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Federated Investors (NYSE:FII)

Q2 2011 Earnings Call

July 29, 2011 9:00 am ET

Executives

Ray Hanley - Analyst

Deborah Cunningham - Chief Investment Officer of Taxable Money Markets, Senior Vice President and Senior Portfolio Manager

John Donahue - Chief Executive Officer, President and Director

Thomas Donahue - Chief Financial Officer, Vice president, Treasurer, President of FII Holdings Inc and President of Federated Investors Management Company

Analysts

William Katz - Citigroup Inc

Craig Siegenthaler - Crédit Suisse AG

Michael Carrier - Deutsche Bank AG

Michael Kim - Sandler O'Neill + Partners, L.P.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Kenneth Worthington - JP Morgan Chase & Co

Cynthia Mayer - BofA Merrill Lynch

Roger Freeman - Barclays Capital

Operator

Greetings, and welcome to the Federated Investors Management Co. Second Quarter 2011 Quarterly Earnings Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Raymond Hanley, President of Federated Investors Management Co. Thank you, Mr. Hanley, you may begin.

Ray Hanley

Good morning, and welcome. Leading today's call will be Chris Donahue, Federated CEO; and Tom Donahue, Chief Financial Officer. We also have Debbie Cunningham, the Chief Investment Officer for Federated's Money Market Group, who will give us some remarks on money market conditions and participate in the Q&A.

During today's call, we may make forward-looking statements and we want to note that Federated's actual results may be materially different from the results implied by such statements. We invite you to review our risk disclosures in our SEC filings. No assurance can be given as to future results and Federated assumes no duty to update any of these forward-looking statements. And with that, I'll turn it over to Chris.

John Donahue

Thank you, 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 the financials. Looking first to cash management. Money market average assets decreased from the prior quarter due mainly to tax seasonality in separate account assets. Money market mutual fund average assets were nearly the same as the prior quarter. Our market share remains steady at around 8.8%. Debbie will comment later on recent money market conditions, including the impact of the debt ceiling and European banks. Tom will address related fee waivers.

On the regulatory front, money funds continue to be an active topic of discussion based on comments from the SEC and the FSOC. The regulators believe that further changes should be considered and are under review. We are unable to make any predictions on any particular outcome or a particular timeline. We do note however, that the industry issuers and investors in money funds are opposed to a fluctuating NAV. In our view, there is no evidence that a floating NAV would positively impact investor redemption patterns or improve the resiliency of money funds. In fact, we believe fluctuating NAVs would have the opposite effect. Capital buffers are not necessarily responsive to the severe liquidity crisis that negatively impacted money funds and other investors in 2008. Our initial reaction to ideas like the Squam Lake capital buffer before the results of the voluminous studies necessary to adequately research such a concept with this level of complexity, is that it's probably not a practical solution. One outcome could end up being too compressed or even eliminate the spread between prime and government fund yields, which would be just another way of ending prime funds, which is not the goal of the entire operation.

We believe that money funds were meaningfully and sufficiently strengthened by last year's extensive revisions to 2a-7. And we're seeing those changes help now as we deal with the noise created around the perception of risk and prime money funds from European bank exposure. We remain favorably disposed to improvements that would enhance the resiliency of money funds by addressing the primary issue faced during the financial crisis namely a market-wide liquidity crunch.

Now turning to our equities business, we have 6 actively managed strategies in a variety of styles that have top quartile 3-year records that are well positioned for growth: Capital income, Prudent Bear, International Leaders, International Strategic Value, Kaufmann Large Cap and Strategic Value Dividend. In particular, Strategic Value Dividend strategy is well-suited for investor demand for high-quality dividend income. It continues to produce strong flows with over $1.2 billion of year-to-date net inflows to funds and separate accounts combined. The international version of this strategy reached its 3-year anniversary during the second quarter and achieved 5 stars as it ranked in the top 13% of its peer group for the trailing 3 years. This strategy, along with the InterContinental and International Leader Strategies provide a solid position in international equities with positive flows in the second quarter and lots of room for growth.

Overall, equity fund net flows were negative in April and May but positive in June and slightly negative here in the first 3 weeks of July. Flows in equity separate accounts were negative mainly due to a $315 million redemption from an absolute return mandate, an area where we recently changed portfolio managers. Net sales of the Strategic Value Dividend strategy were solidly positive. And we saw another quarter of lower net redemptions in the MDT Quant strategies for SMAs, which improved from about minus $300 million in Q4 to minus $200 million in Q1, minus $77 million in Q2.

On the Kaufmann Fund. The Kaufmann Fund performance improved in the second quarter as the fund ranked in the top third of its Lipper category similar in Morningstar. The Kaufmann Large Cap Fund ranked in the top decile of its category and the Small Cap Fund ranked in the top 14% for the quarter. The core Kaufmann team and investment process remained intact. The team's approach is to focus on high-quality growth companies and use extensive proprietary research and a "bottom's up" style with high conviction and low turnover. Obviously, a long-term approach. So that if we looked at the 22-rolling, 3-year performance periods beginning with 1986, the fund was ranked in the first quartile 14 times and was ranked in the fourth quartile only 4 times, 3 of which were in the '98, '99 and 2000 period. Interestingly, past periods of underperformance were followed by substantial outperformance.

Turning to fixed income. Fund flows were negative in April and May and then turned positive in June. These flows are positive through the first 3 weeks of July led by the Total Return Bond Fund and the return to positive muni fund flows. During the second quarter, Total Return Bond Fund showed modest outflows due largely to a couple of significant asset allocation changes made by investors in April and May that combined for about $360 million in lumpy redemptions. Fund returned to modestly positive inflows for June and into July. We also saw reduced outflows in municipal bond funds during the second quarter and inflows in July, as I mentioned. The strategies with positive second quarter flows include Total Return Bond -- Total Return Government Fund, high yield, international and stable value. We also add solid inflows into 2 recently launched funds, our Federated Unconstrained Bond Fund and our Federated Floating Rate Strategic Income Fund.

Turning to investment performance. Looking at quarter-end Lipper rankings for Federated's equity funds, 27% of rated assets are in the first or second quarter over the last year, 38%, 3 years, 24%, 5 years, 80%, 10 years. For bond assets, Bond Fund assets, the comparable first and second quartile percentages are 29%, 1 year, 50%, 3 years, 70%, 5 years and 75%, for 10 years. Looking at Morningstar rated funds, 25% of rated assets are in the 4 and 5-star products and as of 6/30, and 82% are in 3 and 4 and 5-star product. At quarter end, we had 10 equity funds with Morningstar top quartile 1-year performance, including International Strategic Value Dividend, Capital Income, Asset Allocation, InterContinental and International Leaders Funds along with several MBP funds. We also had 7 equity funds with top quartile 3-year records and 7 funds with top quartile 5-year records. As of July 27, managed assets were approximately $349 billion, including $265 billion in money market, $31 billion in equities, $53 billion in fixed income including our liquidation portfolios. Money market mutual fund assets stand at about $237 billion. So far in July, money market fund assets have ranged between $237 billion and $241 billion and have averaged $239 billion.

Looking at some of our distribution highlights, year-to-date, gross sales of equity funds and separate accounts on a combined basis increased about 19% compared to the same period in 2010. We continue to invest in distribution capabilities and are in the process of adding 12 new sales personnel to the broker-dealer sales division. We are encouraged by sale success in this area over the last 3 years. Since 2008, broker-dealer sales have increased from approximately $6.4 billion to $12 billion. And the number of advisors doing significant business with us has increased from 29,000 and 35,000. The added resources will enable us to penetrate additional mid-sized broker-dealer firms.

We've also recently hired 3 new Consultant Relation Reps in our institutional area to broaden our reach within the institutional consultants and plan sponsors. We are also modestly investing in advertising with an initial focus on the Strategic Value Dividend strategy. We were in print and Web campaign advertisements over the last couple of months. We've been pleased with the results and plan to run additional ads later in the year.

Regarding acquisitions, we remain focused on developing an alliance to further advance our business outside of the United States. As we work on this, we are also having success abroad for cash management. During the second quarter, we added $2 billion in new business from a large offshore client. We're also working on 2 new money market portal opportunities in the U.K. and have received approval in Ireland for our sterling-denominated money fund that will launched in Q3. In the U.S., we're actively seeking consolidation deals. We recently completed the 2 deals we announced last quarter, with the EquiTrust Funds and the Tributary International Equity Fund, adding about $600 million in new assets in a variety of strategies. Now for the financials, I'll turn it over to Tom.

Thomas Donahue

Thank you, Chris. And as Chris mentioned, conditions for money market funds continue to be challenging in the second quarter and into the third quarter here. Money fund yield waivers reduced pretax income by $19.4 million for the quarter compared to $13.1 million in the prior quarter. The line items impacted are covered in the press release. Yields decreased during the quarter which led to waivers exceeding the April calculation based on then current market conditions. Yields have generally trended lower as the market deals with the debt-ceiling issue and concerns over European debt. Based on recent market conditions and asset levels, these waivers could reduce income by approximately $23 million in Q3 for Federated.

More recently, we've seen an uptick in rates for repo and T-bills, which impact waiver levels in the government funds. Expect these rates to move off of the extremely low levels in the first couple of weeks of July as we move towards some resolution of the debt-ceiling issue. We have seen some upward movement over the last couple of days. And Debbie will review this in a few minutes.

Looking forward, we estimate that gaining 10 basis points in gross yields will likely reduce the impact of these waivers by about 1/3 from the current levels. And a 25 basis-point increase would reduce the impact by about 2/3. Looking at total revenue, the decrease from the prior quarter was due to higher money fund waivers, partially offset by one additional day in the quarter and by higher equity and fixed income-related revenues. We continue to properly manage expenses and continue to invest for growth. The operating margin was higher in Q2 than in the prior quarter, calculated before the litigation settlement expense booked in its first quarter. The operating margin was also higher compared to Q2 2010, calculated before unusual items related to insurance recovery and impairment charges.

We amended and restated our term credit facility in the second quarter to revise the facility contained to $200 million revolver to replace the previous facility, which was scheduled to expire later this year. On the term portion, we were able to lower interest expense and we expect to save about $8 million in interest expense over the life of the facility. We expect interest expense in the third quarter will be approximately $3.6 million, down from $4.2 million in Q2.

Looking at our balance sheet, cash and marketable securities totaled $294 million at quarter end. This, combined with expected additional cash flows from operation and availability under present debt facility, provides us with significant liquidity to be able to take advantage of acquisition opportunities, as well as the ability to fund related contingent payments, share repurchases, dividends, new product seeds and other investments, capital expenditures and debt repayments. Before we take questions, we'd like to have Debbie comment on the recent market in money market world.

Deborah Cunningham

Thanks, Tom. I thought I'd cover just 3 quick topics: our outlook and what's happening from a short-term rate perspective, what's the current state of affairs from a European bank exposure perspective and then the most -- the newest item of concern is that the debt-ceiling negotiations for the U.S. Treasury.

From a rate outlook perspective, if you look at the yield curve for money market securities today versus a year -- or a quarter ago, it's relatively steeper but it's steeper for the wrong reason. It's steeper because the shortest end of the yield curve has actually lost a few basis points in yield. So one to 3 months is basically 2 to 3 basis points more expensive with lower yields than where we were a quarter ago. While the back-end of the yield curve, which nobody's really buying too much at this point, 6 to 12 months has remained flat. Our expectation from an outlook perspective for Fed tightening has been pushed into 2012, and that's reflective of the slower growth that we've been experiencing from an economic perspective. We do continue to believe though, that there will be some yield curve steepening in the second half of 2011, with the back end of the yield curve backing up to some degree and more opportunity in the marketplace to buy some better relative value positions as the second half of 2011 proceeds.

From a European bank perspective, a couple of things have happened in the recent times. The stress test for those banks by the EU has been completed, with some amount of success afforded to that completion. The package for Greek debt restructuring has also been reached and although it is not a quick fix in the marketplace, we never thought it would be, this was going to take up to a decade to proceed smoothly and get completed. But it has received fairly good market impact. And by that I look at the spreads that we see on the European banks and again, we use 22 different banks, highest-quality banks within the eurozone, high-quality ratings diverse underlying the -- of their loan portfolio and effectively these banks have stayed the same from a spread perspective in the marketplace to widening maybe 2 to 3 basis points.

From a Federated prime fund exposure, we have currently and will still maintain, are still maintaining, somewhere in the neighborhood of between 40% and 45% of our prime funds to exposure with these European banks. Again, we have no direct exposure to the Greek banks but the European banks that we use do have some exposure on a secondary basis to the sovereign Greek nation. And again, we're continuing to be comfortable with the ownership of these banks. We post that on our Website on an every 2-week basis so you can get the most quarterly information there when you're looking for it.

The third item is the debt-ceiling issue and the potential concerns in the marketplace about a default downgrade and then sort of looking at just the market quick conditions and the liquidity in the marketplace. From a default perspective, we think this is a very remote likelihood if we require it if it did actually did happen from our perspective. Fund Board of Directors action, the -- we would need to make as an advisor, a recommendation to the Board of Directors based on the underlying credit quality of the nation itself, market valuations, the fact that this is not an insolvency issue but rather a willingness to pay and a political theater issue. All of those, at this point would lead that if we had to come to such a situation, our recommendation would be to maintain the ownership of these technically defaulted instruments at that point. Again, thinking that this is a very remote possibility.

On the other side of the equation is the downgrade. There's been lines drawn in the sand from the rating agencies as to what to expect from a debt-cut perspective in order for the AAA ratings to be maintained. We think this is less remote, obviously than a default, but still we don't think this is probable. First thing to note is the downgrade is on a potential basis for long-term ratings only, not short-term ratings. So nothing would be affected from the short-term ratings perspective for the securities that are held within money market fund. What this would do is basically raise the level, off which spreads are measured.

Treasury securities are still the largest with the most volume, most liquid, as highest quality instruments in the world, not surpassed by Johnson & Johnson, not surpassed by Wal-Mart and some of the others in the marketplace that have been noted. And certainly not surpassed by bank deposits where, in fact, the backing of those banks comes from the U.S. government. So these would still maintain their liquidity in the marketplace but with the price volatility, that would be a little bit more stringent than what it has been in the past and at a base level off of which the rest of the market would price at slightly higher than it is today. From a Federated fund perspective, despite the outlook for negative potential downgrade for the long-term ratings for the U.S. government debt, the Federated money market funds have been affirmed with their AAA ratings. So even if the U.S. debt was downgraded to the AA, double AA+, AA-, whatever would happen to be, at this point, the AAA ratings for Federated funds would be maintained.

From a market conditions perspective, we're looking at Treasury Bill Rates that are actually finally paying us something in the context of this negotiation and the extended time period that it's taking. So and perversely, it has a little bit of a positive effect overall on the underlying yields of our portfolios, the treasury curve which has been flat to negative out to 3 months, just a week and a half today -- a week and a half ago, now stands anywhere between 9 and 15 basis points. So we're actually getting paid for taking the risk of ownership of treasury securities during the months of August, September and October.

Lastly, from a Federated funds perspective and a flow standpoint, you noticed on the July assets, the assets from money market funds are not markedly changed, and we are not seeing clients moving with negative outflows due to these issues. A few are, but certainly not in any widespread form and not in any way, shape, or form reflective of any kind of a problem. The liquidity in these products is high, the weighted average maturities is low, positions ourselves well for what we think is the second half, steepening of the yield curve. And it provides ourselves with a lot of comfort for our shareholders in the context of liquidity that might be needed. With that, I'll turn it back to Ray.

Ray Hanley

Yes, we'll open up for questions now, please.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from Craig Siegenthaler with Crédit Suisse.

Craig Siegenthaler - Crédit Suisse AG

I understand that you're limiting your comments around regulation. However, shouldn't the risk of certain regulations be impacting overall capital management decisions in the near-term? And I'm just kind of relating this question to your comments on M&A and also kind of the lower levels in that cash you hold versus some of your peers.

John Donahue

So in terms of M&A, the strategy that we have of doing both consolidation deals and international deals, we do not feel ought to be impacted by regulatory ideas. We've been looking at these ideas for several years now and it is a constant situation, where because money market funds are not perfect, people keep coming up with ideas. And there's a lot more ideas that people could come up with, that will still be studied. And so I would say that it would be wise for somebody like Federated to not allow that to restrain us from moving forward. And we don't think they're going to be doing anything that would kill the money market fund business in any event. All of the ideas are always couched in terms of study more and then even the FSOC recently mentioned things like, in order to increase stability, market discipline and investor confidence, things should be studied. And I think when the verdict comes in of all of the studies, you will find the money market funds standing there, though they are in there imperfect position, withstanding the resiliency, demonstrating the resiliency they have to customers and in the marketplace. So that would be how I would look at the issue of money market fund regulation versus M&A activity. I'll let Tom handle the other part of your question.

Thomas Donahue

Craig, right now, if you look at our balance sheet, we really have net debt of somewhere around $100 million and we have a revolver availability and we certainly have an excellent bank group that is ready, willing and able to increase our debt levels if we need to, for an acquisition or for any other reason that you might think. So having flexibility is one of the things that we want to maintain here and we look through and you know we've paid special dividends in the past. And we've purchased shares back, larger at sometimes and smaller at other times. And we will factor all those things in with what's going on in today's environment.

Operator

Our next question comes from Michael Kim with Sandler O'Neill.

Michael Kim - Sandler O'Neill + Partners, L.P.

First, just to kind of follow up on the regulatory environment. Chris, I understand you don't think floating NAVs are the answer, but it does seem like the regulators are leaning toward instituting some incremental changes. So just be curious to get your take on what proposals maybe seem more likely now that in the proposed liquidity bank doesn't seem to have all that much support?

John Donahue

Well, it's very, very hard. As I said, there are much for us to make a judgment about which one of these things can work when we don't initially perceive their workability. They didn't like the sort of polite capital ideas that Fidelity had with 40 or 50 basis points of buffer. They didn't like the liquidity bank, which took care of the major problem that occurred in 2008, namely liquidity of the whole system. And so they get down to ideas, which have not shown themselves to be workable. Several percentage points of capital is neither economic nor viable in terms of maintaining the existence of prime funds. So it's really hard for me to try and say, oh, which one of these things is ahead of the others. If you do however, look at some of the phrases they've used, they talk about something called deterrence to redemption. I don't know what exactly they mean by that, that's a quote out of FSOC. But if what they are talking about are some pretty legitimate ideas that we think could work, for example, the way we did the Putnam deal back in the day, was that the Putnam board decided to hit pause on redemptions for a week and then turned the whole fund over to us. And there was plenty of liquidity in the system because the Fed opened up the windows to buy good paper. So notice there was no credit maneuver here, it was all on liquidity. Well, if you give the board the right to do that without forcing a liquidation, that would be an interesting one. Another one on that would be, well what about redemption in kind, it's been discussed many times. And there's an example of a fund, the AMR fund, who basically said they were going to do a redemption in kind and that ended the redemptions. I don't know if that's what they have in mind, or not. And one other idea which was put out early on, that had to do with this, was to simply say if you run into reserve fund, then take the 3% and set that aside and give everybody else daily liquidity of par on the 97% of the fund that's there. And proceed down that road. And maybe that's a, what they mean by deterrence to redemption. But at this point, there's a lot of work that has to be done if they're thinking about doing the things that Squam Lake has been talking about.

Michael Kim - Sandler O'Neill + Partners, L.P.

Okay, that's helpful. And then maybe a question for Debbie. Doesn't sound like it, but are you maybe repositioning your money market fund portfolios just to get more liquid in front of a potential step-up in redemptions related to the issues here in the U.S. and then presumably, that would put some additional pressure on yields which could push the waivers even higher? So just curious to see if you think that dynamic is playing out?

Deborah Cunningham

Well, we have become more liquid. You'll see higher overnight and 7-day liquidity positions within our portfolios. As well as shorter weighted-average maturities, which is also reflective of that additional liquidity. Not so much because of concern out of shareholder redemption, but it plays nicely into sort of our strategy of thinking that later in the year, we're going to see better yield curve opportunities and have better relative value decisions that can be made at that point. What is actually also kind of interesting at this point when I was mentioning what's happening from a Treasury Bill perspective, a lot of the reasons why we weren't investing and there were periods of time during the month of July when we actually just had cash in our government portfolios because all that was available to buy at that point in time in the marketplace for the duration of securities that we were looking for, were at 0 to negative yield. So it seemed like less risky of a strategy to just simply leave it in cash. That is not the case with today's portfolios. And that's a reflection of the fact that many who are sitting on the sidelines or were in our market from a cash perspective have left, as such when those investors have left the marketplace, yields on Treasury and repo securities have started to lift. What had been overnight Treasury and mortgage-backed repo rates of one in 3 basis points, pretty consistently, during the month of June and early July, turned into something that's more like 9 to 15 basis points. What had been 0 to negative yields on 3 months and under Treasury Bills are now anywhere from 9 to 15 basis points. So as I was saying before, a little bit perversely in this case, our liquidity position and our shorter weighted-average maturity, which generally speaking in a market that is not yet experiencing a rising rate environment, would as you ask, cause rates to be lower, cause yields on the funds to be lower. In fact though, due to market conditions that are current, that's not the case. You'll have seen, if you looked at our reported deals over the course of this week, they've been basically rising each day.

Michael Kim - Sandler O'Neill + Partners, L.P.

And then just a final question for Tom, could you just talk about the economic impact related to some of these initiatives in terms of hiring new sales people and maybe the pick-up in advertising?

Thomas Donahue

Yes, the -- if we --it's more than just the salespeople. There's some back-office people that go along with that. Probably for the next year from now, that's roughly independent on when we're able to fill them. That's somewhere around the $2 million cost item. So when they're fully in, it's roughly a $3 million per year number. The advertising, probably for the rest of the year, will be somewhere around $1 million or so.

John Donahue

Which is about the same run rate that we were at in the first half of the year, so.

Operator

Our next question comes from Ken Worthington with JPMorgan.

Kenneth Worthington - JP Morgan Chase & Co

Can you talk about the decline in the amortization cost this quarter, the amortization the deferred commissions fell meaningfully, and I know the trend has been down, but it fell a bunch more in 2Q. And then on the amortization of intangibles, that fell a lot too. I think in 1Q you adjusted SunTrust, but it seemed to get you back to kind of the run rate where you've been for the last couple of years, so color there would be helpful too.

Ray Hanley

Ken, it's Ray. On the deferred sales commission amortization, as you know we did financing arrangements there and they had defined lives and one of the tranches from that past financing rolled off, and so you can go with that new number as a run rate. And on the intangibles, we also completed amortization on an acquisition-related intangible, so that rolled off. And then the other factor was that SunTrust in Q1 as you pointed out.

Kenneth Worthington - JP Morgan Chase & Co

Okay. Great. Thanks. And then on the fee waivers, the noncontrolling interest that had a pretty big impact this quarter, so what is the nature of the noncontrolling interest and it more than doubled from last quarter even though kind of the gross revenue and distribution impact was kind of less than 25% each, so why are the proportions off so much?

Ray Hanley

The noncontrolling interest, essentially, is similar to the way the distribution expense would work in that if we're not collecting fees then we would have a lower distribution expense and we would have a lower distribution through the noncontrolling interest line item. So it's really the same dynamic. As to the proportions, it has to do with the underlying asset mix that would feed that noncontrolling interest line, being weighted more to government product. And so it's relative lower yields, it would've pushed that up a bit. But it's the same kind of dynamic as you see above the line.

Kenneth Worthington - JP Morgan Chase & Co

Okay. And then I guess lastly, maybe for Debbie, how are the money market funds performing? The reason I ask is, I think in the last quarter you'd kind of talked about a view where in a quantitative tightening would begin -- could begin in 3Q, reverse repos in 3Q through tightening by year end. I guess does that view actually have an impact on the way the money market funds are invested? And I don't know how quickly things can be repositioned, but did the view have an impact on performance? And is that -- is there any impact from this? I guess I'm kind of fishing on just how performance is in these funds?

Deborah Cunningham

Sure. If you look at our muni and our prime funds, they're all on average in the top quartile performance. Our government funds are probably in the top third, slightly lower than the prime and the munis. And that's simply a reflection of less opportunity in the marketplace and less possible items for them to actually invest in at this point. The yield curve has been extremely flat. And so whether you are at 30 days, 40 days or 50 days, didn't too much make a lot of difference on a performance basis during the second quarter. We think that in the second half, it will start to make a little bit of difference. We are shorter, as I said, at this point and have what I would call left some powder dry with the expectation that although, as I said, we pushed our outlook for Fed tightening into the 2012 time period. And along with that sort of the quantitative tightening cycle beginning, but we do think the anticipation of that in the context of a continued growing economy although on a slower growth path, we'll start to see some yield curve opportunities with the buy -- a bit of the back end of that yield curve steepening out to some degree in the second half and giving us a little bit more opportunity for that short paper that we have in there that we'd like to place further on the curve but just don't feel like it's quite right on an opportunistic basis. The outlook though really has not caused us any problems from a performance basis, the funds haven't been penalized in that form.

Operator

Our next question comes from Roger Freeman with Barclays Capital.

Roger Freeman - Barclays Capital

I guess I wanted to just come back to the rates in the money market space for a second, just trying to understand a couple of things. On the one hand, you're talking about the yield having moved lower in the third quarter and guiding the higher waivers. But just -- the T-bills are higher, and I was just looking at LIBOR too, 3 months and overnight, it's basically flat 3Q to 2Q. So wondering how does dynamic shake out to a down?

Deborah Cunningham

Sure. What we're giving you with current market rates in short-term bill market conditions and overnight repo conditions, we have not used for our projections for third quarter waivers. We've used more of what we saw at the beginning of July, the beginning to the middle of July. This is recent, this is over the course of the last week and a half where we've seen short-term and treasury rates start to move north. And even LIBOR starts to tick up even just fractions of a basis point at this point but starting to move at least in a higher direction. So if this holds, you'll see the yield start to go upwards and be reflective of those short-term rates. If, in fact, this is only a result of uncertainty in the marketplace at this point in time with regard to debt negotiations and the lack of a budget deal at this point and when that in fact occurs, if you see those levels go back down again, then you'll see the projections of the waivers that they see. And today, it's completely realistic. So it really is a reflection of what are very, very short-term conditions right now vis-a-vis what is potentially likely if -- once the uncertainty in the marketplace is taken away.

Roger Freeman - Barclays Capital

Okay, that's really helpful. And then actually, when -- like -- so when do you make a decision as to whether to pull back on fee waivers, right, because at some point, you make a business decision as to do that. It's not an automatic flow through, so you would have to believe that it's -- there's some persistence to this?

Ray Hanley

Remember how we've phrased this to make sure that the yields on the money funds don't go negative.

Roger Freeman - Barclays Capital

Right. So I mean, it really works like that, that you will just keep it -- at whatever, 0 or 1 basis point, whatever they're at now and to the extent that they're going to rise higher than that, you would just take every extra differential?

Ray Hanley

That's how we've done it so far.

Roger Freeman - Barclays Capital

And then I guess with respect to the sort of flows in money markets, there's been all this press about money market funds dumping T-bills and actually looking at the past week of flows, $35 billion in outflow, and $27 billion was from government funds. Is that -- so two questions there: One is, is the reason that's happening because more of the investor perceptions and funds not wanting to hold these from a PR standpoint because the U.S. debt would actually get downgraded something like 6 notches before it's not Tier 1 investments or something. And why aren't you seeing that? Because you said, you're not seeing redemptions?

Deborah Cunningham

If you look at our performance on a flow basis, I talked about our performance on a rate basis. But if you look at our performance on a flow basis throughout all of 2011, it's been better from an industry -- than an industry perspective. I think that at this point, our institutional clients and our knowledge of them and their knowledge of us is very high. We've provided a huge amount of communication and information to them over the course of these issues that have been sort of prominent in the money markets for all of 2011, as I said, starting with the immensely low rate environment, moving into the European debt situation, now focused on a pretty much centric basis at this point right around the debt negotiations and treasury securities and the potential downgrade to those. So I think our ability to communicate, inform, provide feedback to our clients has really been extremely helpful over the course of these, what are, somewhat volatile times. And would continue to kind of look for that same sort of performance from a flow perspective vis-à-vis the market going forward.

Roger Freeman - Barclays Capital

Got it. Okay, lastly, Chris, do you think that -- I mean, to the extent that if we had some kind of stress in the system resulting from all this hoopla around the debt ceiling that could actually bolster your case? And assuming that the money market funds manage it effectively to bolster your case around a 9-inning incremental regulatory reform, that, that could maybe win some play with regulators?

John Donahue

The answer to that is yes. I think you already have seen it for 40 years of withstanding a lot of stuff in the marketplace. And I believe that money market funds came through the 2008 crisis very, very well, though dented. And I think they came through very, very well and are coming through very well. All the noise was associated with the Greek and the European situation. And I think when we look back on this, whenever we're able to look back on this, on the debt ceiling issue, that you will find the same thing. And part of the reason for that is, the underlying resiliency of the funds themselves coupled with the desire of the investing public to use these funds for their cash management purposes. And these are 2 powerful ingredients in helping the overall economy.

Operator

Our next question comes from Bill Katz with Citigroup.

William Katz - Citigroup Inc

Just want to come back to the duration versus yield discussion again. So if you were to get some kind of normal relief, if you will, from debt ceiling passage or whatever, why is your assumption that yields would continue to back up? I'm just trying to understand that -- I guess what I'm looking at is if you're shortening your duration against the yields you're not catching it now, the reverse happened to you in the fall and therefore you could actually have a worse fee waiver outcome than you're anticipating?

Deborah Cunningham

I think there's 2 answers to that: The first is just of overall economic outlook. We don't think we're in a double dip type of recessionary environment and we do think, although as I've said before, growth will be slower on an economic basis in the second half. We still think it goes forward. And as such, when the market starts to realize that and continues to focus on it, yields will -- the yield curve will become a little bit more positively sloped. The other side of the equation, what has really been problematic for money market funds especially in the second quarter and even to some degree in the first quarter of 2011 was huge amounts of cash sitting on the sidelines and waiting for certain situations to play themselves out before they went back into their natural marketplace. Hedge funds, sovereign debt investors were -- for a large part of the first half of 2011, squarely sitting in the repo and the treasury marketplace, creating more demand for a supply that is less and less from the investment banks and from the dealers in the marketplace. So it was simply a supply-demand thing where the demand was much greater. Once the resolution of the debt ceiling goes forward, those investors go back into those -- their natural marketplaces and get out of our cash markets, which causes that imbalance on a supply-demand basis to go back to normal. And although we may not have the elevated rates in treasury that we see today out to 3 months, 9 to 15 basis points, we should not see the 0 to negative basis points that we were seeing for much of the months of June and July.

William Katz - Citigroup Inc

Okay. So, Tom, let's look back to your guidance here a little bit, if we sort of stay in a more static environment, is your fee waiver assumption here overly negative then, relative to this discussion?

Thomas Donahue

Do we try to put a number in there? We argue about whether we even should say a number, Bill, and we run all kind of different models and pick -- but we know what July is, okay, and July is pretty ugly. If you almost multiply July, you get pretty close to our $23 million number, but we have a little less than that because we think things are going to improve. Is our number optimistic or pessimistic, I don't know.

John Donahue

What we tried to do here is, in looking at the over/under, is to pick exactly the middle. So on today's call, the only number we can give you is the number we have and we can't say we're over/under. Now if you ask me in a month if I'm in a conference, and then I'll say, well I'm over, well I'm under, that kind of a thing. But as of today, that's our best guess given those assumptions that we've made. And everybody is welcome to have their own opinion on this as well. And I mean that seriously.

William Katz - Citigroup Inc

There's just one last one for me. Thanks for taking my questions. It's a big picture question. Chris, if you look back in the history of your company, I was doing this, this morning, over a decade, if you strip out really the outside impact of '07, '08 in terms of the money market lift, your earnings have basically been dead flat. And I'm sort of curious, what's going to be the callus or what's the backdrop necessary to see a more competitive rate of earnings leverage from here?

John Donahue

The earnings are an important ingredient in the future growth of Federated, no doubt. And there are a couple of things. One is obviously, and then I'm going to set this aside real quick, is the restoration of the waivers. Okay. And at some point, rates will go up and that's now been put off. Even Debbie thinks it's '12 fine. Now, the reason I've spent so much time in my remarks on our regular core equity and fixed business is that we think we've got a lot of good mandates that we're betting on. That's why we're putting more salesmen on the field. And we think it is going to be a good, steady, growth and restoration of positive flows in SMAs and direct sales and in the broker-dealer area. So that is something. It doesn't qualify, I think, in the way you're talking about in terms of an immediate catalyst, but that's what we're doing for the long haul. That's the story I'm trying to get across here. The other thing is that we are determined to continue to find something on the international side, which we think will help the overall effort to growth and how you all will look at it in terms of us scoring meaningfully on international assets, which help the overall valuation and obviously, have to add to earnings. So I would -- to summarize, growth in restoration of the Money Fund business continue to repeat the sounding joy as we've gotten some excellent models and work in the equity and fixed income area and the international acquisitions that we continue to look for.

Operator

Our next question comes from Allison Heffernan [ph] with Keefe, Bruyette, & Woods.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

It's actually Rob Lee. Maybe shifting gears a little bit to investment fixed-income business, and I apologize if you mentioned this earlier, I may have missed it, but do you have any kind of commentary around kind of RFP activity pipelines within the fixed-income business, institutional business?

Ray Hanley

Yes, Rob. It's Ray. In terms of RFP activity, it's stayed about the same in Q2 as Q1. And both of which would have been elevated running in about 1/3 higher rate than what we saw through 2010. So I'd say our RFP activity is heightened from a pipeline standpoint. I'd say that we're in $100 million range. We had some funding in Q2 that was masked by some of the other things going on with the redemptions that we talked about. But the pipeline at this point, we're hopeful that, that will pick up just given the RFP activity and the records that we're dealing with there.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Right. Great. And I'm maybe just curious, Chris, you talked earlier in the call about adding some personnel to the marketing franchise in the broker-dealer channel and what not. You talked a little bit about your existing broker-dealer penetration. I mean, have you seen it -- is it -- how maybe you've seen the change in the last year or 2, is it pretty concentrated within 1 or 2 large franchises? Just trying to get a little more granularity on kind of where you stand and...

John Donahue

Overall, the sales have about doubled from $6 billion and a fraction to $12 billion. So overall, it's done well. Is it concentrated? That is concentrated in maybe the top 10 or so of the broker-dealer community. And so, what you're seeing when we're talking about putting on 12 new sales individuals in the broker-dealer is, you're seeing basically a contraction of the sales area that the individuals can call on based on who they can actually see. So we're creating new sales territories, and that's why I mentioned that this then gives a whole new gang of individuals, a whole new gang of opportunities in the smaller brokerage firm, midsize-type brokerage firms, again based on focus. So we're building off a business model we think is working and it is concentrated in the largest dealers. But then this sets the stage to get to other dealers that we think we can do an excellent job with. And that's why I mentioned the fact that we've gone from calling on or having FAs 29,000 to 35,000, and we think we can increase that. I mean, you're dealing with about 125,000 FAs overall, depending on how you look at them, whether they are full time or part time and how much business. But there's a lot more that can be done. So that's what we're looking at.

Robert Lee - Keefe, Bruyette, & Woods, Inc.

Okay, thanks. Maybe one more question for Deborah. You mentioned earlier that -- I think, you attributed your ability to sustain better relative flows or asset levels in part to your experience and relationships with your clients. But, you know, when you look at -- that the industry has had some outflows last several weeks, year-to-date, is there anything you could point to as maybe about your business mix that you think is maybe a little bit different from what the kind of broader industry is? I mean, that maybe help account for that? I guess if you look at the industry data, it's institutional products as opposed to retail products that are suffering most of the outflows, and you do have a fairly large amount of kind of retail-like products I guess through third-party distribution. Is that causing your flow picture to be relatively better as well?

Deborah Cunningham

We call them institutional products, but you're absolutely right. Each institutional customer has, on an underlying basis through their distribution channel, many retail customers underlying. So I think that, that in fact probably does have a very positive impact overall on our flows versus our competitors. When you think of institutional business, generally you think of corporate treasurers or some sort of state or municipal treasurers that are a single client controlling a single large sum of investment cash. In fact, when you look at our -- and don't get me wrong, we have those clients also, but generally speaking, the typical institutional base that we have is much more diverse if you will on an underlying basis from the third-party distributors that we use.

Operator

Our next version comes from Michael Carrier with Deutsche Bank.

Michael Carrier - Deutsche Bank AG

First, maybe a question for Debbie and Chris. Just given the whether it's headlines or maybe eventual pressures on sovereigns, banks, in the money market area, are you seeing more demand -- I know the market's a lot smaller, but more demand for the corporate side at prime? And then second, if we do get a downgrade or something worse, does it bring up more pressure in the industry and maybe not for you guys because all along you've done relatively well versus peers, but there's always some players that may not be as savvy, and then the regulatory calls for change start to ramp up again?

Deborah Cunningham

Sure. First of all, let me address the second part of the question first. In the -- again, possible but we still think fairly unlikely event of a downgrade of some of the rating agencies for the long-term section of U.S. government debt, to some degree that might perversely be helpful. And again, I know that seems kind of crazy, but there are 2 reasons why I say that: Number one, I mentioned effectively that doesn't take away the status of U.S. government debt as the bellwether, the slight quality instrument, the largest volume, highest quality, most diverse, most offered, most sold instrument in the world. It's still become, it is still the most liquid instrument in the world. And whether the AA or AAA rated, it will maintain that status. As a AA rating though, it maintains that status with a slightly higher yield component. So we are able then to buy those treasury securities that's something that's slightly higher in yield. We don't have -- there's nothing on a mandated basis from a regulatory perspective nor from our prospectuses within those products that say we have to buy only treasury bills that are AAA rated. It just says we have to buy treasury securities, so that doesn't affect what we can buy and in some way, shape or form, it could actually increase the yields of those instruments. The other side of the equation is, we do have -- there are some customers in the marketplace that do need AAAs. It's part of their investment policy. It could potentially be part of their regulatory requirements. And as such, if the treasury bill no longer meets that AAA requirement, as I mentioned before, our money funds are still rated AAA. And they will maintain a AAA even without a AAA rating for the underlying holdings of treasury securities. So to some degree, the money fund will become a choice for those who potentially were using direct instruments themselves. So again, I'd certainly -- a downgrade is not something that we would welcome, look forward to, think as a high likelihood on a probability basis. But there are some positive outcomes and consequences that could be as a result of it. Back to the first part of your question, when you're talking about the differentiation between sovereigns and corporates and financials in the marketplace and are people looking more towards the corporate side of the equation, I do think there's a couple of different things on a dynamic basis that are working there. First of all, there are more corporates in the marketplace, and although we're not growing very quickly from an economic perspective, we are going forward on an economic basis. And if you just look at sort of earnings in the corporate sector, they've been vastly positive, and the credit metrics of those institutions have actually been improving. So they have more need on the customer and a growth basis underlying to actually borrow in a short-term market for their working capital purposes. So there's an increased amount of supply in that type of paper. So I think that there's more to choose from than there may be was 2 years ago when the U.S. was in a recession. The other side of the equation though is, you have to think, you have to know, it maybe is not intuitive, but you have to know that if the U.S. suffers some sort of a debt downgrade. Wal-Mart suffers in some way, shape or form too. Johnson & Johnson suffers in some way, shape or form to. Exxon Mobil suffers in some way, shape or form too. So it's not a safe haven that takes the place of what would be a downgraded U.S. Treasury security at that point. It would likely also have some flow-through effects to those corporates, and potentially cause a reduction in what they need from a short-term financing perspective. But right now, they're doing well from a credit, quality and analysis perspective. And in such an economic situation that we're currently in, they're needing a little bit more funding. So those are those dynamics are positive, but I don't think it's a replacement in any way, shape or form for what happens or what we use U.S. government debt for in our portfolios.

Michael Carrier - Deutsche Bank AG

Okay, thanks. And then, Tom, just on the investments, makes sense, given some of the traction that you've been experiencing on the long-term side in terms of equity and fixed income. I guess just given the environment, how do you guys balance? There are some firms that are starting to pull back a bit, you know, just given the weaker growth flows into the industry have been a bit softer. So just how do balance that? Are there any areas where you can pull back if the growth trajectory here, the inflows in the industry, do start to weaken?

Thomas Donahue

Yes. Mike, I think what has happened around here is, the last couple of years, we did pull back and we've relatively maintained that although we've invested with a number of new products, and we continue to invest in technology and we're doing this expansion of the broker-dealer side of things and continue to replace people when we need them. So we're staying in there and continuing to invest in the business. If you looked at the press release, you saw that from last year, the equity funds and the fixed incomes both grew in double-digit numbers. So it's a worthy business to continue to allow to grow.

Operator

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

Cynthia Mayer - BofA Merrill Lynch

Sorry, I have one more money market question. I think, for a while, you've been saying that a 10 basis point increase in gross yields would reduce the impact of waivers by 1/3 and 25 basis point by 2/3. But since the yields have gone down, the waivers have increased, wouldn't that relationship change in some ways? So it would take a smaller increase in yields at this point have a bigger impact?

Thomas Donahue

Not really, Cynthia. We've -- because the decrease in yields have been concentrated in particular in the government funds, the proportions still hold true. I mean, the dollars, the underlying dollars would be different. And whatever, that's kind of a guideline just -- the main point out of that being that, it obviously doesn't take very much upward movement to remove most of 2/3 of the waivers. So it's more of an indicator than a precision thing.

Cynthia Mayer - BofA Merrill Lynch

Got it. Okay. And then just one more question on the possible downgrade. If the ratings of U.S. short-term debt remain AAA but the long term didn't, would that cause investors to crown to the short end and pressure those yields?

Deborah Cunningham

I think investors generally go to the short end of the yield curve when there is uncertainty in the marketplace, in their normal marketplace. So if you're talking about longer-term investors going straight into the money markets, it's only at that point in time when they are very uncertain about the conditions of that longer-term sector. If in fact the downgrade occurs, if there ends up being a split rating with some at AAA and some at AA, if there is solidly in the AA rating camp, I think whatever the rating agencies finally opine based on whatever debt deal is negotiated, that uncertainty hopefully will go away. And the result and change in yield spreads and the yield curve itself will likely, I think, attract the natural bond investors back out into the bond curve. I don't think, generally speaking, a treasury bond investor would be in treasury cash just simply because of the difference between a highest-quality long-term rating versus a highest-quality short-term rating. I think it's really more reflective of just uncertainty that they would go into that cash officially[ph] .

Cynthia Mayer - BofA Merrill Lynch

Great. And then just over on the fixed income side, it looked like in the quarter there was a $1.8 billion exchange out of separate accounts and a $1.8 billion exchange into fixed-income funds. I'm just wondering what that was, and is there any fee change in there?

Thomas Donahue

There's no fee change, Cynthia. That was something we're able to work through to solve an issue for a client operationally who needed to have the holdings in the fund format rather than in direct security, so we actually transitioned that into a collective fund to accommodate what the client needed to do.

Operator

Our last question comes from Roger Freeman with Barclays Capital.

Roger Freeman - Barclays Capital

Yes. I just had one follow-up just on the growth in your sales force. I wanted to see if you could just put a couple of numbers you gave us in contact. So the 12 new folks in the broker-dealer division, what kind of -- like how many were there? What percentage increase is that, I guess particularly relative to regional? I guess your point is that they focus on regional because you're splitting up the territories. But I guess what's 12 of whatever the baseline is? And also 3 in the consultant relations, what kind of increase is that?

John Donahue

The overall number, which we have been using about since we want public was about 190 or so wholesalers. So it's an increase off of that.

Thomas Donahue

And specifically, Roger, in the channel, we would say that of that 190, a little less than 1/3 would be in -- specifically in broker-dealer. And we have another 1/3 of the total is in internal sales, and so that actually you could think of as being cross functional. But if you looked at the assignment to broker-dealer, you'd get about 54 out of that, roughly 190, though the 12 would be an increase to that 54 number. And then in terms of the consultant relation positions, we have about 30 people total in our institutional sales and retirement services sales force. They do a variety of things. There's about 12 that specifically would be in institutional sales. The 3 would be added to that roughly 12.

Operator

There are no further questions at queue at this time. I would like to turn the call back over to Mr. Hanley for closing comments.

Ray Hanley

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

Operator

This concludes today's teleconference. You may disconnect your lines at this time, and thank you for your participation.

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