On Friday, Federated Investors hosted a conference call discussing their latest quarterly earnings. (See the transcript here.) We excerpt most of the scripted money fund related comments from the call below, and will quote from the Q&A section later this week. Chris Donahue, CEO and President of Federated, says, "Looking first at cash management, total money market assets increased by $13 billion in the fourth quarter and average money market assets were $8.5 billion higher than the third quarter levels. The growth was concentrated in our Wealth Management & Trust channel. Money market mutual fund average assets were $249 billion, up about $10 billion, compared to the prior couple of quarters. Our market share increased to over 9%. Growth occurred in government money fund assets as prime and munis were about flat. While yields remained low, our business continues to grow."
He explains, "Looking at the regulatory front, money fund discussions continue. The Chairman of the SEC has indicated those further regulations will likely be proposed and may include fluctuating NAV [or] capital from sources, this could include sponsors, fund shareholders entering the capital markets along with potential redemption barriers. At Federated, we are firm in our belief that money funds were meaningfully and sufficiently strengthened by the 2010 extensive regulation revisions into 2a-7. We saw those changes work successfully through series of events in the United States, the debt-ceiling crisis, and the downgrade and in Europe, with Greece, in European banks, among the challenges that were faced in 2011."
Donahue continues, "Investors continue to use money funds as an efficient and effective way to manage cash. The funds had ample liquidity in compliance with the revised regulation. Investors have ready access to recent portfolio data and the SEC has a view into the holdings of all money funds.... We are encouraged to see support for allowing these changes to be more thoroughly evaluated before imposing additional and potentially damaging additional regulations as expressed ... last month by an SEC commissioner. In another favorable development, the Commodity Futures Trading Commission recently confirmed their positive view of the liquidity and stability of money market funds for investment of customer funds. This follows an exhaustive multiyear review."
He adds, "As I said before, we are favorably disposed to measures that would enhance the resiliency of money funds while maintaining the critical features that make money funds viable to 30 million investors and to our capital markets. These 30 million investors, who currently maintain $2.7 trillion in money funds, do so in a large measure because they desire daily liquidity [for] their cash investments from high-quality funds and managers. We believe changes that fundamentally alter the money funds, like floating NAVs or imposing redemption fees or 30 day holdbacks on a portion of redemptions, will cause many investors to abandon money funds. This change has potentially enormous negative systemic consequences. Moving money out of money funds could be expected to move to banks where it is ill-suited for lending and will require additional capital and FDIC insurance while making the top banks even too bigger to fail. Perhaps money would also move to less visible, less regulated alternatives, which raises the question of adding to systemic risk."
Donahue also says, "Imposing capital requirements on a product that already has basically 100% equity capital is not necessary or in our view advisable. Capital held against money funds may give you illusion of protection to investors who are informed clearly that money funds are investment products and are not guarantees. This concept was, of course, illustrated by the Reserve Fund. Imposing sponsor capital is another way to set in motion the demise of money funds. In our view, it is very unlikely that sponsors of money funds holding capital against these funds would avoid consolidating the funds on to their balance sheet. The implications to banks and other fund sponsors are likely to be enormous and detrimental while the benefits are uncertain at best. In our view, this will lead to sponsors moving away from offering money funds. In the event that changes are made to fundamentally alter money funds and cause investors to exit, short-term debt issues will be hurt by the destruction of an efficient and effective funding mechanism that has worked well for over four decades with very few exceptions."
Finally, he adds, "We recently announced the acquisition that will broaden our international business. We are in the process of acquiring the London-based Prime Rate Capital Management. In addition to approximately 1.5 billion pounds sterling of assets, we will incorporate their experienced team in our money market business, and gain sterling, euro and dollar-denominated usage product to boost our growth prospects abroad. We expect this deal to close in the first quarter. We continue to seek additional alliances to further advance our business outside the U.S., and we continue to work to grow our current offshore businesses organically. In the U.S., we are seeking consolidation opportunities as they come available."
Tom Donahue, Chief Financial Officer of Federated, explains, "Taking a look first at the money market fee waivers, the impact of pretax income in Q4 was $26.1 million. The increase from last quarter can be attributed to Treasury money fund products, as changes in other fund categories roughly netted out. In Treasuries, we have higher assets, higher revenue, higher distribution expense and higher waivers. Gross yields were in the mid to upper single digits. In certain funds, we exhausted broker sharing of waivers with intermediaries, and as a result, distribution expense waivers as a percentage of revenue waivers decreased from 74% in the third quarter to 71% in Q4. Based on current assets and yield levels, we think these waivers could impact Q1 2012 by around $27 million in pretax earnings."
He adds, "Compared to the prior quarter, revenue from money market asset increased by $5.5 million to $99 million, due to higher yields and higher assets. Operating expenses, increased primarily due to higher money market related distribution expense also from higher yields and higher assets. In particular in our prime funds, higher yields during Q4 led to an increase in revenue and an increase in related distribution expense. The rest of the distribution expense increase was due mainly to higher yields and higher assets in the other money fund categories again with related revenue increases. Looking forward and holding all of our other variables constant, we estimate by gaining 10 basis points in gross yields will likely reduce the impact of minimal yield waivers by about 36% from these levels. The 25 basis point increase would reduce the impact by about two-thirds."
