Last week, we quoted from Federated Investors' CEO Chris Donahue, who spoke recently at Barclays Capital's "2010 Global Financial Services Conference". (See Crane Data's Sept. 14 News "Federated's Donahue Says Liquidity Bank Idea Whose Time Has Come".) Today, we quote Donahue's responses from the Q&A section of his presentation, when he was asked about capital reserve requirements and the ultra-low rate environment. His responses follow.
He was asked, "How can you be so sure that capital requirement won't be part of the opening solution for the money market fund industry? Donahue answered, "Well, I can't be sure about it, but I'm confident about it. Here is why. Let's say they even go with ... requirements of 7% [capital]. JPMorgan has over $400 billion dollars of assets. Where are they going to get their $30 billion dollars of capital, if that is the number? [Even if] that is too high, because money funds shouldn't be as much, would it be half of that, or $15 billion? Even that doesn't work in the business. Capital requirements like that are the same as sounding the death knell of the money fund as a business. At some point, the economics have to work as well, and at some point those capital numbers are too high in order to allow the business to function."
He continued, "JPMorgan is the example I like to use because they are not in favor of capital either, and we find it something that is in our mind unnecessary if you go along with the liquidity bank.... [W]e have access to $500 million dollars ... we are not exactly short hitters on this field either. We are able to play ball at those kinds of levels. But if they decide that it should be 7.5%, then really they are telling something different about the existence of the money fund business. And we just don't think that is what's going to happen."
Donahue explained, "Furthermore, I think there is an overlay for various people that they are always going to be discussing these kind of subjects, whether is capital or variable NAV, because no one wants to just say, 'Oh, well everything is perfect....' So in order to protect themselves ... various regulators will always be studying these types of issues. We've tried to reflect our views in terms of what we've done. There is no reason for us to have to buy SunTrust's assets if we didn't believe the kinds of things that I was just saying. I can't be certain about what the regulators will do, but we have a lot of confidence that that won't be in the offing."
He was also asked how the business would fare if rates stayed this low for 5 years. Donahue answered, "If short rates stay at these levels for 5 years, you have bigger problems than what is going to happen in money funds. We just don't foresee that, however. We are determined as an enterprise because of how we structure our business that we can withstand these low interest rates even if they go through '10, '11, etc.... [T]he reason is that we are basing this on the core expenses of the fund being covered.... As long as interest rates, meaning the short term repo rate ... stays at or about 20 bps -- that means that over time the gross yield on those funds would be 20bps -- all of the third party cost and core expenses are covered. There is even some amount of bps to be divided among intermediaries, Federated and the customers in actual yield. We are in it for the long haul, but I've never heard anybody with the projection that interest rates are going to stay [down for] 5 years, or that [the Fed] means by the word 'extended' some sort of 5-year run."
