Federated Investors released its Q3 earnings Thursday night, which showed a $7 billion increase in money market fund assets for the quarter. The press release says, "Money market assets were $246.9 billion at Sept. 30, 2015, up $1.4 billion or 1 percent from $245.5 billion at Sept. 30, 2014 and up $4.9 billion or 2 percent from $242.0 billion at June 30, 2015. Money market mutual fund assets were $216.3 billion at Sept. 30, 2015, up $1.1 billion or 1 percent from $215.2 billion at Sept. 30, 2014 and up $7.5 billion or 4 percent from $208.8 billion at June 30, 2015.... Growth in money market assets was offset by lower equity and fixed-income assets in Q3 2015 compared to Q2 2015." Federated saw a revenue increase in the quarter, due primarily due to a decrease in money fund fee waivers. In an earnings conference call Friday morning, Federated CEO Chris Donahue talked more about reducing fee waivers as well as new products and the impacts of money fund reform.
The release says, "Revenue increased by $6.2 million or 3 percent primarily due to an increase in revenue from higher average money market assets and an additional day in Q3 2015.... Operating expenses increased by $1.2 million or 1 percent primarily due to an increase in distribution expenses resulting from higher average money market assets and an additional day in Q3 2015." Money fund fee waivers in the quarter were $20.3 million, down from $22.3 million in Q2 and $30.2 million in Q3 of 2014. Year-to-date, fee waivers are $69.5 million, down $20 million from the first 9 months of 2014. The release adds, "Operating expenses increased by $1.2 million or 1 percent primarily due to an increase in distribution expenses resulting from higher average money market assets and an additional day in Q3 2015." Federated gets about open-third of its revenues from money market funds.
In the earnings call, CEO Chris Donahue says the bulk of the money fund asset increase came from transitioning over $3.7 billion in assets from Reich & Tang, which Federated bought earlier this year. Also, he says, "In our cash separate account business, we added the West Virginia Local Government Investment Pool, which funded at about $1.1 billion during the third quarter."
On new products, he explains, "We continue the substantial effort necessary to adjust our product offerings well in advance of the October 2016 requirement for floating NAVs for institutional prime and muni funds. We are working to have products in place to address the cash management needs of all our money market clients. We expect to offer prime and muni money market funds that meet the new requirements, as well as government money funds, separate accounts, and offshore money funds. We continue to work on a privately placed fund for qualified institutional investors who are either unable or unwilling to use money funds, as modified by the new rules. In addition to Reich & Tang, we announced an agreement with Huntington to transition $1.1 billion in money market assets in the fourth quarter. Interest levels and discussions around money market consolidation remains elevated."
Chief Financial Officer Tom Donahue says the decreases in fee waivers were "due mainly to higher fund gross yields. Based on current asset and yields, the impact of these waivers to pre-tax income in Q4 is expected to be about the same as it was in Q3. Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q3 levels would likely reduce the impact of yield waivers by about 45%. A 25 basis point increase will reduce the impact by about 65%. We expect to capture about two-thirds of the pretax income related to the remaining money fund yield waivers." He pointed out that this does not mean Federated will recapture fees from the past, it refers to going forward.
When asked about the concept of using fee waivers as a competitive advantage to gain market share, Chris Donahue explains, "We have seen it ... people have an inclination to want to use pricing to try and capture share. This is not our idea at all. We're not going to be using these as weapons or strategies in order to gain share by reducing price, or not allowing the price to go back where it would have gone if they ever decide to raise rates."
Donahue says, "They're [clients are] leaning every which way. Some of them have not yet ... figured out what to do. Others have decided that they definitely want a stable NAV at any cost and at any situation. A lot of money fund clients are looking for cash management service, which implies dollar in, dollar out, and that would tend to push them into government funds. We are seeing viability for other types of products -- private funds, perhaps even 60 day [maximum maturity] funds -- because after the first consideration of stable NAV, the yield does become an important second consideration."
He explains, "We have seen with clients who sweep that they either don't want to mess around with the floating NAV or they don't want to change their systems in order to do a sweep.... They're going to be heading primarily toward retail products where they can, as opposed to institutional... When we are looking at developing the private fund and the pricing thereof, we are looking at the standard type pricing that we have now. This is not to say that we can't and won't be in a position to respond if others decide to go another way, but that's currently how we're looking at it."
One analyst asked about the timing of money fund asset moves leading up to October 2016. Chris Donahue said that is a difficult question to answer. Some assets have already moved and some will move around year-end because that's when some of the banks who are shedding deposit assets will look to remove that money from balance sheet, he responded. "But I think it has to almost wait until the full maturity of the October 2016 deadline for implementation of the new rules, because that's when everybody really knows what everything's going to look like."
He adds, "Now, every one of us who is in this business is going to try and get things organized well ahead of that. But that's the point at which I think you begin to see meaningful positive flows coming back into the money fund business. Right now, obviously, we're spending a lot of time, as our others, restructuring products, talking to clients, and they're trying to figure out exactly where to go.... This is part of what informs our effort to create the products, but it's really tough to say exactly when you begin to see that money move."
Debbie Cunningham, CIO of Global Money Markets, adds, "As rates increase, historically, money market funds have lagged the direct marketplace. We've already started to see yields increase on money market products despite the fact that the Fed hasn't made a move yet. But when those moves actually start in earnest, even if it's at a slow pace, the expectation is that money market funds are going to keep pace much more closely correlated than has historically been the case. That's when you are going to see deposit rates lag. They are going to lag for two different reason -- one, banks don't want those deposits anymore, and two, it's an administered rate. So they can figure out a way that makes it easier for them to shed them in a rising rate environment, especially when they're not keeping pace with that rise. We do think that the rising rate environment will begin that movement process."
Finally, on the state of the business in general, Donahue concludes, "It is more challenging in the sense that every time you turn around there's another gang of regulation. We've been through the redo on money market funds, which to the people working on it is truly waterboarding, as we were told by one of the Commissioners it would be. We're now dealing with liquidity rules, a fiduciary rule, and the SEC has said they're going to come out with a derivatives rule before year end.... [Regulation] 'oligopolizes' the business. You can see it clearly in the money fund business. It makes it more and more difficult for other players to get in.... So I can at once say that it is far more challenging and say that we're very happy with where we are and with our growth prospects. At the same time, I would contend vigorously that this investment management business is a great business."
