Federated Investors, the 4th largest manager of money market funds with $205.7 billion, held its 1st Quarter earnings call Friday, and CEO Chris Donahue, CFO Tom Donahue and CIO Debbie Cunningham discussed Federated's money fund product plans, fee waivers, potential asset flows, and more. Donahue comments, "We continue to make progress in reshaping our Money Market fund product line in response to the 2014 rules. The fund's Board will consider a variety of related proposals next month and we expect to be able to fill in additional details on product changes in the coming months. 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 money funds, separate accounts and offshore money funds." (See the Seeking Alpha transcript of the call here.)
He continues, "We're also working to develop privately placed funds in an attempt to mirror existing Federated money market funds to serve the needs of groups of qualified institutional investors unable or unwilling to use money funds modified by the new rules. The new rules are subject to a lengthy implementation period. The floating NAV requirement for institutional prime and muni fund takes effect in October 2016.... Last week we announced a deal with Reich & Tang Asset Management to transition approximately $7 billion in money fund assets to Federated money funds. We're working with Reich & Tang financial intermediaries and fund shareholders to transition these assets, which we expect will begin in June.... We recently announced the addition of the West Virginia local government investment pool and expect about $1.2 billion to fund in the third quarter."
CFO Tom Donahue comments, "The impact of money fund yield waivers of $27 million was down from the prior quarter and year-over-year. Based on current assets and assuming overnight repo rates for treasury and mortgage backed securities, we're on roughly 9 to 12 basis points over the quarter and T-bills stay in the two to 10 basis point range. The impact of these waivers to pretax income for Q2 would be around $24 million. `Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q2 levels would likely reduce the impact of yield waivers by about 40% and the 25 basis point increase would reduce the impact by about 65%. We continue to expect to recover about 75% of money fund yield waiver related pretax income when yields increase to the point of eliminating these waivers."
He explains, "This estimate is based on our assessment of competitive market conditions including the expectation that we will incur higher distribution expense as a percentage of money fund, money market revenues when rates and yields increase. Multiple factors impact waiver levels and we expect these factors and their impact to vary. These factors include changes in fund assets, available yields for investments, actions by regulators, changes in the expense levels of the funds, changes in the mix of customer assets, changes in product structure, changes in distribution fee arrangements with third parties. Federated's willingness to continue to see waivers and changes in the extent to which the impact of the waivers is shared by third parties. Q1 effective tax rate was about 38% as expected and that continues to be our expectation going forward. Looking at the balance sheet, cash and investments totaled $280 million at quarter end."
During the Q&A, Chris Donahue commented, "[W]hat I expect to happen over the longer term is that in a post October 16 environment, Federated will see increases in assets in the money market fund area because the dust will settle, all of the education will have occurred on the efficacy of the new product offerings and the things that exist in the marketplace now to encourage more cash use will continue, for example banking regulations that causes certain customers to not be favored as deposit customers.... [It] used to be [that] half of the corporation's [cash was in] money funds. Today that number is closer to 20%, and I think they will come back in. So overall I think we will begin to see increases in assets, which I think will turn back to increases in market share for our offerings."
Debbie Cunningham commented on the potential prime vs. govt fund spreads, "[Historically it's been] 12 basis points [so a 60 day maturity fund would be] somewhere in the six basis point neighborhood. [T]here will likely be some swell of assets that initially takes the easy path ... going into a government fund from a prime fund.... [But] supply/demand differences in the marketplace ... would probably cause that 12 basis point spread on historic basis to go a little bit wider. How much wider? 20 basis points, 30 basis points, 40 basis points? You pick the number. But at some point [investors] yet have the allowances to go back into prime at that point. There will be a point at which they then look at whatever that spread differential is and think it's fairly attractive. What we think will be the case is that there will be sort of reverse swells that go back in the other direction probably over a longer period of time, but with less volume in each one of them."
Chris Donahue commented, "As regards to roll up activity, as I've said on these calls before, before the '08 timeframe, there were over 200 firms offering money funds. Today if you look at the list there are 80, and the bottom 25 or so don't have enough of assets to really make a third-party go of it. And so increasingly, you see one at a time type things like Touchstone or like Reich & Tang or others that we've done come along.... If you look at the whole picture of it you would say gee, '08 caused people to leave the money funds, the '10 amendments caused others to leave. The '14 amendments will cause still others to leave, and the actual implementation date in '16 will cause others. So it is more or less a steady March, but it is without a sudden catalyst."
Donahue adds, "What we've said is that at the fund Board meetings, which is mid-May, we will go to the Board with the proposals as to which funds will end up in which category. We have already announced the types of buckets and the types of funds that we will have, and so we're sticking with that and now we're putting the finishing touches on getting clearance from the Boards that this particular fund will be a retail fund, this particular fund will be an institutional fund, this fund will be a 60-day fund etcetera. And I won't commit to a time right now, but it will be some time after that Board Meeting when will say which funds are going to be going in which direction and it maybe that there are more than one announcements that come out. In addition, we have a large proxy that we're working on for our one fund that has several portfolios in it equal to $175 or so billion of our money fund assets, and so that is a big effort to get that proxy statement done and that will be occurring. We'll also have seven or so fund mergers and will probably spawn 20 or 22 new classes. So there will be a lot of those kinds of changes and they may take enough time that we go through and have more than one announcement about what's going on. The proxy statement of course itself will be a large and substantial public announcement."
Cunningham answers, "From a spread differential perspective between prime and government, like I said before, it's definitely going to increase. [W]e're [likely] going to see spreads increasing in some way, shape or form. From 12 to 20 to 40, I don't know exactly where it stops, but at some point there is a trade off that customers who chose to go into the government option then don't need to will want to rethink ... their options in the marketplace because the differential is now large enough. Historically that's been somewhere in the 20, 25 basis point range but, [this] could be different, and certainly in the context that we've been at zero for so long, who knows what holds going forward. But it's not that we think that there will be government yields going in one direction while prime goes in the other. We do think that they will both be [higher but with] prime going up a little bit higher."
Donahue commented, "At this point, I don't see anything in changing what we have determined we are going to do in terms of the kinds of funds that we're going to offer. In other words, we're still going to offer 60 day funds, and, as I mentioned, we're going to work on private funds. We're looking at separate accounts, and we're going to have 'Mary Jo White' funds -- that's what I call institutional prime funds that have a floating net asset value that are greater than 60 days. So we're going to score on all those streets."
On the SEC's FAQs, he said, "It was interesting to note that on the 60 day funds, they've gotten into the communication and marketing of it, and here you're not permitted to say that you seek to maintain a $1 net asset value on your 60 day fund. Regardless of whatever intents you have or however Debbie is managing the fund, you're not allowed to say that and further you must say that the NAV will fluctuate. So you have these two things to deal with. This will require increased education, and that's why I said in answer to an earlier question that once people see how these products work the education is complete, the dust settles, then people can logically see how these things are all being interpreted."
Donahue also stated, "In terms of amount of money in motion ... on the money fund side, we've heard estimates from $100 billion to $500 billion of money moving from prime to govie on an initial basis. And I can't really put my finger on either side of that or come up with a good estimate myself.... We've been having discussions with some of our larger clients [about] increasing balances because of the Basel III impact of non-operational deposits.... In terms of clients they're waiting to see how the dust settles. So I'm not able to say what exactly our client base will do, and believe me we talk to them quite often. But they look at cash management as something that's simple and that's done and they'll decide when they have to. So I don't have a precise answer on what amount of our clients will go in which direction."
Cunningham adds, "I would say that from a retail prime perspective, that there will be something on the order of maybe 10% of those assets from a Federated standpoint shifting into something other than where they are now in that prime retail category. And it mostly has to do with broker-dealer sweep.... The vast majority of our intermediaries that offer that service won't have an issue with it, but we found a few that likely could. On the higher side so that's sort of the low end of estimation of assets switching and money in motion. On the higher end, we're probably up in the third of the assets that would be and what would be our true institutional clients most of them retaining the capability.... So I think we have a variation depending upon the types of clients and I think that's probably ranging somewhere in the 10% up to 30%, 35%, 40% range with the initial money in motion change. And then with ultimately some of the portion of that going back into their original type of product at some point when spread to widen out. What that takes from a spread perspective is hard to say."
When asked about $1 trillion possibly moving out of banks, Federated's Donahue answered, "I can't comment on how you got the trillion dollars. I think it's big in terms of an opportunity. But don't forget that those banks are going to be doing everything they can to somehow keep that money in the family in some way, meaning their own family that doesn't negatively impact their capital, the ratios or how they run their business. So they're going to want to try to keep it, and they already have it. But on the other hand, that's why they're talking to us, because we're a warm and loving home. So I can't put a number on what we'll get. But there is a substantial opportunity and that's why I said at one point that I believe in the post 2016 environment you will see up assets in money funds."
