Federated Investors reported earnings late last week and hosted its latest quarterly earnings call on Friday. (See the Seeking Alpha transcript here.) As they do each quarter, Federated's management team weighed in on a number of money fund related issues. CEO & President J. Christopher Donahue commented, "Looking now at money markets. Total money market assets decreased by about $11 billion, with funds down about $10 billion and separate accounts down about $1 billion. Much of the fund decrease about $9 billion was due to withdrawals related to client M&A activity. This is usual business."
He continued, "We also had one client redeem a significant amount, about $8 billion, in April due to a change in their cash management process and we saw asset decreases around tax payment periods in both April and in June. These decreases were partially offset by three clients each adding more than $1 billion, adding [up] to about $5 billion, as well as net increases from other clients. Interestingly, prime money fund assets increased about 4% in the second quarter to $31.3 billion. Taking a look at our most recent asset totals, excluding Hermes. As of July 25 managed assets were approximately $384 billion, including $258 billion in money markets, $64 billion in equities, $62 billion in fixed income. Money market mutual fund assets were $174 billion."
CFO Tom Donahue said, "Total revenue decreased by about $8 million from the prior quarter due mainly to lower average assets and higher money market fund waivers partially offset by an additional day in Q2. Reported revenue was down about $17 million compared to Q2 of last year of which $8.2 million was due to the impact of the adoption of the revenue recognition standard. Higher waivers primarily from money market fund and changes in asset mix of average money market assets also impacted revenues. Operating expenses decreased $8.9 million compared to the prior quarter and $13.3 million from Q2 of 2017. The decreases from the prior quarter was due to lower compensation and related expense from payroll tax seasonality and to lower incentive compensation. Distribution expense decreased mainly due to lower money market fund assets. The decrease from Q2 of 2017 was primarily due to lower distribution expense due mainly through changes in the mix of average money market fund assets. The adoption of the revenue recognition standard also reduced distribution expense by $7.4 million and other expense by $1 million compared to Q2 2017."
When asked about fee waivers, Chris Donahue responded, "These are different fee waivers than those that were done in order to maintain a positive yield back in the day. So, let's set that aside, and I know you know that. What occasions these particular waivers are simply competitive forces in the marketplace in order to maintain these products at a competitive level." President Ray Hanley added, "You can look through our disclosure. I mean … prior to even the low point of the rate cycle, we would report in their hundreds of millions of dollars' worth of fee waivers. So as Chris said, this is really a continuation of a long-term trend of waving portions of our fee for competitive purposes."
Another analyst also cited the "competitive waivers [mentioned] in the release," asking, "So to what extent were they more severe this quarter than you've seen in the past?" Hanley responded, "I don’t know that they were more severe. I think that when we were doing attribution to those line items they stood out as significant enough to mention.... So, I don't know that I would call them more severe…. In terms of area of product, no, they kind of go across the different types within money market. So they would correlate more to asset levels … in terms of the financial impact and not necessarily to the type of asset."
Federated's earnings release explained, "Revenue decreased by $16.8 million or 6 percent primarily due to the adoption of the new revenue recognition accounting standard. In addition, revenue decreased due to higher voluntary fee waivers for certain money market funds for competitive purposes and a change in the mix of average money market assets. During Q2 2018, Federated derived 61 percent of its revenue from equity and fixed-income assets (44 percent from equity assets and 17 percent from fixed-income assets) and 39 percent from money market assets. Operating expenses decreased $13.3 million or 7 percent primarily due to decreases in distribution expense related to a change in the mix of average money market fund assets and the adoption of the new revenue recognition accounting standard."
Analysts also asked about the shift of deposits from banks into money market funds. Money Market CIO Deborah Cunningham answered, "Yes, we are seeing that. We started seeing that in the second half of 2017, and it is certainly continuing into 2018. As you well know, I’m sure the deposit beta with banks is very low in an upward trending interest rate environment which we've been in now for several years. And I think, certainly, the institutional side of the marketplace has recognized that and has started to transition into money funds, some of their deposit product, cash, liquidity. [But it's been a] little slower on the retail side. So, from a bank's trust perspective, I'd say it's less and maybe lagging a little bit there but it certainly has started. And it's interesting: the flows have gone both into the government funds as well as the prime funds. The government fund is more from a sweep product perspective because those products do not have gates and fees associated with them. For the Prime and Muni product, it seems to be more on a ticket trade basis, but substantial size from those businesses."
Another analyst asked about a shift to "direct ownership" of securities. Cunningham responded, "That is not a trend that we've been seeing.... [In the past] the biggest direct switch from funds into a product in the market was to switch into repo, and repo is just not that accessible any longer. There's fewer participants in the marketplace, although the rates in the second quarter offered was a little bit better than it has been over the previous quarters compared to where other short-term interest rates like commercial paper and CD rates are. It still is something that is contractual. It's got a lot of 'legal' associated with it, and as such, we've not seen too much of a switch into the direct marketplace. Some of our very large clients that have some of the M&A activity, potentially some of repatriation activity, they have taken some cash and put it into the direct commercial paper and CD marketplace. But it's not a big trend, its more sort of the supersized players in the market that have gone that route."
Finally, Federated's latest 10-Q filing tells us, "On April 5, 2017, European Parliament passed EU money market fund reforms (Money Market Fund Regulation or MMFR), which went into force on July 21, 2017. The MMFR provides for the following types of money market funds in the EU: (1) Government constant NAV (CNAV) funds; (2) Low volatility NAV (LVNAV) funds; (3) Short-term variable NAV (VNAV) funds; and (4) standard VNAV funds. The reforms became effective (i.e., must be complied with) in regards to new funds on July 21, 2018 and will be effective in regards to existing funds on January 21, 2019. Federated continues product-type analysis (e.g., whether certain CNAV funds should convert to LVNAV funds), compliance and other efforts utilizing both internal and external resources to prepare for MMFR. Federated also continues to engage with trade associations and appropriate regulators in connection with the MMFR as the European Securities Market Authority and the European Commission begin work on the next stage of implementing the MMFR."
It adds, "While the MMFR will need to be complied with in 2018 or early 2019, government CNAV and LVNAV fund reforms will be subject to a future review by the European Commission in 2022. This review will consider the adequacy of the reforms from a prudential and economic perspective, taking into account, among other factors, the impact of the reforms on investors, money market funds, money fund managers and short-term financing markets, the role that money market funds play in purchasing debt issued or guaranteed by EU Member States, and international regulatory developments. As noted above, it is uncertain whether Brexit could delay implementation of the EU money market fund reforms. For Federated money market fund products subject to the MMFR, Federated has begun to take steps to structure such products consistent with the MMFR."
