Federated Investors released its latest quarterly earnings report and hosted its latest earnings call late last week. As usual, both contained a wealth of information about money market funds and the money fund business in general. The earnings release says, "Federated's money market assets were $258.8 billion at Dec. 31, 2014, down $17.2 billion or 6 percent from $276.0 billion at Dec. 31, 2013 and up $13.3 billion or 5 percent from $245.5 billion at Sept. 30, 2014. Money market mutual fund assets were $225.5 billion at Dec. 31, 2014, down $14.5 billion or 6 percent from $240.0 billion at Dec. 31, 2013 and up $10.3 billion or 5 percent from $215.2 billion at Sept. 30, 2014." (Note: A transcript of the Federated earnings call is also available on the website Seeking Alpha.)
Federated's release continues, "Revenue increased by $3.1 million or 1 percent due to higher average equity assets under management, partially offset by lower average money market assets. The increase in revenue was also due to a decrease in voluntary fee waivers related to certain money market assets primarily due to lower average money market assets. For information about voluntary fee waivers related to certain money market funds in order for those funds to maintain positive or zero net yields, please see the table at the end of this financial summary. During Q4 2014, Federated derived 69 percent of its revenue from equity and fixed-income assets (46 percent from equity assets and 23 percent from fixed-income assets) and 31 percent from money market assets."
It explains, "Fee waivers to maintain positive or zero net yields on money market funds and the resulting negative impact of these waivers could vary significantly in the future as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, yields on instruments available for purchase by the money market funds, actions by the Federal Reserve, the U.S. Department of the Treasury, the SEC, the Financial Stability Oversight Council and other governmental entities, changes in expenses of the money market funds, changes in the mix of money market customer assets, changes in the structure of money market funds, demand for competing products, changes in the distribution fee arrangements with third parties, Federated's willingness to continue the fee waivers and changes in the extent to which the impact of the waivers is shared by third parties."
On the Q4 call, Federated President & CEO Chris Donahue comments, "Now looking at money markets, period end fund assets increased by about $10 billion and average money market fund assets increased by about $5 billion from the prior quarter. The growth was weighted to prime funds which added $7 billion. Our market share at year-end was about 8.2%. Money market separate accounts increased reflecting tax seasonality. We continue to work on product modifications and additions related to new money market funds rules which were released in July. We expect to have products in place to meet the needs of all of our money fund clients. These will likely include prime and muni money market funds modified to meet the new requirements, government funds, separate accounts and offshore money funds."
He says, "We are also working on developing privately placed funds in an attempt to mirror existing Federated money market funds to serve the needs of groups of qualified, usually institutional, investors unable to use money funds modified by the new rules. The new rules as you recall are subject to a lengthy implementation period. The floating NAV requirement for institutional prime and muni funds takes effect in October of 2016.... Taking a look at our most recent asset totals as of January 21st, managed assets were approximately $263 billion including $259 billion in money markets, $51 billion in equities, $53 billion in fixed income. Money market mutual fund assets were $223 billion."
Federated CFO Tom Donahue comments, "The impact of money fund minimum yield waivers was $29.5 million and it was down slightly from the prior quarter and about the same as Q4 2013. Based on current assets, fewer days and assuming overnight repo rates for treasury and mortgage-backed securities, run at roughly 6 to 8 basis points over the quarter and T-bills stay in the 2 to 8 basis point range. The impact of the waivers to pretax income in Q1 would be around $28 million. Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q1 levels would likely reduce the impact of minimum yield waivers by about 40% and a 25 basis point increase would reduce the impact by about 65%. Looking ahead, we expect that we will recover about 75% of minimum yield waiver-related pretax income when money fund yields increase to the point of eliminating these waivers. This estimate is based on our assessment of competitive market conditions including the expectation that we will incur higher distribution expenses as a percentage of money market revenues when rates and yields increase."
During the call's Q&A, Tom Donahue adds, "The expense related to the money market business and all the various structures and what are we doing, we spent a decent amount of money working to maintain that business in the past few years and so a lot of the resources there are going to help us structure new products and attract, maintain and gain new business. So I don't see big expense increases there, is the short answer."
Chris Donahue answered another question, "It's really hard to foresee the leakage at this point. We don't see it, we don't hear it from clients and if you've looked at the industry statistics, you've seen that money market fund assets are basically up over $2.7 trillion. So, on that part of it, there remains a tremendous desire on the part of clients across the board for these types of products. In terms of where we're going, we not yet ready to announce to all of the individual shareholders and individual funds how it's going to look. We have a pretty good idea of how it's going to look."
He also tells us, "There will be a number of fund mergers. There will be the spawning of more classes, we will have products in each area, treasury, government, prime and muni that meet the requirements. [We'll] also have 60 day funds, [and] have retail funds divided from institutional. But we are very much right now in what I like to refer to as the waterboarding stage of this whole exercise and we've, as Tom mentioned, changed the regulatory response expense into a restructuring of products expense and we think we will be able to score on all streets. And I look forward to, after the dust settles, being able to get back onto the track of increasing money market fund assets post the October 16 date."
Donahue responds later, "In terms of LCR, we are hearing from some of our larger clients ... as you read in the press, there is a rigorous effort to evaluate every cash management client in order to determine the capital cost and therefore the economic efficacy of keeping those clients by those large banks. And some clients are being asked to graduate from the relationship with the bank and this of course will inspire people to want to use money market funds. And I don't think there is going to be an alteration in that factor. It is very, very difficult for us to try and size that.... [As I] said earlier in this call that after the regulations are all put into place that we can look forward to higher balances again, in my opinion, and this is one of the factors."
The Federated CEO also says, "Well, the consolidation ... continues. Basically before the '08 crisis there were over 200 firms offering money funds. Today if you look at the list, there will be a list of 80, but the bottom 25 or 30 will have either very little money or money that they totally control the redemption right on. So, we look forward to more consolidation of the smaller players, but on the other hand if you look at the list, the top 30 or so players are not going to get out of this business. It's essential to where they are even though they may not have large components. So, yes there will be more consolidation as these regulations unfold but a lot of it has already happened."
Finally, he adds, "So in the new environment because we're going to have a bunch of fund mergers, some funds will disappear but we're also going to spawn more classes as I mentioned. And it's hard to say right now whether that would have any meaningful -- I don't think it would have any meaningful effect on expenditures. What I can say is that because of the elimination of an institutional prime money market fund as we knew it, there will be increase in costs in the marketplace and to us, because everything else that we're coming up with is not as good as that product. Of course that was the intention of the regulators."
