Federated Hermes, the 5th largest manager of money market funds, reported Q1'20 earnings late last week and held an earnings call on Friday. (See the earnings call transcript here from Seeking Alpha.) The company's earnings release explains, "Money market assets were a record $451.3 billion at March 31, 2020, up $132.9 billion or 42% from $318.4 billion at March 31, 2019 and up $55.8 billion or 14% from $395.5 billion at Dec. 31, 2019. Money market fund assets were $336.1 billion at March 31, 2020, up $121.3 billion or 56% from $214.8 billion at March 31, 2019 and up $49.5 billion or 17% from $286.6 billion at Dec. 31, 2019."

They write, "Revenue increased $52.1 million or 17% primarily due to higher average money market and equity assets. During Q1 2020, Federated Hermes derived 56% of its revenue from long-term assets (38% from equity assets, 13% from fixed-income assets and 5% from alternative/private markets and multi-asset), 43% from money market assets, and 1% from sources other than managed assets.... Operating expenses increased $30.3 million or 13% primarily due to an increase in distribution expenses associated with higher average money market fund assets. Federated Hermes ranks in the top 6% of equity fund managers in the industry, the top 7% of money market fund managers and the top 11% of fixed-income fund managers. Federated Hermes also ranks as the 13th-largest SMA manager."

On the earnings call, Federated Hermes CEO Chris Donahue comments, "Moving to money markets, assets increased by about $56 billion or 14% in the first quarter to a record high of $451 billion, reflecting a flight to safety in turbulent markets and a significant yield advantage compared to the average deposit rate. Money market fund yields also compared favorably to applicable direct market rates and even longer duration securities. With the Fed move to a target range of 0 to 25 basis points, short-term yields, including those of money market funds, decreased over the quarter and are expected to decrease further. Tom will comment on the impact of minimum yield waivers in Q1, which were not material. Our money market mutual fund market share, including sub advised funds at the end of the quarter was 8.8%, about the same as at the end of 2019."

CFO Tom Donahue tells us, "Total revenue for the quarter was up about $1 million from the prior quarter, due mainly to the acquisitions as mentioned and from higher money market assets, which added about $3.4 million.... Distribution expense increased about $3 million compared to the prior quarter, with about $4 million from higher average money market fund assets partially offset by a reduction of about $1 million from fewer days in the quarter…. The impact of money fund yield related fee waivers in Q1 was not material. Based on recent assets and expected yields, the impact of these waivers on operating income in Q2 could be about $3 million. 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 level of funds, changes in the mix of customer assets, changes in distribution fee arrangements with third parties, Federated Hermes willingness to continue the fee waivers, and changes in the extent to which the impact of the waivers is shared by third parties."

During the Q&A, President Ray Hanley says about fee waivers, "We've talked before about the mix of assets when you slot them into the expense levels of the various funds that they're in. And, generally, we have more of the assets in the institutionally priced products, in the 15 to 20 basis point expense cap range, as compared to the last cycle. That's because back then we had higher broker dealer suite assets using money market products and over the past several years brokers have converted significant portions of that to deposit-based sweep models.... The other significant difference would be the growth over the last couple of years [of the] government fund side. As you know, the prime products were impacted significantly ... by the 2014 rule changes that took effect in 2016. And we've had good growth on the prime side, but the proportion of assets in government portfolios would be higher than it would have been in the prior cycle."

Hanley adds, "In terms of waivers, as Tom indicated, there's a lot of potential volatility even coming up with a number for this quarter because rates move around, asset composition moves around. It's not linear, you get to a point where you're just below the funds, just above the funds expense ratio and so you have no waivers and then you drop a couple of basis points and the waiver switch gets turned on. So, there are so many variables that it's not appropriate for us to try to forecast it out over longer periods of time. Of course, you can look back at what happened over the years where we did have waivers recognizing differences in the asset mix, etc., that I pointed out before."

Money Market CIO Debbie Cunningham comments, "When we look at our government products, as well as our prime products, [and] new products, they all have positively sloped yield curves, which is -- right now which is positive, which is a good thing. On the government side, we've probably got steepness of anywhere from 15 to 20 basis points, depending upon whether you're looking at Treasuries or government agencies, fixed or floating, albeit these are at extremely low levels. We do believe that a couple things could happen to improve that over the next months and quarters to include a huge amount of supply ... and more of that to come with a lot of that being centered directly in our space, the liquidity space."

She continues, "We also believe that a technical adjustment from the Fed could be forthcoming. It did not occur this week at the Fed meeting, but we do believe taking the lower bound where the RRP currently sits at zero up to 5 basis points, which is where that rate stood through the last zero rate environment.... We do believe that to be likely.... All of that is beneficial to where we're doing business on an overnight basis, obviously, but also where we're reinvesting as securities mature. The smaller portion of our asset mix, that being prime and municipal, have spreads that are anywhere from 50 to 70 basis points, depending upon what securities you're looking at, fixed or floating, commercial paper, different types of short-term securities, CDs. So the reinvest there is actually a much simpler process and the ability to keep out of waivers and keep above the zero rate environment is simpler. However ... our mix of assets from a government to non-government standpoint at this point is heavily skewed towards the government space."

When asked about regulatory changes, Donahue responds, "So money market funds continue to be the eighth wonder of the world in my opinion and the question you asked of course returns to the thrilling days of yesteryear when even back then the arguments were not based on what was needed in the marketplace, they were based on political considerations, namely that the Fed decide -- well it is really Treasury Secretary decided to slap insurance on the funds back then when all that was needed was liquidity. The industry, us in particular, others were clamoring for liquidity and that's the role of the Fed is liquidity. When you look at what's happened recently, what happened was they put out trillions of dollars of activity and an infinitesimal percentage of that was utilized by money market funds at the beginning in the prime space. And once again it was the quest for liquidity where the Fed as it has done on many occasions in the past and with other programs is in charge of making sure that these markets actually work."

He adds, "In addition, especially on the prime side, there is a great thirst to get companies that are employing people financed on the short end, and money market funds are a wonderful way of doing this. And so they approach this with mixed views at various times. So to us, nothing more is needed on the money market fund side. In fact, it would be better if they went back to allowing ... Prime Money Funds to have a $1 net asset value, and then you could use them in sweep products and increase the financing for corporations and on the municipal side. There is a huge 'to do' going on now about financing municipalities and local governments and one of the best ways to do this on the short side is both to allow them to invest in a prime fund and to allow them to issue into money market funds on the municipal side. So to me the money market funds continue to be a beautiful viable system and they are not in need of any other attention."

When asked where all the money is coming from, Cunningham tells us, "As [far as] the growth in assets goes and the diversification of the underlying clients, I don't believe very much is actually due to bank line [of credit] draws. We've been asking that question and our answers that we've been getting have been ... the diversification of the flows is pretty substantial. It's corporate, it's financials, non-financials, it is the institutional as well as the retail side. It's universities, it's various other municipal entities. It's different types of trust accounts through the banking system. So it's really pretty diversified, and I don't believe much at all can be attributed to the drawdown in bank lines that has been occurring for some corporates."

On money funds vs. bank deposits, she adds, "Even as the yields on our products come down, they're still above what is available [on deposits] for the most part. And on the bank deposit side, those rates have also been coming down. They follow the market down much faster than they follow interest rates up. And as far as the expectation of stickiness, what I mentioned before growth in assets has come in a very diversified way, that generally results in more stickiness of those assets staying around. It's been a mix of existing customers as well as new customers, new customers that are diversifying away from either current providers ... in the mutual fund business or diversifying away from other competing products and into the money fund business. But in either case, I think that diversification again adds to the likely sticky nature of those assets."

Cunningham states, "The other thing that I would mention, once investors are comfortable moving a portion of their liquidity assets into money market funds, the experience is generally one that is good and substantial. They achieve daily liquidity at par really on pretty much a moment's notice for both purchases and redemptions. If they want to add to their asset mix, they purchase and subscribe into a fund and that's taken. If they want to redeem, we provide them back with their liquidity immediately. So I think that liquidity on a constant basis is really something that is noted by investors. It was noted in the first quarter, it continues to be noted in the second quarter, and basically receiving that at par with the market return is what they're continuing to look for."

Tom Donahue tells us, "The fee rates across the -- all of the money markets are a little under ... 8 basis points for advisory fees. And there are not meaningful differences between the categories. We don't really price the funds in that matter. So that's the average across all types of money funds." Cunningham adds, "Most of our products are run in a barbelled fashion where we have a substantial amount in either floating rate or very short-term overnight to one week type of paper. And then we offset that from a weighted average maturity target perspective out in the 6 to 9 to 12 month sector for fixed rate purchases. So generally speaking, overnight rates at this point are anywhere from 2 to 10 basis points, depending on what sector you're looking at. And, one month rates are probably in the neighborhood of 7 to 30ish type of rate. When you go out to the 12 month sector of the curve, which would be the part where we're adding incremental basis points and yield to the products in the Treasury space, right now you're at 15 or so basis points. We think that's been as high as 25 in the last several weeks and we think it can get back there again with the additional supply from the marketplace in Treasury securities. Then, for prime type securities, you're looking at somewhere in the neighborhood of 70 basis points or so, 70 to 80 basis points."

Finally, on consolidation, Chris Donahue says, "Well, over time what we have seen is that there's never been an immediate catalyst that causes people who don't have a whole lot of assets to throw in the towel. As I said on these calls before, if you have control over the redemption, you can run a small money fund and that's a fine thing because you're not going to get crushed on the redemption side. If you look at these statistics, the top 25 money market fund purveyors have over 90% of the assets. And I think there are maybe 55 or so people listed who have money funds. And the ebb and flow of that is a constant look on our part for those who wish to find what I call a warm and loving home on the money market funds side. And periodically there are things that cause the companies to do it. The CFO gets to look at it, the CEO takes a different strategy, things change. And so to us, the bottom half of that chart is always available for acquisition purposes. And then periodically some of the bigger ones decide they want to move in a different direction."

Cunningham adds, "Just to add color to that, in the context of value add and in money market land, that may only be a basis point or two, but it's incrementally valuable to be able to garner a few extra basis points in the products that you're choosing for your liquidity and your cash. And when you're a larger player, you're able to find different structures and different counterparties. Maybe from a repo perspective that give you an extra one or two basis points or that give you extra supply. You're able to review if the structures of asset backed commercial paper that again smaller players may not have the credit analysts, the staffing to be able to undertake those. And the extra one or two basis points that you're getting in those structures, along with the high quality that comes along with them, is valuable to the underlying clients. So size definitely has some advantages in this aspect of the market."

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