Federated Investors hosted its latest quarterly earnings call on Friday (listen to the replay here and see the transcript from Seeking Alpha), and, as usual, CEO & President J. Christopher Donahue opined on many things related to the money market mutual fund business. Regarding Federated's results, he tells us, "Looking first at cash management. Average money market fund assets were down $13 billion from Q1, and period end money fund assets decreased by $10 billion. The decrease included seasonal effects of tax payments and decreases by certain institutional investors against the backdrop of declining rates and yields over the quarter. Debbie [Cunningham] will comment later on, on market conditions and our outlook for rates." (Note: Federated also launched a campaign supporting the website "Save Money Market Funds", which is asking investors to comment to the SEC's proposals.)
Donahue adds, "Our market share for money funds decreased slightly in Q2 to approximately 9% from 9.2%. For historical purposes, recall that in '08, our share was about 8.5% and back in 2000, it was about 5%. The impact of yield-related fee waivers increased in the second quarter. Repo rates have been at very low level since mid-May, which of course, impacts the waivers. And Tom [Donahue] will comment on this in his remarks."
Donahue explains, "On the regulatory front, the SEC issued its 700-page money market fund reform proposal for public comment last month. We commend the SEC for taking a thorough and thoughtful approach proper to preserving their jurisdiction for money market funds. We're working on a series of comment letters to address various aspects of the proposal. The main points of the proposal have been extensively reported, so I won't go through them. Our initial reaction to the proposal is that parts of this are workable, like gating, and would improve money funds, and other parts are unworkable, like floating the NAV, and unnecessarily detrimental to money funds with negative implications for investors, issuers and the financial market."
He tells us, "Our core beliefs remained consistent. We continue to advocate for sound policy that enhances the resiliency of money funds for our clients, who fully understand that money funds like other investments have elements of risk. They are not interested in radical, costly and unnecessary change like floating the NAV. The floating NAV would create market inefficiencies without providing meaningful benefits. In particular, as both the Fed and the SEC has acknowledged, the floating NAV would not eliminate the idea of runs."
Donahue adds, "We know that many institutional money fund users have gone on record to make it known that they cannot or will not use any floating NAV money funds due to a host of legal and/or investment policy restrictions, operational complexity and tax burdens. Tax issues remain unsolved and significant. The cost with that systems to accommodate the floating NAV would be enormous. These and other issues will cause many users to move from the product if subjected to a floating NAV. We believe that some of these money fund users will migrate from institutional funds to government agency money funds creating dislocation in that part of the market. Others will increase deposits in banks, in particular among the largest banks, making them even bigger. So others will look to separate accounts, offshore products and other less regulated and less visible alternatives."
He says, "This process is unnecessary and will be very disruptive to investors and to the financial system. The cost will be significant and real. And the benefits will be minimal, if any. The impact of the floating NAV were it ultimately to be enacted on the money fund asset levels of our clients is difficult to assess. We are hopeful that a significant portion of our current $97 billion in prime money fund assets would be properly classified as retail under the proposal's definition, recognizing that the implementation of a retail exemption could be operationally difficult and involves added complexity because a large portion of our assets are held in omnibus accounts."
Donahue comments, "In contrast with the floating NAV, gating, that is giving the fund's Board of Directors the option of a gate on redemption in extremely rare periods of a dysfunctional market, as experienced by money funds and other participants in '08, promotes the equal treatment of investors and improves financial markets by potentially stopping a run, dead in its track. It has proven to be effective in practice, avoids costly and unnecessary disruption and most importantly, preserves the critical features and benefits of money funds for investors, issuers and the capital markets."
He also says, "Following the meaningful reforms enacted by the SEC in 2010 and voluntary efforts by major industry participants, which continue today, to further increase transparency by publishing daily shadow price NAV, money funds are among the safest and most transparent investment products. And will be further enhanced by adding the gating option. Radical change like floating the NAV will unnecessarily cause the demise of the institutional prime money market funds, a high-quality product that enhances our financial system on many levels."
CFO Tom Donahue says on the call, "Taking a look first at money fund fee waivers. The impact of pretax income in Q2 was $23.7 million, up from $21.7 million in the prior quarter. The increase was due mainly to lower rates for treasury and mortgage-related securities. Based on current assets, and assuming overnight repo rates for treasuries and agency securities run at 3 to 8 basis points over the quarter, the impact of minimum yield waivers to pretax income in Q3 could increase to $28 million. Looking forward and holding all other variables constant, we estimate that gaining 10 basis points in gross yields would likely reduce the impact of minimum yield waivers by about 45%, and a 25 basis point increase would reduce the impact by about 70%. It is important to note that the variables impacting waivers can and do change frequently. Revenues in Q2 decreased 2% from the prior quarter, due largely to minimum yield waivers and lower average money fund assets."
During the Q&A, Chris Donahue says of their "Prime" exposure, "So we're right now, we're at $97 billion in Prime; $12 billion of that is from offshore products, okay? So that's not subject to the SEC.... Another $5 billion is our leftover historical direct retail, along with our internal use of Prime funds ... so that's not an issue. Then we have $25 billion of the $97 billion that comes from broker/dealer sweep accounts, where usually the underlying customers tend to be retail as defined.... Then we have $8 billion that comes from our institutional cash market, which tends to be large corporate customers who could not meet $1 million day-type redemption. Okay. So then we have 2 other categories. We have $32 billion in Trust and Wealth Management, which is our bank trust business is basically. And another $15 billion in our capital markets. So this $47 billion, all these clients, more or less, have come in through omnibus accounts and they are very difficult to characterize. We do know ... the $1 million isn't going to work for [some of] them and others say that, most of the time it works but sometimes, it doesn't. And so they might be thinking about different numbers. So it's very difficult for us to characterize that $47 billion because we don't see behind the curtain as to what their redemption profile is."
Finally, when asked about consolidation, he answers, "We would be open to discussing with others who choose to get out of the money fund business at any time. So we will be open to doing that. And we have been doing that for many years.... [R]emember that I guess it was about in '07, there were over 200 people doing money market funds. Today if you look at the list, they list about 80 people doing money funds. And I think the bottom 10 or 15 of those have 10 million or 20 million in it. So you barely have 60 firms doing money market funds.... I think there are consolidation candidates there. But there has already been a [lot of] consolidation going on here, or to look at another way, an oligopolization of this business. `And that is encouraged each time you put on more rules, regulations and challenges, so that will just continue.... Owner operators like revenues and businesses even if it may not be the best [area]. It would be best if we could just do acquisitions [in] equity that will help the ratios, the PEs and all of that. But, if we think we can make a good trade on money funds, we're happy to do it."
