Federated Investors' fourth quarter earnings call with analysts Friday morning was dominated by talk of money market funds, specifically, the lessening impact of fee waivers, industry consolidation, reform-related fund flows, and Federated's soon-to-be-released Private money market fund. The Pittsburgh manager's latest earnings press release says, "Federated's money market assets were $256.4 billion at Dec. 31, 2015, down $2.4 billion or 1 percent from $258.8 billion at Dec. 31, 2014 and up $9.5 billion or 4 percent from $246.9 billion at Sept. 30, 2015. Money market mutual fund assets were $221.6 billion at Dec. 31, 2015, down $3.9 billion or 2 percent from $225.5 billion at Dec. 31, 2014 and up $5.3 billion or 2 percent from $216.3 billion at Sept. 30, 2015." Federated's share of the money market fund business in the U.S. was 8.0% at year-end, according to our Money Fund Intelligence XLS product. You can hear the replay of the earnings call on www.federatedinvestors.com or find the call transcript on Seekingalpha.com.
President & CEO Chris Donahue states, "We continue to advance on the substantial effort necessary to position our product offerings well in advance of the October 2016 requirements for floating NAVs for Institutional Prime and Municipal money market funds. We announced our institutional fund lineup in November and completed a series of fund mergers in December. We continue to work on a privately placed fund for qualified institutional investors who are unable or unwilling to use money funds as modified by the new rules." Later in the call Donahue said they were expected a Q2 launch for the Private fund. He added, “We completed the transition of $930 million in money market assets from Huntington in the 4th quarter and continue to look for consolidation opportunities."
Federated showed strong revenue increases, "primarily to a decrease in voluntary fee waivers related to certain money market funds." The release says, "The increase in revenue was partially offset by a decrease in revenue from lower average money market assets." In 2015, Federated "derived 33% of its revenue from money market assets." Yields jumped (0.03% to 0.06%) and charged expense ratios for money market funds moved higher (up 4 bps to 0.20% on average) in December as the Federal Reserve hiked rates for the first time in almost 10 years. Note that net and gross yields (and charged expenses) continued inching higher in January.
Federated COO Tom Donahue says, "The pretax impact of money fund yield related waivers of $16.4m was down from the prior quarter and Q4 of last year. Based on current assets and yield we expect the impact of fee waivers on pretax income in Q1 to be about $11 million. An increase in yields of 25 basis points in 2016 could lower this waiver impact to about $4 million per quarter and a 50 basis point increase could lower the impact to around $1 million per quarter. Finally an increase in yields of 75 basis point could nearly eliminate these waivers. However, as we previously discussed, partially offsetting any potential waiver recovery is the impact of a potential change in a customer relationship that may reduce pretax income by about $6 million per quarter beginning late in 2016. This is most of the amount of waivers that we began estimating a year ago that may ultimately not be recovered." Later in the call, Federated officials were asked about this potential change, saying it was a one-off situation and that they weren’t at liberty to say who the client was.
In the Q&A portion, the discussion turned back to fee waivers several times. One analyst comments, "I just heard that one or maybe more of your larger competitors may keep their prices at these depressed levels as fee waivers go up." He then asked about price competition in the MMF space. Chris Donahue responded, "I'm going to give you two elements to this. One, there has been one competitor who for a considerable amount of time, meaning more than a year, maintained a price of paying higher than what the yields would indicate in the marketplace and that has been something that we've had to deal with.... The other one was the individual client. This individual client is simply redoing the structure of their arrangement. And yes there are pricing things involved with it, but it is an individual customer who for a lot of different reasons is making these kinds of moves and we have not seen this duplicated in other clients nor do we have any other clients similarly situated." Later in the call he added, "We're not currently planning to have a different type of waiver recapture because of what competitors are doing or may do."
Chris Donahue continues, "So, yes there will be constant competition from others, but don't forget that it is the logical result of big hairy regulations to oligopolize the business. There are just less and less people going to be in this business. Before 2007 there were over 200 people offering funds and now there's about 60 and the bottom of those don't have much money and don't have much opportunity to distribute to third parties."
When asked if he thinks there will still be any small managers, say under $50 billion in AUM, in the next 5 to 10 years, Donahue says, "Yes ... and the reason is that either if you control the right to redeem your assets, then you could run a money fund with very modest assets.... And if you decide you can accommodate the regulations by running either all government funds or something like that -- then you can run a relatively small group. A second group will be those who have large fund groups and therefore can handle all the regulations and want to be offering all the products that are necessary to their fund group. They may not get to $50 billion in money market fund assets, but they will have those as an accommodation to their clients. So yes, those types of groups will continue doing business while the total number of purveyors of these products will continue to dwindle."
He also said it's possible we could see more large acquisitions, like BlackRock's purchase of BoA's MMF business. Later in the call he adds, "In this type of business, there's so much change..... `n some of those institutions, the money market fund business does not drive the truck.... We always put out our sign that we are warm and loving home for any of those opportunities."
On Federated's MMF platform and the opportunities going forward, Donahue explains, "Once the dust settles, we think there is excellent opportunity for growth in this business by us. Part of the reason is because the force of these regulations is to "oligopolize" more, and we are on the side, we believe, of the winners or the larger players in this business. Furthermore the clients right now are still to a large extent in "pause" mode. That will begin to change in first and second quarter as people decide what they're going to do and we see how much movement goes from institutional prime and or muni into Govies. We will have all the products available. We think we've got some pretty creative things going with our private fund. We think we're going to be well set up to capture this business for the long term."
Money Market Chief Investment Officer Debbie Cunningham adds, "If you look at the fourth quarter results, Prime funds were up substantially over the quarter and continued to be faring well in January. Having said that, with conversations continuing with our clients, we are aware that there will be some of them that at this point believe they will be moving into the government marketplace. And that's all well and good -- we have buckets to catch all of the various raindrops. If you want only Treasury we have that, if you are Treasury with repo we have that, if you want government agencies we have that, so there are a lot of different products that we can offer. It's one of the reasons why we didn't do any of the conversions that many of our competitors in the marketplace did."
She says with banks shedding deposits, "We think the industry in fact will grow and be substantially larger." Cunningham continues, "The private fund ... is a very innovative product that we believe will capture the attention of many customers in the marketplace and will give them basically the experience that they have had in a Prime Institutional money market fund, to date. So we think we're ready. We did a lot of fund mergers in the fourth quarter so our product is right-sized. We believe from a performance perspective and from a size perspective, we're positioned well in the marketplace as clients go through and make their decisions -- probably late second, early third quarter of 2016."
How will Federated be impacted if there is a wholesale shift out of Prime? Donahue says, "Since we have products in all areas, we think we will do pretty well. The returns on the government fund can be slightly less than the returns on the prime funds, and that's one of the reasons we come up with a private fund to attempt to duplicate that experience. Our main job will be to retain the client's allegiance, because what happens immediately -- meaning at the end of the second quarter, third quarter this year -- does not necessarily mean that's the end of the game. We do not yet know how much of that will move. You've seen estimates from as low as several hundred billion, which has already moved, to all of it, which would be $1.5 trillion, and estimates all in between. And we don't know what effect that will have on the spreads that exists between Govies and the Institutional Prime funds. Without knowing those, it's really hard to gauge exactly what will mean on the finances of Federated."
