will see less impact from money fund fee waivers beginning in the second quarter and continuing over the rest of the year. Tom will provide some more specific comments in his remarks. Importantly, our money market funds share has remained over 8% during the quarter.

Beyond cash we have a broad array of solid products in both bonds and equities. In Q1 we saw gross mutual fund tails increase to over $2 billion per month for combined equity and bond funds. This is an increase of about 7.5% from the average in 2009 and builds on the 64% growth we saw in the 2009 versus 2008 timeframe. We gained market share in 2009 on the gross sales for bond funds and for equity funds as well.

Now, looking more specifically at equities, assets increased slightly during the first quarter to just over $30 billion. Net inflows were negative in January and March and positive in February. For the first two weeks of April these flows are negative.

For the full quarter we saw positive flows in the Intercontinental Fund and in the alternative space with the Prudent Bear Fund. The Strategic Value dividend [REN] fund continues to show solid flows and net flows were also positive in the [Caughman] Large Cap Fund, the Clover Smaller Value Fund and Federated Mid-Cap Growth Strategies Fund.

Looking at our equity product lineup, we have solid products in a variety of areas that should be well positioned to capture flows including on the domestic side Clover Value and Small Clover Value, [Caughman] Products, Prudent Bear and our group of value and income products. The Intercontinental and International Leaders Funds are solid performers among our international products.

Within the equity separate account outflows were largely due to net redemption in our SMA products. Now looking at bonds, our sales continue to be strong in the first quarter with gross sales of more than $4.5 billion and net sales of $1.2 billion.

We continue to see improvement in the composition of these sales. For the first quarter all categories of domestic bond funds showed net inflows. The percentage of gross sales in ultra short products has decreased from about 50% in mid '09 to just under 30% here in the first quarter.

The percentage of net sales in these funds has dropped from around 60% to 14% in the same timeframe. Bond fund flows remain positive in the first two weeks of April. In fixed income separate accounts we won a handful of mandates in the first quarter that we expect to fund for over $1.5 billion over the next couple of quarters.

We expect to continue to see significant wins in this area given our solid performance over the cycle. We had approximately $350 million in new financing of institutional fixed income separate accounts in Q1 partially offset by the closing of a $240 million account from a client who made a mandate change no related to investment performance.

About half of the new institutional assets were sources outside the United States and we expect additional success in this area as we've improved our profile with certain large mandate wins.

Turning to fund investment performance and looking at the quarter-end Lipper rankings for federated equity funds, 20% of rates assets are in the first or second quartile over the last year, 32% over three years, 76% over five years and 78% over 10. With the bond fund assets, the comparable first and second quartile percentages are 25% for one year, 65% three years, 74% for five years and 83% for 10 years.

Interestingly, 99% of international equity assets are in the top two quartiles for the first year, one year, 71% for three years, 76% for five years and 71% for 10 years.

As of April 21st our managed assets were approximately $337 billion, including $260 billion in money markets, $30 billion in equities and $47 billion in fixed income which includes liquidation portfolios. Money market mutual fund assets stand at about $229 billion.

So far in April, our money funds assets have ranged between $239 billion and $228 billion and have averaged about $235 billion.

Regarding acquisition, we continue to conduct an active search for an acquisition or partnership to further advance our business outside the US as an important component of our strategy to expand global distribution and footprint.

We remain active in looking for potential consolidation deals including in the money market business. As always, we cannot predict the probability or timing of any potential deals. Tom?

Thomas R. Donahue

Thank you, Chris. The revenue decrease in Q1 compared to the prior quarter was due largely to the impact from money fund yield waivers and lower money market assets as detailed in the press release. With lower distribution expense due to the money fund waivers, the operating income impact of these waivers was $17.8 million.

As Chris mentioned, we have started to see some improvement in certain short-term rates and this is beginning to positively impact waivers. For Q2 we think that based on current market conditions and our expectations for rates, the operating income impact from these waivers will decrease to around $15.5 million.

While we believe that the impact will continue to decrease thereafter we caution that a wide range of outcomes is possible. Factors that impact these waivers include yield levels, available on the market, changes in assets within the funds, actions by the Fed, Treasury, the SEC and other governmental entities, changes in the expenses of the funds and our willingness to continue the waivers.

In terms of sensitivity, we continue to estimate that a 10 basis point increase in fund gross yields would reduce the waiver impact by about one-third while a 25 basis point increase would reduce the impact by about two-thirds.

Looking at our assets weighted average money fund gross yields from mid-January to mid-April, overall gross yields are only up about one basis point as higher Treasury fund yields were partially offset by lower government agency fund yields. Prime has remained about the same.

Fewer days in Q1 also impacted revenues by $6.8 billion compared to Q4, partially offset by $1.6 million in related lower distribution expense.

Turning to expenses, compensation expense increased from the prior quarter due mainly to seasonality of payroll taxes and 401K matching contributions. Q1 also included a true up of bonus expense, therefore, we would expect that about $65.5 million would be a good estimate for Q2 comp run rates.

Looking at distribution expense, yield waiver, lower money fund assets and fewer days in the first quarter drove the variance from the prior quarter.

The successful launch of the Federated Enhanced Treasury Closed End Fund in January added approximately $850,000 in net operating expenses in Q1. The expense was near the low end of the range due to contributions from other Geo parties. The operating rate was $180 million in new assets and we are looking for additional opportunities in the closed fund space.

As we discussed last quarter, the dividends paid in January reduced reported EPS by approximately $0.04 per share due to the impact of the two-class method required for calculating EPS.

On the balance sheet we recently announced the closing of an amended and restated term loan facility effective April 9th. The $425 million structure is fully drawn. Approximately $186 million of the proceeds were used to retire existing debt. The balance of the loan is $236 million and our $200 million revolving credit facilities are available for general corporate purposes including acquisitions and related contingent payments, share repurchases, dividends, new products, [seeding] and other investments.

We entered into an interest rate swap to produce a fixed interest rate of 4.396% for the five-year term. We felt that the opportunity to extend the term and the size of our debt funding at this rate was attractive and positions us to be opportunistic as we actively seek an acquisition or partnership to expand our international business.

The deal was very well received in the bank market and was oversubscribed with 22 banks participating. In addition to the $1.50 dividend paid in January, we repurchased 111,000 shares during the quarter and that concludes our presentation.

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

Question-and-Answer Session

Operator

We will now be conducting a question-and-answer session. (Operator instructions) Your first question comes from the line of Roger Freeman - Barclays Capital.

Roger Freeman - Barclays Capital

I guess you commented in equities SMA. You mentioned there were SMA withdrawals. Can you just elaborate a little bit further? Was there anything in particular driving that?

J. Christopher Donahue

The thing that was particularly driving that were redemptions on the [MVP] account that are the largest portion of the SMA business. That was due to performance.

Thomas R. Donahue

Roger, the [MVP], of course, is a fundamental quant method and the performance there, I guess, you've seen other quants with similar performance challenges. The more recent performance has been better and we continue to have the product position well on the SMA platforms. But there have been accelerated redemptions.

Roger Freeman - Barclays Capital

The imperative head accelerated probably in March because March was a particularly bad month for quant strategy.

J. Christopher Donahue

It's more like - accelerated probably wasn't the best word but over the last several quarters we've seen regular outflows. But, again, the more recent performance - last year was a tough period for quant models to work and the last two years we've continued to tweak the model. The team is intact and the more recent results look better.

Thomas R. Donahue

The long-term results in six out of the eight mandates are still beating benchmark, which is -- they're more of a benchmark oriented velocity than compared with other funds.

Roger Freeman - Barclays Capital

I guess Prudent Bear looks like - I think there were negative flows there last month. Is there anything to sort of start to read into that with respect to just this market advance and what is the client demand for [their] market strategies?

J. Christopher Donahue

The flows in Prudent Bear will be volatile and have been. So money comes in and goes out based on people's individual instincts as to when they want to play that particular way with a portion of their assets. So it is almost impossible for us to predict on a weekly or monthly or even quarterly basis which was those flows are going to go.

Thomas R. Donahue

Roger, we would expect over time to see a different cost admission of shareholders in the fund when we acquired it when the distribution was much different. We're positioning the product with our clients, a product that enhances nearly any portfolio and should be a part of portfolios and not simply a bet on the near-term direction of the market.

Roger Freeman - Barclays Capital

Then, I guess, lastly around the money markets, so you said in April so far I guess you averaged $235 billion. Is that relative to your - was that just mutual fund money market or is that your total money market balance?

J. Christopher Donahue

It's just the funds and it reflects getting through the mid month tax period which could have been within the historical range of what we've seen in past April 15th tax periods, which, of course, is what happens in the industry as well.

Roger Freeman - Barclays Capital

Just lastly, a big picture on the money market sort of macro view, our money market strategist is saying that total money market assets will get back down to $2 trillion by the end of the year, so back to pre-crisis levels. Do you fundamentally agree or disagree with that? Obviously you're sitting right -- .

J. Christopher Donahue

I didn't hear exactly what you said. Your strategist felt that the -- .

Roger Freeman - Barclays Capital

Yes, they're basically saying that the money market assets get back down to pre-crisis levels around $2 trillion industrywide by the end of the year. I'm just curious as to how you feel about that sitting in the middle of the business.

J. Christopher Donahue

We have not made a projection as to how low those numbers will go. That one would be certainly lower than what I would personally expect without having done the work on it. But what remains is an enormous systemic liquidity enhancement to the system so that whatever those numbers are on a temporary basis the money market funds remain a critical ingredient throughout the system, whatever the size.

So we look at it as maintaining clients, maintaining market share and setting ourselves up for the future on things. So I think the way we would be looking at that is we're looking more specifically at knowing the customers that come into those funds as we have done historically in order to be able to build the funds accordingly to take care of whatever needs our particular customers are about.

This is really more critical than a macro view on how much money is moving out in trillions. We're looking more at the billions in the individual funds.

Operator

Your next question comes from the line of Michael Carrier - Duetsche Bank Securities.

Michael Carrier - Duetsche Bank Securities

I looked at where the fee waivers are today and let's just assume we stay at the April level in terms of the money fund. It looks like if we just look at what the operating income impact would be, eventually when you get to normalized levels of rates you add about $0.40 to your earnings and then you're back to around that $2 level.

I guess going forward, particularly on the long-term products, you've done a lot of acquisitions and you've made some progress. You see the long-term flows on the fixed income side. I guess, do you feel like it's continue to penetrate the distribution and increase sales or do you think there's still product gaps that you need to fill in?

J. Christopher Donahue

We aren't currently looking for or believe we have certain product gaps right now except for our afore mentioned efforts to enhance our international footprint, which would be both a product and a distribution type effort.

But on the domestic side we think we're in pretty good shape and it would be enhancing the distribution, getting on more platforms, working on the performance on certain areas that need it and more or less repeating the sounding joy of the business model in the marketplace.

Michael Carrier - Duetsche Bank Securities

Just on the new debt facility, if I look at the cost that relative to where you guys were and the size, it looks like it's somewhat of a drag, maybe $0.05, $0.06 to your earnings. So is there something - do you have that in place because you feel like maybe on that international side there's something in the next six to 12 months that you would like to be doing? Otherwise I’m just trying to figure out what all the cash will be used for.

J. Christopher Donahue

When you phrase it as there's something that we would like to be doing in a shorter timeframe, the answer is yes. If you interpret that meaning that will happen, then you've taken it a little too far. So the way you phrased the question I can handsomely say yes. I'll let Tom comment on the other part of it.

Thomas R. Donahue

Yes, I mean, you just run the 4.396% times the size of the loan, the effective as we've talked about. We expect to invest the money and possibly curtail that, those expenses a little bit and [adversify] the way with our portfolio managers.

J. Christopher Donahue

I'll give you another overall prospective. We have not traditionally - if you look at our history - build up money for no purpose. So we're always thinking about what to do with capital, be it earned capital, borrowed capital or whatever for the best interest of shareholders and the long-term development of the franchise.

That philosophy is still intact and governing the decision making over the creation of the loan and its utilization.

Operator

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

Craig Siegenthaler - Credit Suisse

Just given where kind of inflation is and if it stays at these levels for longer and the risk that the Feds may keep rates low also for longer, have you researched any way to potentially change the money market fund business, maybe have it more adapt to this environment and looking at how you can eliminate [types] of risk of fee waivers going forward maybe without destabilizing any [rate]?

J. Christopher Donahue

We have looked at numerous ways to try and do that and none of them really work. Whether you are talking about charging people in different ways, reverse splits, all sorts of - every way you could think of turning over those rocks we have looked at.

The reason they don0't work is because the money market fund is so simple and so transparent that it will not allow any of those kinds of creative changes [to do] what the product is. The people want daily liquidity at par.

So whatever the inflation view, whatever the Fed view, the structure of the money fund is its very strength. We just haven't been able to figure out ways to have that change to enable ourselves to collect a fee or I assure you we would have been working on those.

Now, if you'd like, I don't know that we exactly agree with your characterization of what interest rates are, but I'll let Sue Hill comment on that just for the record.

Susan R. Hill

I'd be happy to do so, Chris. We're currently, I think, pleased by the rise that we've seen in the first quarter and into the second quarter in short-term interest rates, which doesn't reflect necessarily an expectation of near-term monetary policy changes from the Fed but really is more a reflection of the beginning of the Fed's exit strategy in managing the excess reserves it has on its balance sheet.

So we would expect as we go forward in the second quarter that will continue to trade with repo rates and the Fed funds rate in the 20 basis point area, which is a pretty good distance from the close to zero that we saw in the beginning of this year.

As we move forward towards the second half of the year we expect that the Fed should begin to employ some of the tools that it has begun to develop for use in its exit strategy. We would look for monetary policy tightening from the Fed probably well into the latter part of the year, possibly into the fourth quarter.

Craig Siegenthaler - Credit Suisse

Under those kind of near-term assumptions you're assuming the impact from fee waivers operating income declines from about $18 million this quarter to about $15.5 I guess in the second quarter. Given that impact, is your view of kind of normalized operating EPS in the first quarter about $0.53 versus the $0.42 you reported today?

J. Christopher Donahue

Well, I mean, you could take the waiver number and obviously if the yields have been high enough the waivers wouldn't have been there. But it's a multivariable analysis and pretty tough to isolate one, although that's certainly a visible large one.

Operator

Your next question comes from the line of Michael Kim - Sandler O'Neill.

Michael Kim - Sandler O'Neill

Just to maybe follow up on a previous question, where do you think we are in terms of the money market funds cycle and do you expect the industry to continue to lose assets until the Fed eventually does step back in and start to tighten?

J. Christopher Donahue

What we would generally expect is that there would still be outflows in money funds here over the short term. Historically, movements occur when the Fed begins to signal and people begin to think that money market fund rates will go up. You start seeing other types of movement. So that’s a little bit anticipatory.

On the other hand, in this particular cycle, it's been so long and the rates have been absolutely so low that you've already flushed out of the system a good number of the players who are interested in having a yield. So the usual dynamics may not play as strongly as you might expect going into a Fed rise.

Michael Kim - Sandler O'Neill

Then in terms of kind of the equity side of the franchise, it looks like the one and the three-year Lipper rankings has slipped a bit more recently. How much of an issue do you think that this could be once we do start to see retail investors become more comfortable moving back into equities more broadly?

J. Christopher Donahue

You always have to have excellent performance and excellent distribution in order to have all cylinders functioning. So wherever we don't have that on the one, the three and the five-year basis that's ground under repair or areas that need to come out better.

On the other hand, there are excellent positive performances in every one of our teams that give us the product that can progress in the future and I mentioned some of those in my remarks, namely the two offerings of value from our friends at Clover and Rochester, namely the dividend fund, the Strategic Value Fund, namely the afore discussed Prudent Bear Fund, a couple of [Caughman] offerings, even the stock and bond fund.

So there's a good array of products in each pod that give us a lot of optimism. I think there's either six or seven funds that have top quartile three-year records and those are the ones that have the positive flows and have the good stature for growth here in '10.

Raymond J. Hanley

Mike, I'd add the International offerings, Intercontinental and International Leaders where, of course, a lot of the industry flows are happening. Their one, three and five-year records are very strong.

J. Christopher Donahue

Thank you, Ray.

Michael Kim - Sandler O'Neill

Then just finally, kind of coming back to the recent term loan refinancing, just how much of that was driven by maybe being able to get some favorable terms versus maybe thinking about shoring up your balance sheet ahead of some potential resolution on maybe money market fund capital requirements?

J. Christopher Donahue

Well, before you get the money market fund capital requirement [I'll] answer the question, then I'll talk about that in a second. It's absolutely shoring things up, attractive rates. Our forecasts are for rates to go up, so locking in that kind of rate we were very satisfied with.

We expect to have a lot of opportunity to do things with the money and we're pretty satisfied with the amount and with the oversubscribed nature and the bank group offering expanding into 22 and having that behind us. We actually need to borrow more than this for even a bigger deal. We did not raise this money in terms of any capital requirements for the money fund business though.

Operator

Your next question comes from the line of Cynthia Mayer - Banc of America - Merrill Lynch.

Cynthia Mayer - Banc of America - Merrill Lynch

Can you just give a little more color behind the assumptions behind your waiver guidance? I think you mentioned repo rates in the 20 basis point area. What other short-term rates would influence that and what are your assumptions on those? How do you see that trending into 3Q?

J. Christopher Donahue

Well, I'll let Sue Hill talk about where we see rates going in the near, near term, the next quarter or two but to speak specifically about the waivers, we really haven't seen much movement outside of the repo rates. The process is for the rates and things like the T bills, the short-term agency paper and, of course, prime instruments to move up.

Then you have a period where, based on the duration of the fund, in the 40, 50-day range, the funds have to turn over their portfolios. That's why we're cautious about - we would expect the step down in the impact in waivers to look kind of like the way the step up in waivers looked, of course, depending on how the macro environment is for rates.

But it'll be a gradual process because first you have to see the instruments go up and then you have to turn the portfolios over.

Thomas R. Donahue

The other comment, Cynthia, is when we talk about $15.5 million is the asset levels that we have today.

Cynthia Mayer - Banc of America - Merrill Lynch

As they come off are you going to have the same split with distributors I assume?

J. Christopher Donahue

Yes.

Cynthia Mayer - Banc of America - Merrill Lynch

Can you - since the most yield sensitive investors you said have left already, can you maybe characterize the ones that are leaving now? Are they more retail folks who are leaving for higher rates at banks or are they just investors taking out money for taxes? How would you characterize them?

J. Christopher Donahue

It's very hard to give them one paintbrush and I tried to do that in my remarks that there are some that are just paying taxes. We cannot repeat this enough that late March, April people actually do pay taxes and build up money for that purpose.

Generally speaking, however, the real question that people could be asking about money funds is how come there's still almost $3 trillion in money funds at all? The real answer to that is because these customers want daily liquidity a part of cash management service. So, yes, there will be movement as the interest rates stay low.

People at various times click off and move into some other instrument. But the vast majority stay because it is an integrated cash management system and has as much, if not more of an operational overlay than an investment overlay.

So now the question is what about these people leaving right now? Again, I go back to taxes, people who came in the year-end for short term, regular cash management uses and then other things in the marketplace. So we really have a tough time saying that there's one brush to paint the whole picture with.

Cynthia Mayer - Banc of America - Merrill Lynch

Maybe if you can just update us on regulation. Do you have a sense of what the pace is on that and is this a process that will go on another three months, six months, year? What do you think?

J. Christopher Donahue

Cynthia, which regulation are you talking about? Are you talking about the big bill in the senate or are you talking about regulation on money funds?

Cynthia Mayer - Banc of America - Merrill Lynch

I'm sorry, regulation on money funds.

J. Christopher Donahue

Regulation on money funds we think has reached a threshold point because they adopted a new rule to A7. So that cleared the deck of putting out what amounts to best practices that we and others got together to put out and help the SEC come up with to A7.

So I think A7 - an excellent job on that and that took a lot of pressure off of the immediacy of enhancing the resiliency of money funds. The next thing is going to be the president's working group report.

If you know when it's going to come out then I'd appreciate knowing because we don't have any indication as to when that will happen. We understand that they will continue to mention in there that they want to study the idea of variable net asset value on money funds, which, of course, is debt for money funds, which, of course, is not good and we don't think will happen.

So the next round of money market fund regulation, I think, is pretty far off. At least there's no movement. There's no current SEC rule proposal that's out there. They asked a lot of questions the last time so that they could begin to solicit the industry's views on subjects that maybe weren't covered in that first round of rules but have not given an indication other than it will be post-president's working group as to when they would come up with something.

So it's very, very difficult for us to put a time on it. We are thankful and appreciative that the SEC did do the first round of [2A7] so that at least in this industry we can say the first and important movements on enhancing the resiliency of money funds have been accomplished.

Cynthia Mayer - Banc of America - Merrill Lynch

Maybe last question, I think - I just wanted to clarify something. I think you said that the first quarter comp included a true up. How much was that? You said the run rate for comp you thought a good run rate going forward would be higher. Right?

Thomas R. Donahue

Well, for the Q2 estimate, yes, the true up and the seasonality of these balances throughout, you end up adding to the number to get to the $65.5 million.

Operator

Your next question comes from the line of Ken Worthington - JP Morgan Chase.

Ken Worthington - JP Morgan Chase

You mentioned that 50% of the institutional sales were being sourced abroad. It sounds kind of like an impressive number. I guess maybe why are things working so well abroad and how are you accessing the institutional clients?

J. Christopher Donahue

The performance of the mandates that are winning has been excellent and, therefore, competitive. So we've been getting into finals in other places and then winning some deals. We have a pretty good group of sales people. We have a Frankfort office and the sales team here in the United States does some of that business as well.

That's pretty much how it's done. It's the old federated way of wholesalers making presentations and responding to RFPs and getting into finals and winning a few deals. It has been helpful that we've kept that Frankfort office open for over a decade now and that's kind of the headquarters over there.

Ken Worthington - JP Morgan Chase

Then maybe for Ray, the decline in revenues from fee waivers, can you give us the breakout between the investment management fee and the - what is it - the admin fee?

Raymond J. Hanley

Sure, the decline in waivers was just under $70 million in total. I’m sorry. It was $42 million of investment advisory fee and $28 million of other service fees. So the investment advisory fee portion went up by $9 million and the other service fee portion went up by $3 million. That made up the $12 million change from the prior quarter.

Operator

Your next question comes from the line of William Katz - Citigroup.

William Katz - Citigroup

Just back to the fee waiver guidance for a moment, if your assets were to continue to slide lower until you actually had a little bit of a higher nominal rate of interest rate, how does that affect the discussion here? We've been talking so much on the yield side, so I’m puzzled to see the list as [AUN]s continue to trend lower.

J. Christopher Donahue

Well, Will, essentially our money funds in normal times pre-waivers, our realization rate would have been in the 14, 15, 16 basis point range net of distribution expenses and today that number is closer to 10. So we would expect, of course, as waivers recede that that will go back up at or near its former level. But that would give you the - you could do your own kind of push pull on assets and waivers with that information.

William Katz - Citigroup

Second question, just on money market business, one of your competitors who reported earnings earlier in the week had mentioned that they continue to apply economic capital against their money market business.

I'm just kind of curious from a strategic or competitive standpoint are you getting any kind of questions from clients or major distributors that are challenging you a little bit on the mismatch and strategy around capital?

J. Christopher Donahue

Other than you using the term mismatch, the answer is no. We are not getting comments. The reason I comment on mismatch is because we think and our clients think that this business is about confidence and not about capital because money market funds are, in fact, investment products and that's just the essence of what they are.

So we have not had commentary from clients on this subject. It is a known discussion but I think people recognize that what they first want is the confidence of the product and the management of the product because relying on something to happy after something else happens is really not what they want. They're interested in daily liquidity at par. So we just haven't had that kind of push back from the clients.

William Katz - Citigroup

Mismatch maybe is a poor choice of words. I apologize for that. Second question or another question, you look back at your capital management big picture perspective in the last couple of quarters, in the last quarter you had the special dividend and it looks like you pawned it out of operations. I guess the yield on that portfolio probably would have been close to zero.

Then you roll forward and you've built up the debt at about a 5% borrowing cost. Can you sort of step back a little bit and help explain just the logic flow around the capital management and how paying a dividend with zero borrowing now, maybe doing a deal with 5% borrowing is in the best use of the shareholder interest?

Raymond J. Hanley

Yes, I'll go first, Bill. I think the dividend which we did was a view of shareholders and looking at the stock price and how are we going to reward shareholders and not being satisfied with the level of our stock price, not thinking that it reflected the earnings power and growth into the future of the company.

So how are we going to reward shareholders? We decided to do that through a special dividend. Now you come back and say, "Now what about raising capital and why getting $425 million into the company and the opportunity to do things?"

Number one, as I said before, we are attracted to the rate, locking in the five-year program was what we wanted. In the past the bank group did not really - because of the market situation - been really willing to do that. They were now willing to do that. So we signed up as you see.

In terms of taking that money and investing it and using it, we will continue to try to do that and our number one criteria we always talk about is the acquisitions and when we'll see share buybacks and, of course, we declared a $0.24 dividend, so we see continuing that too.

J. Christopher Donahue

Bill, there is an element of financial flexibility baked into this cake, too. Don't forget that the financing package we had matured in October of '11. So now it's April of '10, fine. But that package had to be addressed and it's hard to imagine a better circumstance to try and address that than the circumstance that exists right now where you have money availability, rate attractiveness and an enthusiasm by the management to want to do something on the international side.

So those are some of the features of confluence around having enthusiasm for putting this package together.

William Katz - Citigroup

Maybe we can finish that conversation offline. Just the last one, just in terms of more typical buying gross margin type discussion, so listening you talked about blocking, tackling and resounding the sounding joy. You're equity [put pay] in the United States is sort of tracking the industry plus or minus a little bit.

Is there a situation we may need to step up the investment spending to really take market share at this point in time which might come at the expense of margins to potentially build out the equity business?

J. Christopher Donahue

What do you mean by investment spending? You mean buying more portfolio managers or do you mean buying another investment operation?

William Katz - Citigroup

Well, I don't know. I apologize to be combative, but I don't know if it's branding, more comp and wholesalers, deeper set of wholesalers but it just seems like to really move the equity needle here you seem to be up against a stiff competition. I'm sort of wondering do you need to spend generically more to build that side of business?

J. Christopher Donahue

Well, we haven't looked at it that way. Let me - just to give you a summary of some of the things that have been done that have accounted for the rather impressive increase in gross sales, especially on the equity side and that has been the addition in only the fourth quarter of '08 of Prudent Bear and Clover.

It has been the revamping internally of the focus of the compensation program on the sales force where that compensation program has been restructured to more lean on getting products on platforms and equalizing the benefits of the compensation program, whatever products happen to be sold. That's only now being realized in the marketplace this year.

So we've looked at the comp and the structure. We're pretty happy with the total number of wholesalers, 186. You can go plus or minus a few but we're not looking for that. Now if you start talking about advertising or image and things, we consider that often.

But it just strikes us that for our wholesaling force we're better off spending the money on rifle shots with our intermediaries than trying to spend the $1 million a month on making waves in the marketplace through the advertising.

So you're right that it is very competitive but it is a source of positive to us that we have been able to increase the equity sales and knowing that we have these products that we think can do a pretty good job that we think we can get our gross sales and net sales of equity back positive and in numbers like what we had almost a decade ago.

Operator

Your next question comes from the line of Robert Lee - Keefe, Bruyette & Woods.

Robert Lee - Keefe, Bruyette & Woods

A couple of quick question, first, maybe looking at the equity business, I’m just curious about the stickiness of the high redemption rate. I mean, I understand that Prudent Bear can be volatile and flows there.

But if I kind of look over [the west], I mean, you demonstrate there historically you've tended to run above industry average but it seems like it's been pretty sticky last four quarters at a reasonably high rate. Is there anything in particular that is attributing to that? What kind of strategy do you have in place to try to kind of bring that down a bit closer towards the industry norm?

J. Christopher Donahue

We have looked very aggressively at the redemptions to the extent of even putting in people that their job description is to fall in love with redemptions. The thing about this business is almost no matter what you do since the single most important right in the investment company act is the right to redeem. It's very, very, very hard to change that.

Now, our historic pattern has been higher than industry average and that is correct. Part of that is because of certain funds that have suffered redemptions recently, namely the [MVT] gang and the larger [Caughman] Fund and some redemptions that have occurred in the capital appreciation fund, all of which, you look at and you say, "CapApp has been turned around in terms of the performance and the [Caughman] boys have been here before. They love their healthcare position." I certainly wouldn't be one to bet against them. We've already talked about the [MVT].

So unless Ray has more color from numbers, that's the overall.

Raymond J. Hanley

No, I think that presents it.

Robert Lee - Keefe, Bruyette & Woods

A couple questions on the regulatory funds, the first one is, Chris, in all the talk about money funds and capital requirements, is it possible to update us on what progress the industry is making on its liquidity facility proposal?

J. Christopher Donahue

The progress that we can talk about is that we are now allowed to talk about the liquidity facility. It was maybe three weeks or so ago that the ICI and the person of [Paul Stevens] in coordination with those that we're trying to work with, namely the governmental entities, went public with the idea of what this liquidity bank would or could do in broad terms.

So now this is progress because now it is out and being discussed. Basically the discussion is that it would be capitalized by a combination of monies from the investment advisors who run commercial paper funds and investments by those commercial paper funds themselves in a liquidity bank that would be either a special purpose trust company or a special bank that would invest in very, very high-grade US government securities and provide the liquidity facility and at the end of the day it would have the availability of the Fed window with its intended discounts/premiums if it needed to be utilized.

This is all within the context of the requirements of [2A7] to have 10% of your money in daily available and 30% on a weekly basis. So this is something that if needed would come in after those features. So that's all I know about it right now.

I can't give you an update as to where the regulators are on it but it seems to us to be an excellent idea that captures a lot of the flavor of what people are looking for and it's one that the industry has done a lot of work on and I think shows a lot of good faith and accurate substantive understanding of what could address issues that people are concerned about.

Robert Lee - Keefe, Bruyette & Woods

Another question on the regulatory or legal issues I guess it is. The recent Harris decision, the Supreme Court, do you see that court's decision in any way changes your different funds company relationships if they're boards or in any way is it any kind of more of a term pressure on fund companies or fund fees?

J. Christopher Donahue

The Jones V. Harris case, which was announced on May 30th was a unanimous Supreme Court decision which supported the Gartenberg Standard which has been the standard that the investment companies and their boards have been using since about 1980.

So we do not expect changes in the relationships of the boards with the funds. When you have a 9-0 unanimous Supreme Court decision supporting what's been going on for decades that's a pretty good indication that the Investment Company Act changes back in 1970 have been appropriately handled by the industry and we would expect that attitude to continue.

Operator

Your next question comes from the line of Marc Irrizary - Goldman Sachs.

Marc Irrizary - Goldman Sachs

One for Chris and then one for Tom; Chris, can you talk about obviously the safety and soundness principals in money market funds and some of the rulings that came out? You've been instrumental in shaping those and ensuring the safety and soundness of the funds.

Now that those accomplishments have kind of passed, are there clients who are less likely in the future or already have sort of voted with their feet and not as enticed by the yields that were once available in the money market funds?

I think last quarter you mentioned that there were some redemptions based on uncertainty around regulation. Could you just comment on if there are some clients who are looking at some of the yield that's no longer available in these funds going forward if that's sort of changed the way they think about money funds?

J. Christopher Donahue

Well, in terms of the safety and soundness of money funds, this is about the first, second and third most important things in money funds. It is their very existence. So it remains the critical way of looking at a money fund.

Having been in this business for 35 years, our clients in particular know that we are very sensitive to this whole subject. So that's one of the reasons that they're happy to deal with us because they're seen the performance and they understand the people and the professionals that are actually doing this business.

Now, in terms of people with recent analysis of rates, we're back to the question we talked about before where, yes, we do see some money going out and see that continuing on some pace that's pretty hard to detect and people slowly but surely, some of them look to higher rates.

But once again, I come back to the fact that when you have people calling you and telling you to leave funds open that are paying zero yield because it's an integral part of their cash management system the idea that those clients are going to move because of a yield variance is really hard to see.

So we can't tell you exactly what the top hat of that chart or that bar is going to look like bu there is certainly a large component of it that makes up the vast majority of our client base that continue to look at it as a cash management service.

If they didn't believe in the safety and soundness, as you put it, in the funds, they would have been gone one heck of a long time ago.

Marc Irrizary - Goldman Sachs

Tom, the $0.04 variance in the quarter with the application of the two-class method for EPS count, is that going to be a one-time item? Is that ongoing? If you pay another special should we just presume it's just going to reoccur?

Thomas R. Donahue

Yes, it occurs with every dividend and because we pay a special. That's why it's so big. But the portion of the $0.04 with the special and a portion of it with the regular dividend, so, yes, if we did another special dividend we'd have another thing exactly the same.

Marc, it normally rounds to a penny. This was $0.04 with the special. It was probably something like $0.03 and change and just under $0.01 for the regular dividend.

Operator

Mr. Hanley, there are no further questions in queue at this time. I'd like to turn the call back over to you for closing comments.

Raymond J. Hanley

Well, that concludes our call and thank you for joining us today.

Operator

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for participating.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Federated Investors, Inc Q1 2010 Earnings Call Transcript
This Transcript
All Transcripts