Federated Hermes Inc (FHI) 2005 Q4 法說會逐字稿

Good morning. My name is Wendy and I will be your conference facilitator. I would like to welcome everyone to the Federated Investors conference call. [OPERATOR INSTRUCTIONS]. Mr. Hanley, you you may begin your conference.

Good morning and welcome. Today we plan a presentation before opening up for your questions. Leading today's question will be Chris Donohue, Federated's CEO, Tom Donohue, Chief Financial Officer, and also are call are Denis McAuley and Lori Hensler from the Corporate Finance group.

Today's call -- let me say that certain statements in this presentation, including those related to money mark assets, investment performance, product sales, new products and acquisitions, constitute forward-looking statements which involve known and unknown risks, uncertainties and other factors that may cause the actual result, levels of activity, performance or achievements of Federated to be materially different from any future results.

For a discussion of the risk factor, see the section titled risk factors and cautionary statements in Federated's annual report on form 10-K for the year ended 12/31/04 and other reports on file with the SEC. As a result no assurance can be given as to future results, levels of activity, performance or achievements and neither Federated or any other person assumes responsibility for the accuracy and completeness of such statements in the future.

And with that, I will turn it over to Chris to talk about the fourth quarter.

Thank you, Ray. And good morning, everyone, from sunny Pittsburgh, which is also headquarters of the power house Pittsburgh Steelers. I will start by reviewing Federated's business performance in the fourth quarter before turning the call over to Tom to discuss the financials.

Federated's money market assets increased from Q3 by $6.6 billion, and average assets grew by 3 billion, reflecting solid organic growth. The trust channel, including capital markets, was responsible for most of the growth. While higher product yields have helped in some of our channels, the potential for further short-term rate increases continues to weigh on some of the more rate sensitive customers, such as corporations. We continue to work on our functional equivalency efforts for money funds and are seeing related asset gains. Assets from the commodities futures trading organization application more than doubled during Q4 to over $1 billion, benefiting from our introduction of a new product there in mid 2005. We are continuing to see this growth into January here.

We also recently received initial funding of about $25 million from our first broker accounts in connection with the options clearing corp effort. And we expect it to grow from there. We continue to develop the potential 15C33 broker cash application, and are moving forward with our early efforts in the U.K. for functional equivalency.

Turning to equities, assets were about flat from the prior quarter, and up 3% from year-end '04. Market appreciation accounted for the growth, offset partially by net negative fund sales. The Federated market opportunity fund, muni stock advantage fund, the newly launched strategic value fund, and the Kaufmann small cap fund continued to produce solid inflows. Outflows remain concentrated in our core equity large cap value and equity income products. Federated's equity managed account product added about $185 million in Q4 gross sales, and $96 million in net sales that are not reported in our fund sales results. We are working on the addition of fixed income products to the managed account lineup and this is anticipated for a Q2 launch here in '06.

On the fixed income side, net redemptions continued with ultra short bonds accounting for 37% of the net outflows. Our performance is generally solid in fixed income, and we are looking to leverage this performance in alternative structures, such as closed end funds, and CVOs, as well as boost fund flows through marketing efforts like the campaign we've built around the concept of the power of income.

As of January 25, our managed assets were approximately $217 billion, including $164 billion in money market, $30 billion in equity, and $23 billion in fixed income. For your information, money market fund average assets have been about $147 billion in January so far. Again, so far, in January, equity fund outflows are running at about the same pace as Q4, and bond fund outflows are running lower than the Q4 levels. As always, we caution against drawing conclusions for the quarter from this early data.

Turning to investment performance, 35% of Federated's actively managed equity funds beat their benchmarks, and 41% were in the top half of their peer group rankings for 2005. For Q4, 44% beat the benchmark and another 33% were within 50 basis points of benchmark. 39% were in the top half of their Q4 peer rankings. And overall our morning star ratings have improved.

Highlights in this period include a very competitive performance in the capital income fund, which was a utility fund that was retooled about three years ago, and since then has had strong performance. And the muni stock advantage fund. These two funds are important components of our Power of Income marketing theme. Both had very strong, namely top decile performance in 2005. We are also well positioned with our growth fund. The Kaufmann fund continues to perform well. The Kaufmann small cap fund reached its third anniversary in December. The fund was the top performing small cap growth fund in its Lipper category among 447 funds over the past three years, and received a five star morning star ranking. The mid cap growth strategies fund also finished in the top quartile for 2005, and has a very competitive track record.

Federated's international small company fund ranked in the top quintile of its peer group for Q4 and in the top 39% for 2005. International products have been garnering significant flows in the industry recently, as I'm sure you're well aware. This fund has gathered substantial assets in the past, and we hope to grow these assets from the year-end total of 478 million.

In Q4, two funds that had challenging performance showed marked improvement. The Federated equity income fund was in the top 11% of its category. And the Federated American leaders fund was in the top 34% of its large cap value category. Of course, we need to see these kinds of results over a longer period, but it is good to see another solid quarter in these areas.

On the fixed income side, performance highlights include our total return government bond fund, total return bond fund, intermediate corporate bond fund, intermediate muni trust, Federated mortgage fund, Federated short-term income fund, and both the government and muni ultra-short funds. All of these were at least in the top quartile of one year for 2005.

Looking at 12/31 Lipper rankings for Federated's domestic funds, I have already commented on our performance here with 44% of the rated -- although I did it in funds before, 44% of the rated assets are in the first or second quartile funds over the last year, with 51% of the assets over the last three years, and 71% of assets over five years, and 61% of assets over 10 years. For bond fund assets the comparable first and second quartile percentages are 56% of assets for one year, 75% of assets for three years, 72% of assets for five years, and 63% of assets for 10 years.

Turning to distribution, in the trust market, which includes the bank capital markets for reporting purposes, money market fund assets grew nearly $6 billion in Q4. Growth was strongest in the traditional trust area, which grew about $3.5 billion, while capital markets added about $1.5 billion. Commodity futures-related increases of about $500 million show up here as well. In the broker/dealer channel, money market assets average -- money market average assets were up for the quarter by about $1.5 billion. Period end assets decreased as the beginning Q4 number included assets related to client conversions that were subsequently redeemed as planned. The core business year has been helped by higher product yields, and by growth in assets from clients in the alliance transaction.

Distribution of the managed account equity product continues to increase in the broker channel. Assets here grew 8.5% in the quarter, to just over $1 billion. In the Edward Jones channel, Federated continued to increase its market share for equity and fixed income fund sales. Federated's income-oriented products are getting some traction in its channel, led by the muni and stock advantage fund. Market share was just under 4% at year-end, up from just under 3% in the prior quarter, and about doubling the level of a year ago. In the institutional channel, money market assets increased $500 million in Q4, to reach $11 billion. We added 10 new corporate cash management customers with initial funding of about $330 million during Q4.

To turn to a look at new products and initiatives, we've discussed the managed account product at the channel level, totally, the assets of this product at year end were about $1.6 billion. Our target for 2005 was $2 billion. With the addition of fixed income products in 2006, we are targeting year-end assets here to be between 2.5 and $3 billion. Next, we launched a new strategic value mutual fund in March, which reached 176 million at year end. We recently launched an enhanced cash separate account product to expand our already broad menu of cash management products, and assets here are over $100 million in its very early stages.

We continue to see heightened interest on the M&A front. We announced Mason street index fund deal with Northwestern Mutual in December. And expect to close in March for about $200 million in equity assets. We continue to have discussions with banks and other fund sponsors but have nothing to report specifically at this time.

At this point, I would turn it over to Tom in order to discuss the financials. Thank you, Chris.

As noted in our press release, Federated's earnings were impacted by expenses related to regulatory settlements in Q4. Total Q4 charge was 3.2 million pre-tax, or $0.02 per share of net charge. The charge impacted the advertising and promotional line item for $1.8 million, and professional service fees for $1.4 million. Of the $3.2 million total, $2.2 million was nonrecurring expenses mainly for communication of the settlement to fund shareholders and for other costs to comply with the agreement. We expect to incur additional expenses related to the settlement, but these are not estimatable at this time. In addition to these expenses, we will continue to have ongoing legal expenses related to civil suits.

For Q4, revenues increased 17% compared to Q4 2004, and we're about the same as the prior quarter. The year-over-year increase was due mainly to higher money market and equity assets. Money market assets increased -- included both the Alliance acquisition and organic growth. Lower revenue from fixed income assets and from third party fund administration fees partially offset these increases.

On the expense side, compensation and related decreased from the prior quarter which included about $2 million of a non-recurring bonus expense. Marketing and distribution expense increased substantially year-over-year due mainly to the impact of the Alliance money market fund acquisition and also from organic growth of money market assets. The Alliance transaction also drove the year-over-year increase in the amortization of intangible expense. And occupancy increased from the prior quarter, which included $1.2 million in insurance proceeds. The GAAP operating margin for the quarter was 35.7, which reflected the 0.9% impact of the nonrecurring settlement-related expenses.

Looking ahead, we are required to expense options starting January 1, 2006. The expected reduction to reported earnings is about $0.01 per share each quarter for 2006, gradually declining through 2010. On the balance sheet, cash and short-term investments stood at $285 million at year end. We repurchased about 165,000 shares in December after announcing the regulatory settlement in late November. We anticipate that future uses of cash will continue to be for dividends, share repurchases, and acquisitions.

The balance sheet also reflected the write-down of a B share related deferred sales commission asset by $85 million. This was due to an anticipated short fall in the associated cash flows, the related nonrecourse debt liability was written down by the same amount, and there's no income statement impact to this write down. Intangible assets increased due to additional goodwill from the Kaufmann transaction anticipated contingent payments, and from the Alliance transaction. Our tax rate for Q4 was about 37%, and based on current tax rates, this is a reasonable estimate for 2006 as well.

We would now like to open up the call for questions.

[OPERATOR INSTRUCTIONS]. And your first question comes from Chris Meyer.

Hi, good morning.

Good morning.

Chris, just a few questions on the money mark business, you can just give us a sense of how you think your market share is tracking in that business? It is quite tough to gauge it when you just look at the industry because it tends to move around a bit.

Sure. In terms of market share, we made a giant leap forward with the acquisition of Alliance, taking our market share from in the 5% range into the 7% range. Over the near term, we have peaked at that number, about 7.38% mid year when we closed the Alliance deal, and the latest numbers we have, which we don't have for year end yet, we would think they're in about the 7.2 range, or so. And so due to some changes in December, that market share came off a little bit. But the way we really look at the market share is over time, on average assets, and we look at the year as though we increased market share smartly, and have set the stage for increasing market share into the future as well.

Okay. That's helpful. And just on seasonality remind me, is there anything --

What?

Anything unusual about your money market business which causes you your Q4 seasonality to be a better quarter than the industry?

Would you repeat that, Chris? We missed a couple of words you said.

Yes, of course. Just looking at your money market flows in the fourth quarter, historically against the industry, it does look like you have a bit more positive seasonality in the fourth quarter than the industry does. Is that a fair read? Or is there nothing unusual about your business that should cause that?

Chris, it is Ray. There is one part that is seasonal and that relates to the money market separate accounts. If you want to talk about funds, it would be a different question. On the separate accounts, the taxable account that we have has seasonality in it, the collection of tax receipts goes up, in the fourth quarter, it actually continues to go up in the first quarter and peaks out in April.

In terms of the fund business, it is harder to explain. Some of the corporations will tend to have more cash at year end, some of the retailers, for example, we have some broker applications where, for tax reasons, their clients will have money in money market products at year end. So those are just some of the causes.

Thanks, Ray. And just on -- is all the flow into money market this quarter organic or is it some acquired growth in there?

It is organic.

And just lastly, more of a conceptual question is, understand that when rates go up and when they're stuck going up, it tends to make money market accounts look more attractive but it seems to be a coincidence now with a much more robust equity market, are you seeing much taking place in terms of asset allocation shifts away from cash into equity markets among your clients?

For us, it is a tough one to gauge, because we deal with those clients on an omnibus basis and we don't see the money track precisely from a fund to an equity fund or something like that. There is some influence of that going on, obviously, but we don't see it firsthand. And Chris, you I would say that, you know, where we're seeing the growth, even in the bank channel, and also in the broker channel, the absolute higher level of rates does help there, it enabled the intermediaries to have a better conversation about cash than they would have a few years ago. But the institutional customer, there still is a lag between the direct market rates and the money market rates. And if we -- when we get to the end of short-term rate increases, then that gap will close. We're able to manage the portfolios such that we will typically have a rate advantage, certainly not a disadvantage, so what you're really seeing are different parts of our business reacting differently to where we are today in the rate cycle.

Okay. So your best guess is that the prospect for higher short-term rates is weighing more on money market flows than strong equity markets?

In the past, when we've had up equity markets, it has actually been a positive for money markets. If you track our money market assets through the '90s, they typically moved up right with the up equity markets. Trust accounts will rebalance into cash, there is more in broker sweep accounts, dividend payments are up, so I think it would be a tough comparison to make. I wouldn't want to do that direct comparison. All we can tell you is that there is a significant base in the customers that are rate sensitive, in our case, namely the corporations, and until that gap closes, those assets have been fairly stable. The growth has come from other parts of the business. One other way to look at this, if you dissect some of the segments of our business, in the broker/dealer world, the cash accounts at broker/dealer are a function of the total account of the underlying account, and the percentage of wallet that that broker has. So if the equity market is up and the value of the account is up, then what we have seen is you end up with more cash.

In a trust department, it is very difficult for a trust department to end up with less than 20% of the total value of the trust department assets in cash no matter what they do and no matter how robust the equity market, just because of the ebb and flow of money inside a trust department. And so as the equity market increased over the 30 different times, over the 30 years we've been dealing with banks, we have seen those balances go up as well, simply because of this feature of how a trust department works.

Okay. Great. That's very helpful. Thanks for that.

Your next question comes from Cynthia Mayer.

Hi, good morning.

Good morning.

Just a follow-up on the market share question, I wondered if you could let us know about what do you think your market share is of the trust channel? And what are the chances of growing that considering that it is probably pretty large at this point? And how has that trended recently?

Cynthia, it is Ray. I will comment on the numbers and then Chris can address the prospects. The numbers are not precise. There is a lag in what is available in the industry. But when we've looked at it in the past, and you sift through the portion of cash that the trust department discretionary assets have in money markets, we've had typically about a third of it, and that goes back over quite some time. There is still more money in total, far more money, not in money market funds, than in money market funds, so we will tend to look at share, not just against money market funds but against the total cash allocation of their account.

And over time, depending on what time you put on it, we have increased our role with the banks. No matter how you look at the number, we believe we have the largest share of cash inside the banks, but because there are no accurate figures it is very hard to say oh, well what happened to the market share this year, even year to year, in those kinds of numbers. In terms of the prospects, we believe that our relationships with the banks and the products that we offer them make us the go to player.

Remember that the biggest competition, as Ray said, is the direct market, not another money market fund provider. Although there are competitors of course. And what we have seen historically is that each time the Fed hits the pause button or even goes the other way for that matter, but just hits the pause button we end up increasing the amount of assets that we get from the banks. So each time you go through this cycle, we end up with a better market share and more assets from the bank. And that's how we would tend to look at the future, given what the fed is probably going to do.

Okay. And then on another topic, I just wanted to clarify a little bit on the comp. I think you said that it's down about 7% sequentially, and what was the reason for that? Is that end of your trueing up or --

It is a little bit of trueing up, but in the third quarter, there was the $2 million nonrecurring bonus.

Right. Okay. So for next quarter, would you expect a small step-up for the new year? Or basically is this a good run rate?

Yes, I mean -- we haven't gone through and figured that out yet. It probably is going to go up, but -- Historically it's gone up because you get a little bumping of the accruals. We don't know. We haven't modeled the first quarter.

Right. Okay. And I guess the last question, it didn't look, at least am the first half of the year, as though you spent that much on CapEx and I'm wondering if you are planning any additional spending on I.T.? It looked like it bumped up a little bit this quarter. Do you feel have you to spend there or not particularly?

We run our CapEx on what project do we need to do, what do we need to, do what what is happening, it is not run out in a plot in terms of the first half an the second half, and we have programs that are going on where we're updating and upgrading and we expect on a year-over-year basis that we're going to basically replace the depreciation numbers or kind of thought process.

Right.

I don't see anything --

Looking at those -- you're not seeing any new incremental expenditures particularly or --

On a year-over-year basis, is that correct.

Okay. Thank you.

Your next question comes from Prashant Bhatia,

Hi. Prior to some of the regulatory issues that looked like you were running with about 100 to 175 million in cash, on the balance sheet, now that the settlement is behind you, could we see that level of cash, you come down to that level of cash again?

Well, we won't approach it with a goal like that. We will approach it on what is the proper dividend level, and what is the -- what is our proper purchase of shares, and then what acquisitions fall in there. And you're right. Prior to the investigation, the second and third quarter, we were not able to buy any shares, so that kind of slowed us down and allowed the cash to build up, what would have been historically been used for purchasing shares.

Okay. And then on the comp expense, just to follow up a little, it has been trending down for a couple of years now. If you -- I guess you're about 40 million in the last quarter, after backing out the severance in there. You can give us a feel for what you're doing with the head count and maybe your head count budget for the upcoming year?

It is Ray. In terms of the head count, it has gone down over the last couple of years, mainly because we outsourced some of our service functions, including a pretty significant amount last year, when we outsourced the transfer agent business. So that's been more a change in the activities that we've performed.

At the same time that that was happening, we were increasing the staffing within the money management operation, particularly within equities, but from a head count standpoint, the service changes would far outweigh the investment management changes that -- the sales staffing has stayed relatively constant.

And on the investment management program, I would say that we've enhanced those -- kind of every year, and the opportunity and what is available there for the investment management tools.

Okay. And just where did you you end the year in terms of head count and maybe if you can give us a feel for what the budget is for '06?

The year end was around 1200. And in terms of '06, we talked about over the last quarter that we were in the process of outsourcing the retirement plan record keeping function. We're very much in the record-keeping business. And continuing to offer a bundled product, but the actual activity of keeping records we're in the midst of outsourcing now, that will have some impact on the head count. But we should still be in that 1200 range.

Okay. And then finally, on the market opportunity fund, that's been a great fund in terms of performance and inflows for you. But it looks like towards the end of the year, we saw monthly outflows for the first time in a few years. Was that something unique for that month? Or is that near term performance related?

It has been a great area for us, it was a very successful separate account, and then we started a mutual fund and have raised, over $2 billion, and the flows have actually continued to be solid there. In fact, in the fourth quarter, we opened up another separate account of around $80 million, a new client, in that same mandate. That would have been away from the fund in the form of a separate account.

So, no, we're not -- that fund is relatively -- a relatively unique product. It is something that lends itself to an intermediary sale because it needs to be factored in as a part of a portfolio. It doesn't really fit naturally into any category but it has developed a pretty good following, and it has produced very strong records, especially in down markets, it had double digit returns in 2000, 2001, and it has continued to have a solid record since.

Okay. Great. Thank you.

Your next question comes from Mark Constant.

Good morning, guys.

Good morning, Mark.

Firstly, just to circle back on the share repurchase thing, you were -- you seem pretty darn excited when the settlement was behind you, but the opportunity to sort of get back in the market there, the nominal repurchases were obviously a fraction of what your historical excitement has been expressed at. Is that just a function of, how much time you had left in the fourth quarter and the liquidity around the holidays? Should we expect your enthusiasm over the course of '06 to be sort of more comparable to historical levels?

That's the way you I certainly feel about it, Mark. We were on the sidelines for most of the quarter, and you point out several reason, I'm not going to articulate them, about what would enable us to end up where we ended up on the share buyback, but we intend to score on that streak during the year but it is very difficult to say how much.

I have enthusiasm for the stock, almost all the time. And we are going to continue to use cash in order to buy shares. But we just can't try to use euphemisms in order to try to get to numbers or as proxies for direct numbers as much as we might like to do that.

Understood. And then separately, this may be somewhat rhetorical, but preaching to the converted perhaps, but if there is an impairment to the deferred sales charge asset -- the deferred sales commission asset, rather, and it is equal to the amount of the reduction in the liability, so there is no effect on net worth or P&L, why is it on your balance sheet again?

Because that is what the chief accountant's office would like it, on our balance sheet.

Okay, but we -- but I'm correct in presuming there is no economic effect whatsoever from that impairment, from your standpoint?

Over a three-year period, there may be a few hundred thousand dollars impact.

Interesting. Okay. Thanks.

The next question comes from Bill Hecht.

Thank you. Good morning.

Hi, Bill.

A couple of questions. I guess I'm trying to sort of understand the dynamics between the flat revenue growth sequentially versus the asset lift and Chris, I know a while ago you had sort of shared an algorithm of X dollars of money market, you need X dollars of fixed income and equity and I'm trying to understand the good growth in the money markets is offset by the ongoing attrition in the fixed income and equity and I know the mixed has changed given the acquisition of Alliance and cash management. What is it for today, is it for every billion dollars in equity and fixed income you need 7, 8 billion are of money market? Is that too rich? How should I be thinking about that? So you get a step up in revenue growth.

Well, it depends on which funds you're in and all of that. But if you look at it broadly, if you end up with 5 billion, 6 billion in money market assets, and then have you to go back and do an average asset calculation, that is approximately equivalent to a billion dollars of equity assets. Again have you to do an average asset calculations. So they're really not algorithm, they're rough rules of thumb. Algorithm is a little more weight on it than I would give it. It is a little more looking at it and talking about it but it requires the detail average asset calculation to see if it is going.

Okay. So to the extent that equities continue to go outflow and you still have fixed income going out, you need enough money markets to offset that, is that fair, to see any kind of revenues step up then?

Well, there are other factors as well as what happened in the fourth quarter. You can have appreciation in equity assets, as I mentioned in the remarks. And you can also have increases in the sales of the other products. But basically, if you have approximately at the same time a $6 billion increase in money fund assets and a $1 billion decrease in equity assets, you will be about even par for the tournament. And so if you either increase the equity or increase the fixed income, as in that little rule of thumb, then you will have increase in revenue.

All right. Second question, sort of around marketing, and I think about almost $2 million of the $3 some odd million charge in the quarter was actually allocated to the advertising and promotion line. So if you back that out, you only had about just under 3 million in advertising and promotion versus almost 5 million in the third quarter. I guess I recognize the seasonality of that, but how do you think about the advertising budget next year, it just seems like a very low number in an absolute sense and certainly relative to what is happening among your peers.

I think it is likely that we would look forward to coming on with doing some advertising into the future here. But I'm not in a position to say how much we would do, in terms of enabling you all to model this. You can look at what we've done historically, we don't run Super Bowl ads, but we are interested in looking at programs to get the message out.

Is there a sense that given that you sort of fell behind a little bit in terms of market share in '05 given all of the regulatory overhang that you might look to sort of step that up relative to history?

Well, that isn't how we approach it. We look at it and say is money spent today going to do a good job for getting the message out and increasing the prospects for the message out and making more sales and getting the funds built to higher levels. Not so much whatever happened in '05 or '04 or any other time frame, as a makeup. So that wouldn't be how we would look at it. But again, it is hard for me to characterize the amount that we've -- that we're looking at because we haven't decided what it is going to be.

Okay. Turning back to the flow discussion for a second, it looks like you -- on an absolute basis your dollars of attrition in the ultra short was flat sequentially. But yet, your flows in the -- the outflows accelerated, which would suggest you had sort of worse attrition. I appreciate your notion that you said that you had a slow down so far into the first quarter, versus the fourth, but are you at a point now where you're sort of losing share there, even though you have good performance? And I'm sort of curious, if we were to get a more decisive rotation out of bonds and back into equity, how do you think that business will hold up?

Bill, I would say that while the outflows in fact have been weighted in the ultra shorts as you point out, there have outflows in -- there are outflows in other categories. We've had inflows in some of the blended products. But when you're looking at high yield or munis or govs, away from ultra short, we've had some outflows there. The performance has been solid. If you look at the bubble chart and look at the track record, they're by and large solid. Chris mentioned us trying to package that performance into some other forms in order to grow assets and then from a marketing standpoint, we mentioned that the campaign that we're running with power of income, so we're putting some emphasis behind trying to move that needle the other way, and we're not going to make much of a couple of weeks but it does seem like the outflows are down a bit, in January. Bill, I mentioned one other factor apropos that question, and that is, that unlike in the equity area, you can have really solid fund performance, top quartile performance, which I listed all the funds where we had that in the year, and yet, the flows tend to go to those who have top decile performance. And this is a little bit of a difference between the way things operate in the fixed income area, versus the way they operate in the equity area. And that's something that we're looking into as well. Because then it is really saying, well, what's your best size, what kind of bets are you making, and if you're making them right or you're making them big enough, and you start to analyze at the margin, that kind of a dynamic.

Okay. Last question, just a conceptual question here. Spend a lot of time on sort of the whole discussion on compensation, but if you look at some of your peers who are generating significantly stronger organic growth, they are all telling -- the message is that there is an upward inflation on compensation to protect the performance of their funds and continue to take market share. Is there a trade-off given sort of the low absolute level of compensation, or even relative to revenues which is I think the lowest ratio in like five or six years, between sort of clamping down on costs versus a give-up of market share or growth.

Well, we don't obviously think that, and we don't look at it that way. The compensation programs are built in and of themselves, by themselves, for the purpose of retaining, attracting the best possible people in order to have the best possible performance for the funds. As Tom mentioned in his remarks, we have over the years revamped the score cards that we use, and we believe they are excellent and very much in tune with the marketplace. And so whatever the fractions that come out of that from an income statement standpoint, it is just not that the way we look at it. We don't start with those numbers, manage those numbers and the only time I ever spend time talking about those ratios are when we get on these calls. It is not a part of the analytics of what we do internally. And Bill, remember, we -- in the Alliance deal, we have a big revenue pickup, and we got all of the money market assets, so, when you do those number, you you got to keep that in mind.

I guess I'm asking, because you know, you had 10% annualized loss rate in your term asset business, and almost across the board, you're seeing nearly double digit organic growth to deposit elsewhere, I'm just trying to help understand what is going to help you close the gap?

Bill, I think it is -- we've talked about the attrition and the performance, we've had good performance in some areas of equity, and we need to improve it in other areas, and unfortunately, it has been the larger areas that have overcome the smaller areas that are growing. And so you get the net negative numbers that you're seeing. We're not viewing it through the lens of our comp spending. The programs are competitive. We were able to hire and increase staff using those same programs, and over the last couple of years, have built up the analyst pool, add portfolio manager, even over the last year, so we don't view this as a comp issue, and we think that the comps will solve itself, when the performance is stronger across the board.

Thanks for taking all my questions.

Sure.

Your next question comes from Howie Flinker.

Hello. I have two questions. One, in your commodity funds, is there any kind of managerial profit share?

No.

No? So it is a straight fee?

It is a regular money market product that is used in a different application.

And what is the fee on that fun?

Well, our institutional money market products would typically be in the 20 basis points fee level.

Oh, I see. So it is basically you're buying an index rather than managing the individual commodity, I would guess.

We're not doing anything on the commodities. It is the brokers who are doing commodity trading that use our money market fund as a collateral vehicle for the --

Oh, I misunderstood. Okay. Thanks. And the second is, could you please describe the circumstances that cause those deferred sales commissions to be cancelled?

We go through an analysis and look at the expected cash flow and determine that there is not significant enough cash flow to warrant the value. You know, the people who are bearing that are the people who purchased the rights to the CDSC.

Yes, I understand that. Does that mean that whoever had the servicing rights or sales rights on those funds saw redemptions?

Well, we would do a whole analysis and including redemptions, and the NAVs of the funds, and all the things that go together to add up how they get paid. And you know, this is a forward-looking thing, and an estimate by us, looking at what we think is going to happen. It doesn't mean that's what is going to happen to them.

No, but you had some assumptions in the stock and bond markets were not disasters in the fourth quarter so I want to know what the logic was, other than, you know, we fooled around with some numbers and we came up with a reduction of 85 million.

We're looking at the cash flows over a three-year period saying that it is impaired.

Okay. And what does this mean when you go to sell the next package of sales commissions or service rights in the financial marketplace?

Well, we've been through cycles on this. I think this is our ninth year of doing this. And there have been ups and downs and the players have continued to be involved. They have adjusted their pricing through various changes in market cycles. But they continue to do this and they have -- certainly have a long-term perspective looking at it. So we still foresee the financing being available at attractive -- That's a good point. The write downs that you're seeing are from assets that were sold seven and eight years ago. The models have changed since then. The buyers are still interested in buying this cash flow, and they typically use it as part of their asset-backed program, which I'm sure you're aware of the asset backs, have been a very strong part of the market. So things adjust and go on, but from our standpoint, we're in the beginning the third year of a three-year program and we will look at it later this year as to the potential of renewing it, or going on to sell funding. The absolute level of B share sales has gone down. And so even if we were to self fund, it would not be as significant a use of cash as if it would have been nine and six and three years ago when we entered into the past arrangements.

I take it that the cost of funding these kinds of programs is going up, because somebody took an $85 million hit, even though it didn't show up on your income statement, the person that has the -- or the institution that has the nonrecourse notes is not going to collect those 85 million to pay those notes.

I think it is a good assumption that the cost of funding over nine years has gone up.

And as a result of the 85 million, it might go up a little more?

Well, I mean that isn't an overnight development. Again, these are from -- if you go back and look at the funds that were sold seven and eight years ago and the type of funds, this isn't something that in fact going into the pricing on this cycle, I think it -- two years ago, the change in the markets over that period was baked into the cake. And it is not just the market went up or down. It is the timing. It is the where the redemption, what was the level, what was the timing of them, and then those particular funds -- then those particular funds, you can't just do a -- the market was up or down and understand it, you got to get into the cash flows, and --

I can assure you, the market goes down, you will have higher redemptions and so will the financiers.

Oh, I'm not arguing about the trend. There is more to it.

Okay. Thank you.

Your next question comes from Ken worthington.

Hi, good morning. On the equity funds, are there any steps that management -- any additional steps that management can take to address equity redemptions? Or maybe said another way, what needs to happen for Federated's equity business to get back to inflows and how does management facilitate that return?

Well, in terms of equity redemptions, we are constantly looking at new programs, new ways, put some new things in, in terms of drilling in on those redemptions, calling the people, the intermediaries, focusing on the story of the fund, and what has happened, and these funds, even that have net redemptions, still have pretty decent sales. And so what that means is that a lot of the intermediaries have heard the stories, and have understood them, and it just requires a lot more contact. But when someone has decided to redeem, because of the function of the investment company, is a plus, namely that you can take your money out at any time for any reason or for no reason, it is pretty hard to back down from that decision. But we still make efforts at it in terms of working on it.

What needs to happened near to get the positive flows is that we need more quarters like we had that I mentioned on, for example, the equity income fund, and the American leaders fund. And if we put a bunch of quarters together, then you can begin to see a diminution in the redemptions and a diminution in the net outflows in those products. So there is not a one-thing catalyst that makes it happen. Over the time, we believe we have put in an excellent group of people, analysts, we've added portfolio managers, relooked at screens, most recently relooking at the screens in the equity income fund, adding portfolio manager about a year ago, to the equity income effort, and adding another portfolio manager recently to the capital appreciation effort. And none of these things are going to make changes in the next five minutes in terms of redemptions. But they can start to make changes immediately in the performance and in the stories that are behind these funds.

From a personnel perspective, do you feel you have the team in place that can continue to drive performance to the levels that it will take to get back to the inflows?

We continue to augment the team here and there, but we believe that we as a portfolio managers, the analysts, the traders, that can carry the ball, and advance the ball across the board on these funds. You know, we added portfolio management talent to the capital appreciation fund, not replaced, we added portfolio management talent to the American leaders, not replaced, and this has been what we have done in a lot of areas. We've added 10 or 12 analysts over the last couple of years, that have good solid experience.in their various areas. So we like the team we've put together.

Great. Thank you. And then second question, portable alpha strategies are starting to become increasingly popular. Federated seems early in the development of some portable alpha products. Can you just kind of give us an update on where those products stand right now, and is there a chance that those products could become meaningful sellers for Federated?

Ken, we have developed that product, and we're in the process of being organized to talk about it. It is a bit of a different thing for us compared to the fund strategy, but we would expect to be talking about that and are beginning to talk about that to clients and so you should look for the beginnings of things to happen there in 2006. And yes, it is something that -- where other people have had some success, but it is early in the game, and we think we have a credible story there. Our short-term -- our expertise on the short part of the curve is well documented. And the ability to port that over to an equity index type of return, we think is something that will resonate with clients, with intermediaries who are looking for more of a predictable return. Thank you very much.

Your next question comes from Michael carrier.

Thanks, guys. Just two real quick questions. On the distribution side, others increased 8% in the quarter. Was there anything notable going on in there?

I'm sorry, Mike. Are you on the revenue part or the --

The assets, by the market channels. On the last page. It is the other channel there. I'm wondering if anything is going on.

Oh, oh, oh, I'm sorry. That's where the tax pool separate accounts are, and so that would have been the -- the bulk of that would have been the gain there.

Okay. And then just on the income statement, investment income increased, did it just primarily interest income on the cash or any other types of gains?

No it is -- the volumes, the assets that we have, cash on the balance sheet and the rates have gone up.

Right. Okay. Thanks a lot.

Your.next question comes from Robert Lee.

Good morning, guys.

Good morning.

Most of my questions were asked. I just had two real simple modeling question, really. As a result of the write-down of the -- for a commission asset, actually I guess I'm coming up with I should.expect service fees to go down about 5 million a quarter. Dos that sound about right?

No, it is really a valuation of that asset on the balance sheet, it is not -- I would not look for any material income statement impact.

Well, I would assume that the deferred sales commission amortization will go down as will nonrecourse debt expense and there's got to be something else to sort of offset M I thinking of it correctly?

You're right, those things will move down generally in lock step, but you I don't know about the 5 million part. We would want to do some looking at that.

The important thing is that there won't be any significant net income statement impact no matter what the level of assets it. So somewhere there will be some revenue decline.

We can circle back to you with more of the specifics.

Okay, that's fine. And the other thing, I think I mentioned Tom's comment just about the tax rate for '06.

The tax rate? We're saying should be about the same as '05, 37% is the estimate.

Okay. Great. That was it. Thanks, guys.

Your.next question comes from David Haas.

Hi, good morning.

Hi, David.

Just a quick question on sort of the capacity you have in the equity business right now. It seems like, you know, there was this five-year buildout, you've been building out, you've said you've been adding without replacing. I'm just curious, at the level of assets have you on the equity side, how much overcapacity do you have right now? That's the first question.

Well, I wouldn't have phrased it like over capacity, so much as because of the funds, the distribution, and the people, there is no reason we shouldn't be at 50 billion. We're at 30.

Okay. So you're correctly sized for 50 billion or potentially more?

Correct.

Okay. And then the second question, sort of comes in, reflecting on what is happening in the space today, with potential combinations, acquisitions, divestitures, and some capital markets activity, to unlock some value and synergies, how are you viewing sort of what is going on in the space vis-a-vis Federated today?

I don't know exactly what you're getting at with that question.

I guess the question more pointedly is how does your view of Federated potentially combined with another entity, does that make sense? Is that something you would be willing to consider? Are there synergies you see with other players out there?

Okay. The basic answer here is that someone in my position, namely the CEO of a public company, in my opinion, simply has no right to just say no. And we have a certain enthusiasm anyway before looking at any and all potential deals that we think would advance the cause of the fund shareholders and the Inc. shareholders. So we will look at any of those, and we would be willing to do even those if we thought those criteria were met. And over our history, we have done various things that evidence that kind of decision making. So we are open to any of those ideas.

Okay. Thank you.

[OPERATOR INSTRUCTIONS]. There are no further questions. Mr. Hanley, are there closing remarks?

No, this concludes the call. Thank you for joining us.

This concludes today's conference call. You may now disconnect.