Eaton Vance Corp. F1Q08 (Qtr. End 12/31/07) Earnings Call Transcript

Feb.21.08 | About: Eaton Vance (EV)

Eaton Vance Corporation (NYSE:EV)

Q1 FY08 Earnings Call

February 21, 2008, 11:00 AM ET

Executives

Daniel C. Cataldo - VP, Financial Planning & Analysis

Thomas E. Faust, Jr. - Chairman, President, and CEO

Robert J. Whelan - CFO

Analysts

Bill Katz - Buckingham Research

Ken Worthington - JP Morgan

Craig Siegenthaler - Credit Suisse

Marc Irizarry - Goldman, Sachs & Co.

Cynthia Mayer - Merrill Lynch

Roger Smith - Fox-Pitt Kelton

Operator

Greetings and welcome to the Eaton Vance First Quarter Fiscal Year 2008 Earnings Release. At this time, all participants are in a listen-only mode. A question-and-answer session will follow with formal presentation. [Operator Instructions]. As a reminder, this conference is being recorded.

It is now my pleasure to introduce to your host, Mr. Dan Cataldo, Vice President of Financial Planning and Analysis for Eaton Vance. Thank you, you may begin.

Daniel C. Cataldo - Vice President, Financial Planning & Analysis

Good morning, and welcome to our first quarter fiscal 2008 earnings call and webcast. With me today are Tom Faust, our Chairman and CEO; Bob Whelan, CFO; and Laurie Hylton, our Chief Accounting Officer. Tom and Bob will comment on the quarter and then we'll take your questions.

The full earnings release and the charts we will be referring to during the call are available on our website eatonvance.com under the heading Press Releases. We need to begin with a reminder that today's presentation contains forward-looking statements about our business and financial results. The actual results may differ materially from those projected due to risks and uncertainties in our operations and business, including but not limited to those discussed in our SEC filings. These filings, including our 2007 Annual Report and Form 10-K, are available on our website or on request without charge.

I'd now like to turn it over to Tom.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Good morning and thanks everyone for joining us. As you all know, credit market turmoil, weak equity markets, and the deteriorating overall economy made for a challenging business and financial environment in the three months ending January 31, coinciding with the first quarter of our fiscal 2008. Equity markets performed poorly with the S&P 500 down 11% for the quarter. And the credit market suffered a variety of distresses that impacted some of our flagship income products.

I am happy to report though that in this environment, Eaton Vance had a very solid first quarter in terms of both financial performance and organic growth, despite these difficult conditions. Total gross inflows in the quarter were $11.7 billion with open-end funds accounting for $7.5 billion, our best quarter ever of open-end fund gross sales. Our retail managed account gross flows surpassed $2 billion, again our best gross sales quarter ever in this product area.

Annualizing the first quarter run rate, we are on pace to match our record fiscal 2007 total gross flows, a significant achievement given that 2007 included $10 billion in closed-end fund sales that we do not expect to repeat in fiscal 2008.

Our net inflows, a key indicator of any asset manager's success, were $3.6 billion in the quarter, equivalent to a 9% annualized organic growth rate. Excluding closed-end funds, this was our second best quarter ever in terms of net inflows.

I know there was a certain skepticism that we would generate strong net inflows during periods such as we've been experiencing in which the bank loan and municipal bond sectors have been under siege and the market for new closed-end funds was nail tightly shut. This quarter's success amidst difficult market conditions is a testament to the strength of our diversified product line, the excellent investment performance we've delivered to clients, and the power for distribution relationships we enjoyed, and further evidence that Eaton Vance is not a narrowly focused niche company. Our strong net flows only partially offset the $12.3 billion we lost, which is a result of market weakness affecting valuations across each of our major investment disciplines.

As a result, our assets under management declined 5% to $152.9 billion at quarter-end from $161.7 billion at the end of the prior quarter. While we hate to see our AUM decline in any period, we understand that exposure to market fluctuations is inherent in the business in which we operate. Even with this quarter's market declines, our assets under management increased 13% or $17.4 billion year-over-year from the $135.5 billion managed at the end of the first quarter of fiscal 2007.

Please refer to the PowerPoint slides one through six for more about our assets under management, gross and net flows, asset mix, and growth rate. Earnings for the quarter was $0.46 per diluted share compared to $0.02 per diluted share in the first quarter of fiscal 2007. Adding back $0.34 per diluted share of closed-end fund related expense recognized in the first quarter a year ago, earnings as adjusted increased 28% year-over-year.

Bob will discuss the financials in more detail in a moment. But first, I would like to address some of the current developments in our major product groups. As I mentioned, our open-end fund business, which is primarily retail, was very strong in the first quarter even under quite difficult market conditions. This can be seen in slide seven, which shows the gross open-end fund sales by investment discipline over the past several quarters. As depicted here, even with the slowdown in sales or our income products, the strength of our equity products made this strongest quarter ever in open-end fund gross sales.

Our equity funds has $5.2 billion in gross sales, led by our strong performing Large Cap Value, Dividend Income, and Emerging Market fund. This is illustrated in slide eight, which lists our top performing funds... sorry, top selling funds for the 10-week period ending February 15th. At the same time as we are selling our value and equity income products, we are also looking for opportunities to tell the Eaton Vance story on the gross side of the ledger where we have a number of talented managers and strongly performing funds rated four or five stars by Morningstar, but is still quite small in terms managed assets.

I am optimistic that the foundation is in place to begin replicating on the gross side the tremendous business success we have enjoyed with value and equity income investing over the past several years.

Fixed income fund gross sales of 1.5 billion in the first quarter were up slightly from the preceding quarter, but down 20% year-over-year. Net flows remained positive for fixed income funds overall and for municipal bond funds in particular, which we consider a victory of sorts given how the credit turmoil has affected the municipal bond market and our funds short-term performance.

Although the one-year performance of our municipal bond funds lag the peer group, our longer term performance there remains excellent. The Eaton Vance National Municipals Fund, our largest municipal bond fund, continues to rank number one among its peers over the past five years and has an overall five star rating from Morningstar.

We believe the issues that have impacted the performance of municipal bond market are not the result of fundamental problems with the underlying credit quality of municipal issuers, which remains very strong, but a changing market via the value of the insurance guarantee that backs many municipal securities.

We believe that muni market is poised for recovery once the uncertainty regarding the financial health of municipal bond insurers is resolved one way or another. We continue to manage all of our municipal funds, open end and closed-end, with the same relative value approach that it served our clients well over the long-term. The fact that we have not seen net outflows from these funds speak to the confidence of financial advisors and their clients have in our team and are approach to the municipals market.

Turning to bank loans, we had over $900 million in net outflows in the quarter as a result of unprecedented declines in loan prices and the resulted declines in our funds' net asset values. We believe the price declines are not a fundamental credit issue, but reflect an imbalance of supply over demand due to factors related to the broader financial market turmoil.

Loan default rates currently stand at approximately 1%, well below historical averages, while the price of the loans are currently trading in a range of approximately 89% of par value. Will loan defaults go up in a period of economic weakness? Certainly, but we are doubtful that they will increase anywhere near the point that would justify a price of $0.89 on the dollar.

As you know, if you have followed us for some time, we take a risk-averse approach to managing in this asset class. The loans we hold in our portfolios currently have credit outlooks and interest coverage ratios consistent with prior expectations and within the normal ranges of what we have seen over the nearly 20 years we have been in this business.

Our overall bank loan AUM has dropped almost 10% over the past year and net outflows continue, we believe valuations may be approaching the point where we could see intuitional buyers come into the market. From a long-term perspective, we believe bank loans represent extraordinary value at current levels.

While we are on the topic of credit markets, I would like to talk briefly about the option rates securities market, which I am sure many of you have read about in the past weak. We currently manage approximately $31 billion in 38 closed-end funds. In addition to common shares, our closed-end funds have approximately $5 billion of auction preferred or APS outstanding. APS are a type of perpetual equity security used by closed-end funds as a form of floating rate leverage.

Beginning last week, dislocations in the broader credit markets have caused the APS of many closed-end funds, including our own, to experience an imbalance the sale orders overbids in a regular auction with the result that the auctions have not cleared. An unsuccessful auction is not a default. The underlying fund continues to pay dividends to all our APS shareholders, but at a specified maximum rate rather than a market clearing rate. The specified maximum rate differs by fund and in most cases is not materially different than the market clearing rate in recent successful auctions.

Importantly, the earnings rate on the Eaton Vance funds' assets continues to exceed the cost of the APS based on the maximum specified rate and leveraging the funds with APS continues to be economically viable. Each of our closed-end funds remains in compliance with all asset coverage tests and all our issued APS continue to be highly rated either AAA or AA.

We understand that liquidity needs to be restored to APS shareholders and we are working with other market participants to develop possible solutions as quickly as possible.

Turning to investment performance, I am pleased to say that our long-term fund performance continue to be excellent across a broad range of discipline. This is illustrated on slide 9. As of January 31st, we had 52 funds that had a four or five star overall Morningstar rating for at least one share class. Our performance as measured by Lipper is equally strong. As of the end of January, 75% of our fund assets were in funds that beat the Lipper peer group average over the past three years, 73% over the past five years, and 92% over the past 10 years.

Our investment teams are focused on the challenges in hand and committed to delivering performance excellence over the long-term. I'm confident that we are well positioned to keep our performance advantage through this difficult market.

Earlier this month, Barron's published their annual rankings of mutual fund families based on composite investment performance over the past one, five, and 10-year periods, ending December 31, 2007. Eaton Vance' funds rank second amongst 67 families in terms of one-year performance, fifth of 61 families for five-year performance, and 12th 52 families for 10 years. On a composite basis combining one, five and 10-year rankings, Eaton Vance' funds placed third.

Needless to say, these are outstanding results in which our organization takes great pride. We understand that our success as a company is closely linked to the investment success achieved by clients.

Our retail managed account business carried forward strong momentum from fiscal 2007 into the first quarter of 2008 with gross flows of $2 billion, a new record high and net flows of $1.1 billion, a 30% annualized growth rate in managed assets. The growth we have experienced in managed accounts, managed assets and sales is shown in slides 10 and 11.

The retail managed accounts sale success has been achieved across a broad range of products, including Large Cap Value, International Equity, Municipal Bond and Parametric's tax-efficient core and multiple disciplined overlay products.

Furthermore, EVM's Large Cap Value, Atlanta Capital's small and SMID-Cap and Fox Asset Management's large and small-cap value discipline, are all coming off excellent performance years in 2007. The strong performance record of these offerings combined with our recent sales force realignment that increases resources devoted to this product area leave us optimistic that the momentum here can be sustained.

Our institutional and high net worth businesses combined for gross inflows of $2.1 billion and net flows of nearly $600 million in the quarter with positive contributions from Eaton Vance Management, Atlanta Capital, Fox, and Parametric. Lisa Jones and her team continue to make steady progress building Eaton Vance Management Institutional business. The EV Institutional Group funded new mandate in large cap-value, large cap growth, high yield, structured emerging markets, and bank loan disciplines during the quarter and continues to gain momentum.

Atlanta and Fox had modest net inflows from institutional in the quarter compared to fairly significant outflow of the year ago, with the flow turnaround, no doubt, helped by the improving investment performance story of both those organizations.

Slide 12 and 13 break down our institutional assets under management by company in major investment discipline. Last quarter, we talked about the new management structure that Eaton Vance Distributors, our retail distribution arm, unveiled in October. One of the main objectives of the new structure is to better align our products and distribution capabilities with the needs of customers.

Just to recap what we did, we formed a new Wealth Management Solutions group to support the marketing of the company's products and services tailored to the high net worth marketplace served by financial advisors. We increased resources devoted to the register investment advisor, sub-advisory and retirement market opportunities, and we strengthened our marketing communications and use of market data to enhance the efficiency and effectiveness of our sales efforts.

Integral to the new the structure are the expanded responsibilities of our field wholesalers who now represent all Eaton Vance products to the advisors they serve, and the role of the new Wealth Management Solutions team in supporting our most sophisticated product offerings and most demanding customers. Although it's too early to declare victory on the realignment, the sales results we've seen... we saw this quarter suggest we are on the right track.

As shown on slide 14, we finished calendar 2007 ranked second behind only American Funds in non-propriety net long-term fund sales, according to Strategic Insight. Slide 15 shows our share of net flows in this channel and how it has grown.

I'd now like to turn the call over to Bob Whelan to review the financial results in more detail.

Robert J. Whelan - Chief Financial Officer

Thank you, Tom, and good morning everyone. As Tom has outlined, first quarter results were impacted by an overall drop in assets, largely due to market declines which offset some very strong sales and distribution results. While both our gross and net sales were impressive at $11.7 billion and $3.6 billion respectively, we lost $12.3 billion in the quarter due to market depreciation for an overall drop in AUM of $8.8 billion. We are reporting earnings of $0.46 per diluted share in the first quarter of 2008 versus $0.02 in the first quarter of 2007.

Earnings in Q1 2007 were impacted by approximately $74 million or $0.34 per diluted share related to one-time closed-end structuring fees, as well as termination payments related to certain closed-end fund compensation agreements. As mentioned, assets under management increased in the quarter to $152.9 billion from $135.5 billion in the first quarter of 2007, an increase of 13% or $17.4 billion. On an average basis, assets under management increased 20% from $132.1 billion in Q1 2007 to $157.9 billion in the first quarter of 2008. In line with that increase in average AUM, revenues increased to $289.8 million from $243.2 million, an increase of 19% quarter-over-quarter. We were able to maintain our strong overall effective fee rate over that time, with the rate of 73.4 basis points versus 73.6 in Q1 2007.

Investment advisory and administration fees increased to $210.7 million from $168.4 million or 24% in the first quarter of 2008 over the same period a year earlier. The increase is due to an increase in average assets under management, which increased 20%, and an increase in our average effective investment advisory and administration fee rate to 53.4 basis points from 51.3 basis points in Q1 2007.

Operating expenses declined 21% to $190.6 million from $241.2 million in the first quarter of 2007, largely due to the one-time expenses related closed-end fund structuring and termination payments in Q1 2007.

Compensation expense increased 5% to $81.9 million year-over-year, reflecting an increase in cash compensation, offset by a decrease in stock-based compensation expense. Cash compensation expense, which includes base salaries, incentive compensation, payroll taxes, and employee benefits, increased 10% year-over-year, in line with an increase in average headcount of 9.4% and reflecting an increase in year-end salary adjustments and bonus accruals.

Within the cash compensation category, sales incentive decreased by $4.4 million, reflecting the $4.7 million in sales incentive paid out in the first quarter of 2007, in line with the offering of the $2.8 billion closed-end fund offering.

Stock-based compensation decreased by 18% or $2.5 million, reflecting a decrease in the number of retirement-eligible employees receiving option grants. We also saw an increase in interest expense from essentially no expense in Q1 2007 to approximately $8.4 million in Q1, 2008, reflecting our $500 million, 6.5 coupon, 10-year senior note offerings, which we completed in late September 2007.

Interest income increased to $4.4 million from $2.3 million in Q1 2007, an increase of 92%. Net income increased to $57.9 million in the first quarter compared to $2.6 million in the same quarter last year, and our effective tax rate for the first quarter was 39.1% to 38.4% in the first quarter of 2007.

Total headcount for Eaton Vance and all of our affiliates at the end of the first quarter was 980 employees versus 888 last year, an increase of approximately 10%.

We think the best measure to analyze our financial result is by looking at adjusted operating income, a metric we use internally to assess our run rate of business momentum and to remove large one-time items. As a reminder, that figure starts with operating income as reported and adds back four items which include closed-end structuring fees, payments to terminate closed-end fund trails, stock-based compensation, and accelerated amortization or impairments.

Our adjusted operating income, as detailed in the table in the press release, increased to $111 million in Q1 2008 from $86 million in the same period in 2007, an increase of 30%. In addition, our adjusted operating margin increased to 38% in the quarter from 35% in the same quarter 2007.

I'd like to highlight some of our efforts to improve our overall capital management and efficiency. As you know, we completed a $500 million senior debt note offering in September. We earmarked a portion of the proceeds of that offering towards incremental share repurchases.

In the first quarter, we purchased approximately 3.4 million shares or $152.5 million in repurchases. The incremental share repurchase plan related to the debt offering is now complete. We have approximately 115 million non-voting shares outstanding.

Cash, cash equivalents, and short-term investments decreased to $346.5 million on January 31, 2008, from $485.1 million on October 31, 2007. All of our short-term investments are conservative and highly liquid instruments. Currently there is no outstanding balance on our $200 million corporate line of credit facility.

Taxes payable increased to $46 million at January 31, 2008, an increase of $25 million compared to our fiscal year-end at 10/31/2007, reflecting an overall increase in taxable income and the timing of Federal estimated tax payment. Our tax rate in Q1 remained in line with fiscal 2007 at approximately 39%.

As required under GAAP, we adopted FIN 48 during the first quarter of 2008. With the adoption of FIN 48, Eaton Vance experienced a gross up in deferred tax assets and liability category, as well as a charge to retained earnings in the amount of $5 million. Due to a combination of dividends and share repurchases, we returned over $628 million to shareholders over the past 12 months.

I'll now turn it back to Tom for some closing comments and then we'll take your questions.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Given the market decline experienced in the first quarter and continuing uncertainty about where markets are headed, we are managing our expenses quite carefully, but we are still adding staff selectively in areas where we think it's necessary to support the growth of our business.

I'll remind you that a meaningful percentage of our compensation is variable based on changes in sales levels and operating income. To the extent sales are strong as they were this quarter, sales-based compensation will be high. However, any pressure on sales or operating income will translate to lower commissions or bonus pool accruals, considerations you could keep in mind going forward.

This quarter provided us with a number of challenges. We are dealing with the challenges and we will do what we can to minimize the impact on the bottom line. However, we will not lose sight of what drives our long-term success, providing superior investment performance in value-added products to the clients we serve. We continue to believe we are well positioned to meet these objectives even amid these difficult market environments.

We'll now take your questions.

Question And Answer

Operator

[Operator Instructions]. Our first question comes from William Katz of Buckingham Research. Please state your question.

Bill Katz - Buckingham Research

Hi, good morning, thank you. I guess I would like to go to the obvious question of the ultra [ph] rate preferred securities market. And just sort of help us understand what might break the log jam, and to the extent that there isn't a breakage in that log jam, can you sort of talk about the impact on the business from two fronts; one, from a potential branding issue and secondly, any kind of economic issue that might play out? Thank you.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Yes, it's Tom Faust. We've been engaged in certainly daily bordering on continuous discussion with other market participants, particularly the dealers who've placed this paper to make sure we and they are working closely together and sharing vast ideas on how to deal with this. It is a complicated issue. The fact is that these are perpetual securities. The fact is that the trustees and the management companies that serve these funds have to balance the interest of two different sets of shareholders. In other words, a solution that may look great for the preferred shareholders have to also make sense for the common shareholders and vice versa.

So there are lots of competing concerns that weigh on us and others that are involved here. We've tried to be a leader in terms of communications. We've put out a notice on our website addressing our point of view and making sure people will clear on what was going on here very early. That appeared the middle of last week. We are in the process of updating that material to provide daily updates on status of our auction preferred securities outstanding.

In terms of what a solution might look like, it's a little hard to say. I mean, there are solutions that might involve returning liquidity to the auction preferred market as it has existed, possibly involving some government intervention, which I don't know that that's possible. But it's certainly something that has been discussed. It is also possible that a solution could be for the fund that offer auction preferred through some mechanism to replace the APS with a lower cost form of financing. We've certainly been pursuing that route aggressively. And I think that there are opportunities to do that. But we cannot comment on when that might happen, as much as people want to know whether it is going to last a week or a month or potentially longer. But these are things that take some time develop, and there are also multiple parties that are involved in figuring out what the right course is going forward.

In terms of the impact on our business, I think you mentioned direct financial as well as reputational issues involved here, clearly we are sensitive to both. In terms of the reputation, it should be very clear that Eaton Vance, our funds are the issuers of these securities, they were offered under a prospectus prepared by us that we believe accurately describe them to be perpetual securities. That made it clear that there was risk of interruption of liquidity in the event that auction markets did not clear as has been the pattern of over the last week. However, we do represent these shareholders, and we are doing what we can to come to a solution that works for APS holders as well as common holders. And certainly, we want to do the right thing by all our constituencies recognize that we have to achieve the right balance.

In terms of the financial impact on Eaton Vance, it's certainly hard to ascribe a direct financial impact of this. It is certainly conceivable that funds could de-lever as a result of this. It's hard for us to support that, given that even at current somewhat higher cost of financing, the funds enjoy a positive spread... a positive carry on their investments that are financed using leverage. So, it's kind of hard to argue that it's in the interest of the fund to de-lever to reduce their assets and reduce their income earning potential to take out at the preferred holders, given that that's not an explicit right that they have. So again, it's trying to achieve the right balance.

But it's... beyond that, it's hard to say what potential negative benefit there might be on Eaton Vance financials. Our stake in this is pretty straightforward. We manage these funds in exchange for a fee. That is a stated percentage of assets. To the extent that the assets of the fund don't change materially, there is no direct financial impact on Eaton Vance. It's not to say that we don't view that as a very important development and are not working hard to try and achieve solutions.

Bill Katz - Buckingham Research

Thank you.

Operator

Our next question comes from Ken Worthington with JP Morgan. Please state your question.

Ken Worthington - JP Morgan

Hi. I was curious to see how the sales progressed throughout the quarter, especially in the areas that we have a difficult time tracking, being the managed account in the institutional. And implicit is basically a lot of your business... the market environment has changed throughout the quarter in a number of your business, the municipal bond market has changed, the bank loan market has changed, the equity market has changed. So, just flavor in may be how January was versus November or December?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

January was a pretty good month. We look at... if you look at our overall fund or managed account net sales, which I think is what you're asking about, we actually did better in January than we did in December and we did better in December than we did in November. So, that's on the fund side.

On the separate account side, the retail SMA side, it wasn't quite that way. The best month was January, the second best month was November, the third best month was December in the period. So our retail business really continues to crank along. And I think one of the reasons why we think those results might be a little bit at odds with what others are reporting and perhaps what even others might have expected is that we have got a very strong performance. And our market share is small and there is still plenty of money being invested in U.S. equities, and value investing, and equity income investing where we have large franchises that are bringing in big flows, and we've been winning new mandates not only on the institutional side, but importantly in our fund and separate account business where we've been able to represent that we've got a better performance record and teams that... whose investment approach made sense and we've been able to win new business. So it wasn't... there wasn't a fall off as the quarter progressed. In fact, it was quite the opposite.

Ken Worthington - JP Morgan

And then, for munis and bank loans?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Well, those were the... the numbers I just gave you are composite numbers that would include munis, bank loans, as well as equities and everything else.

Ken Worthington - JP Morgan

Okay. Thank you very much.

Operator

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

Craig Siegenthaler - Credit Suisse

Thanks. I just have a specific question on the bank loan market. Last quarter, your language on this market was actually fairly constructive, I thought, and loan price is now becoming cheaper. I am wondering if you believe loan prices are close to a low here, or is there another down leg which could be mean that there could be another quarter or two of outflows in the bank loan business?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Yes, I think what we are comfortable saying is that we see a clear disconnect between basically continued strong fundamentals in the market. We in the commentary cited a 1% current default rate, which is at or near record high... record low level, but we recognize that the economy is weakening and that that's likely to change. But for any sort of reasonably likely scenario in terms of what the coming economic downturn might look like, we think at a range of call it $0.89 on the dollar, the bank loans represent very good value.

I don't think we are going to say that this is the bottom. We thought they looked cheap three months ago at prices in the mid 90s with very similarly strong underlying fundamentals. We can say that prices today for loans in general are well below the lows achieved in the last downturn in 2002. So, we are in on uncharted water here. I think it's difficult to call the bottom, particularly because what we are seeing is not driven by fundamental factors, so much as it's driven by supply demand issues related to the broader financial health of major U.S. financial institutions. And so, we think loans are a great buy here today, might they be a better buy in three or six months, I wouldn't want to call that.

Craig Siegenthaler - Credit Suisse

And then do you believe the bank loan business is more defensible from what's going on in the auction rate market, as both the asset and the liability yield are both tied to either LIBOR or the CP rate. So, if LIBOR would, say, decouple and go up a little bit, the asset would also go up and that would be, I guess, more defensive than muni. I mean, is that correct thinking?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

You said the munis?

Craig Siegenthaler - Credit Suisse

Yes, the closed-end muni bonds.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Again, I am sorry, I didn't follow the question cleanly.

Craig Siegenthaler - Credit Suisse

Well, I believe both the asset and the liability, so it's the asset being the funded self its yield and the liability being the auction rate preferred security, both of those are linked to LIBOR or the CP rate?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

That's correct.

Craig Siegenthaler - Credit Suisse

It means, if LIBOR would go up, they both are going to go up almost on a dollar-for-dollar basis after it resets [ph].

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Yes, that's right.

Craig Siegenthaler - Credit Suisse

Inthe muni market, it's not... the asset rate is actually more so fixed and if the liability went up on that side, it'd be closer to pushing that ceiling, I believe.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

That's right. I guess you are talking about leveraged bank loan funds, closed-end or otherwise, are... conventionally they both borrow or finance themselves on the rate tied to LIBOR or something similar to LIBOR. And they invest in securities tied to LIBOR so that there is a relative insensitivity in terms spread on levels of LIBOR. Obviously, the overall return to investors, on a current basis, is quite sensitive to LIBOR because you get a... you aren't spread over LIBOR, if LIBOR moves up, you get a higher current return. That is I think, as you correctly point out, that's different from muni funds that use leverage where typically there you are investing in fixed rate assets, supported by floating rate leverage. And as the cost of leverage goes up, that puts distribution pressures on what's available to the underlying common holder. If it's a closed-end fund we are talking about.

Fortunately what's happing right now is things are going the other way. Even though in the auction preferred market, the securities are... the APS are resetting at the maximum rate, which is somewhat higher than recent rates in the market. But if you go back just few weeks, because LIBOR has been moving down, short-term rates, commercial paper rates have been moving down in terms of the positive carryover the cost of the financing, muni funds are in a better position today than they were just a few short weeks ago.

Craig Siegenthaler - Credit Suisse

Thank you.

Operator

Our next question comes from Marc Irizarry with Goldman Sachs. Please state your question. Mr. Irizarry. Please go ahead your line is open.

Marc Irizarry - Goldman, Sachs & Co.

It's Marc Irizarry. Can you guys here me?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Yes.

Marc Irizarry - Goldman, Sachs & Co.

Okay, great, thanks. Tom, I guess the question is on the closed-end fund launch environment, obviously it seems that the environment is tough enough before sort of these issues on our auction rate notes on APS sort of surface. What's sort of the prognosis for closed-end fund launches sort of for the rest of the year, and do you think that this at all alters what could have been some closed-end funds in the pipeline? Thanks.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

One, I think, important data point to understand is that Eaton Vance has not issued any leveraged closed-end funds since 2006, and really haven't issued any in size at least since the year before that. So we weren't doing leveraged closed-end funds anyway. In terms of what our expectations is for the market, I think, I referred to the closed-end fund market being nailed shut in the first quarter. We don't see that changing in the second quarter. And that was all... that was true before this APS storm hit last week.

There were starting to be some interest in possible products that might be put together, but I think the attention of those involved in closed-end fund market has obviously been diverted to dealing with the APS issue over the last week or so. I think whether the APS issue somehow obtains the overall closed-end fund market is a bit of an open question. If the solution is one that ultimately satisfactory to the both parties, the common and preferred holders, and the period of illiquidity is relatively short, I don't see there any particular lasting repercussion of this. But I think we do recognize and trying to come to a solution that works for everyone that the long-term health of the closed-end fund business is very much tied to how this issue, how and how quickly this issue is resolved. So that's one of among many reasons that we are very focused on this and doing everything we can to help find a solution.

But, if there is a good solution found and it's found on a timely basis, I really don't think it should have a major impact on the closed-end fund issuance more broadly; but even in the absence of this issue, frankly our crystal ball is pretty hazy in terms of new closed-end fund issuance. There is simply is nothing on the immediate calendar that we are aware of.

Marc Irizarry - Goldman, Sachs & Co.

Okay, great. And then just quickly in terms... obviously your equity flows have been very strong in a tough environment on the open-end fund side. Are you sort of measuring your progress in terms of your market share or an absolute level of what you think you should flow on the open-end side of the ledger?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

I guess both. We certainly look at... we subscribe to data services that provide us measures of market share. And certainly the individuals that run top performing fund think that if we are top performing funds, we should also be top selling funds. And... but from a sales standpoint, I think you would have you say that we look at both, and that we look at certainly current sales day to day and trends and sales day to day. But over periods of months and quarters and years, not only do we look at ours sales, we look at market share and we expect that if we have strong performing funds that not only should we be selling a lot of those, but that our market share should be rising. So it's really a combination.

Marc Irizarry - Goldman, Sachs & Co.

Okay, great, thanks.

Operator

Thank you. Our next question comes from Cynthia Mayer with Merrill Lynch, please state your question.

Cynthia Mayer - Merrill Lynch

Hi, good morning. Just a follow-up on the auction rate preferred. I guess I am just wondering, do you think there is any kind of expectation out there among preferred shareholders that you would use your balance sheet to buy back some of the preferreds and do you see any chance that any fund companies would do that?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

We certainly... well, there is no basis in terms of legal obligation for us or anyone else to do that. We have not been involved in any discussions that would involve us committing our balance sheet. The numbers here are pretty daunting. We have $5 billion of auction preferred shares outstanding. So Eaton Vance is not in a position to simply take these assets on to our balance sheet, nor do we see any likelihood of that happening.

Cynthia Mayer - Merrill Lynch

Okay. And, I guess, on an another topic, it looked to me like the average realization rate for the first quarter was below the last couple of quarters, what would account for that? And I am wondering basically if the continued strong flows to Parametric could be lowering the average at all and can you tell me what the flows to Parametric were in the quarter?

Robert J. Whelan - Chief Financial Officer

Yes, Cynthia, it's Bob, thanks for your question. And you are right on the mix shift is essentially... if you look at our fund effective fee rate, there was no change, sequentially held in strongly, but if you look at the three categories and you will have these numbers in terms of high net worth, wrap, and institutional, we saw just a slight decline in the effective fee rate there. So... and that represents a pretty significant, I think, 25% of our assets under management or $39 billion. So a change there and a change for a positive reasons because Parametric is doing so well, we'll bring the overall effective fee rate down slightly. I think we are pretty happy that we are adding institutional business, diversifying our business, and we have actually been able to maintain that rate at a pretty good clip.

Cynthia Mayer - Merrill Lynch

Can you tell me what the Parametric flows were in the quarter?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Cynthia, they were right around $900 million in net flows for the quarter in their separate account, retail managed account and high net worth products.

Cynthia Mayer - Merrill Lynch

Great, thanks a lot.

Operator

Thank you. Our next question comes from Roger Smith with Fox-Pitt Kelton. Please state your question.

Roger Smith - Fox-Pitt Kelton

Yes, I wanted to just step back to the auction rate preferreds again and you mentioned that there were some financing opportunities that you were looking at right now to potentially refinance these products. Can you give us an idea of what those might be? And then as far as thinking about the common shareholders, what are some solutions that would be beneficial to those common shareholders to help unclog this solution?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Yes. The solution that I was referring to in terms of financing would be looking to achieve alternate financing at a cost that's inside what the fund is now paying for the auction preferred. And if that happens, I think that's clearly beneficial to the common guys, the positive carry on the auctions acquired using the leverage would be enhanced. There would be no need to sell assets on a distressed basis to de-lever, and the issue in terms of the uncertainty that's associated with the APS would go away because presumably they would be taken out in some way.

Are there mechanisms to do that? I think that's the big question. Certainly conceptually there is an opportunity to replace APS, which has been a relatively confined market. It's a $25,000 par value instrument, it is not money market eligible. So it's not a 2a-7 security. Potentially there is a possibility of replacing APS financing or supplementing APS financing by tapping into commercial paper or other instruments that can trade in the money market.

In terms of the underlying asset strength coverage ratio on these assets, they're outstanding. There is nothing about them that wouldn't make these desirable securities in another market. It's just that simply the rate setting and liquidity mechanism has been called into question in a period where people don't want to assume things that they assumed for literally decades previously without interruption. But the... so the best solution we see is lower cost financing for the funds and potentially the best source of that is issuing securities, commercial paper or otherwise that are 2a-7 eligible and it can be purchased from money market funds.

Roger Smith - Fox-Pitt Kelton

Okay. And then just on the failed auctions from what we can tell from reading different press articles out there, it seems like the investment banks themselves have kind of stepped away from supporting the product. The investment banks, are they really ones that could help affect the liquidity in the most near-term or who else has the ability to kind of come in here and help free these things up because as you mentioned it's not in the capacity of an Eaton Vance or any of the other asset managers really to lend their balance sheets to kind of unclog this?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

So, one solution is replacing the APS, that's what we just talked about.

Roger Smith - Fox-Pitt Kelton

Right.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Here is a second solution, it's somehow restarting the APS mechanism where that the auctions resume working. And I think it would require a fairly significant commitment of balance sheet capacity by the remarketing agents, the firms that run these auctions to do that. They have been doing that... they have been supporting these auctions for a number of months and based on what we understand of accumulated fairly significant holdings of this paper and also we've got to the point where they... we understand for balance sheet reasons concluded that they could not continue to commit their own capital to doing this.

Is it possible that they could reach a different conclusion? I think it's possible. We are not certainly counting on that. I think it's a lot more likely for something like that to happen if, for example, through Fed intervention or access by those entities to borrowings from the Fed using these securities as collateral, I think those are possible solutions. But we must say, we have not been involved in discussion with the Fed or anyone else that would say that that's a solution that's near our hand. But certainly you can envision given the quality of the underlying assets, the security of these instruments, and I think the broader interest that is involved here, and speaking not just of auction rate preferred shares issued by a close-end fund, but auction rate preferred securities generally. You would hope that there are conversations taking place between major financial institutions and government representatives to try and come up with innovative solutions that might land some of the buying power of the federal government to this. But again, we are not involved in that, that we would certainly welcome a role in that.

Roger Smith - Fox-Pitt Kelton

Great, thanks very much.

Operator

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

Bill Katz - Buckingham Research

Hi, just a couple of follow-ups. Just coming back up to the fee realization rate, it looks like it ticked down just a little over half a basis point sequentially. So, I am just trying to box your notion that the retail side is... retail AUM have been relatively stable. You have seen a little bit degradation given Parametric, is there anything else going on in play, is it just sort of the impact of just sort of the overall market backdrop in terms of the decline in equities that's affecting it or is there a more concerted effort here on the pricing perhaps to perhaps build some share in the institutional market?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

No, it's really none of... there is certainly not... we are not... there is no price discounting going on to try and win business, and even if it were, it wouldn't be a big enough factor to affect things. I think there are some long-term factors involved here. Our highest fee rate assets, revenue realization assets, have traditionally been B and C share mutual fund assets. And though we continue to sell C shares at a pretty good clip, there is a long-term trend, as you know, away from B shares. So, if you are replacing assets that, I think, the realization rate on B share fund is well over 150 basis points in many cases, as that continues to be a smaller and smaller piece of the pie, that puts downward pressure on average realization.

The other thing that affects average realizations in a negative way is that the retail managed account business and the institutional business, both of which are growing nicely, are lower fee businesses than our traditionally money... traditional mutual fund businesses. They are also less expensive in terms of associated costs, but just in terms of fee realization, those are lower return assets than mutual fund shares.

Also remember that a year ago, we had a big closed-end fund added at a fee rate consistent with other option... equity option income funds of 1%. And there was... a year ago we had a short-term effect going the other way where we had big incremental assets at an above average fee that would counter these longer term trends in terms of mix that would bring the average realization rate down.

And so, I think unless we are doing big offerings of new products that come in at rates above that average realization rate we have today, I think you should expect some slow drifting down of the average realization rate on assets managed.

Bill Katz - Buckingham Research

And then just somewhat related follow-up is a number of your larger competitors are talking about sort of a step-up or acceleration or continuation of client interest in alternatives, and also non-U.S. allocation with any institutional bucket. I am just sort of curious as you look at your institutional flows and you make the exception for $300 million plus bank loan fund in January, I believe, relatively nominal organic growth away from that. I am just sort of curious how are you thinking of positioning in that business against some of the secular dynamics that seem to be playing out?

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

The alternative space is something that interests us. It's not something we view as a near-term opportunity. There is, I think, a tendency on the part of consultants and traditional clients to put asset managers into categories, into buckets. We are in the bucket of being a traditional loan-only manager and there is a resistance to accepting changes in that or diversification away from that. So that makes it a little harder than it would be of we are starting afresh. We look at our performance record, particularly in our equity group, and say that the value add that we offer goes out head to head with others on a risk adjusted basis that are in the alternative space. So, we don't think we need to reinvent ourselves in terms of how we manage assets to play in those areas, but it's challenging because of the market segmentation that the consultant firms want to impose on us and others that active in there. So, we like the idea of playing in all market segments, frankly. We want to be diversified players and represented in all markets. There are some special challenges in getting our products moved over into being thought of as something in the alternative space.

The places where I think it more sense are in equity, but also in our... some of our income products, particularly our global macro products, which are... we've got great performance and we think great risk-adjusted performance and perhaps that could be available to... made available to clients that would pay us an incentive based fee and would like a risk return profile similar to the hedge fund world. But it's pretty early stage. We are not close to offering significant product in that market.

In terms of international, the other part of your question, Bill, international distribution is something that Eaton Vance has been involved in, in a relatively small way for quite a few years. We did see a significant pickup in our international sales starting last year and that's continued into this year. Most of that has been selling our U.S. equity capabilities, specifically our U.S. value products in offshore fund vehicles, that's a $1.5 billion or so in assets for us currently, just in that one product, which is a significant product for us. We continue to win new business there. We are involved in a, I think, a long term process; a multi-year process to both expand our capability for managing assets internationally. We've just expanded our equity research team. We added two new analysts, in fact, just this week with the goal of increasing the global focus of all our equity analysts with the intent that internally-driven we will become more global asset managers because we think as the markets have become more global and so will the perspective of many investor become more global, and that we don't have any choice about becoming global in our perspective on managing stocks and other assets.

In terms of distribution, similarly we expect to grow incrementally as opposed to in a one fell sweep by doing an acquisition, though we certainly open to that possibility. And we look for opportunities to add people and add presence in different markets. We are in a bit of spot in that it's difficult to sell international products on a broad basis unless you have international investment and global asset management capability. The two sides really have to grow together hand in hand. We could put forth a big sales effort internationally, but what if we are primarily offering U.S. based assets, I think the success of that group is likely to be pretty limited. So we are committed to doing it as a multi-year process and the two sides have to grow hand in hand.

Bill Katz - Buckingham Research

Thank you.

Operator

Ladies and gentlemen, I will now turn the conference back over to management for closing comments.

Daniel C. Cataldo - Vice President, Financial Planning & Analysis

Folks, thank you for joining us today. We appreciate your participation and we look forward to working with you in the future.

Thomas E. Faust, Jr. - Chairman, President, and Chief Executive Officer

Thank you.

Operator

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

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