Federated Hermes Inc (FHI) 2006 Q3 法說會逐字稿

Good morning. My name is Gina and I will be your conference operator today. At this time, I would like to welcome everyone to the Federated Investors earnings call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [OPERATOR INSTRUCTIONS] Mr. Hanley, you may begin.

Good morning. Leading today's call will be Chris Donahue, Federated's CEO, and Tom Donahue, Chief Financial Officer. And also with us is Dennis McCauley and [Laurie Hensler] from the Corporate Finance Group. In regard to forward-looking statements, let me say that certain statements in this presentation, including those related to money market assets, investment performance, product sales, new products and acquisitions, involve known and unknown risks and constitute forward-looking statements.

There are other factors that may cause the actual results to be materially different from any future results implied by such forward-looking statements. For a discussion of the risk factors, see the section titled "Risk Factors and Cautionary Statements" in Federated's Form 10-K for the year ended 2005, and other reports on file with the SEC. As a result, no assurance can be given as to future results, 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 third quarter.

Thank you, Ray. Good morning. I will begin by reviewing Federated's business performance in the third quarter, before turning the call over to Tom to discuss our financials. Starting with the cash business, money market fund assets grew by nearly $5 billion from the prior quarter, and have grown another $3 billion here in October. The Q3 growth was largely from the broker dealer, and to a lesser extent, the trust channel. We have not yet seen much growth from the more interest rate sensitive corporate client. The net yields on our institutional prime funds are a few basis points below the overnight repo rates. We remain optimistic that we will see growth from the more rate-sensitive client when our net yields exceed the overnight rates, possibly here during the fourth quarter.

In terms of market share, we are at about 6.6% as of the end of September. During Q3, we gained share, measured against the ICI's retail money market data and lost institutional share. Within retail money market assets, the Alliance acquisition in '05 has further improved our leading position in the broker channel, and the higher absolute rate levels have helped, as well.

On the institutional side, certain competitors have picked up assets, largely aggressively promoting products by waiving fees or offering lower cost products. We have experienced this competition consistently over our history, and have found that these assets do not tend to have persistency. The impact of these lower fees is meaningful at this particular point on the yield curve for certain more rate sensitive investors, since the lower fees enable some to offer net yields greater than the overnight rate. We believe that this will not be a long term situation.

As we have discussed before, we think it is better to look at market share over time, given the significant fluctuations that occur over shorter periods. Going back to 2000, our share was around 5%. We increased share to about 6% during the Fed easing cycle from '01 to'03. We increased share again to just over 7% in '05 from the Alliance acquisition and organic growth, and we expect that we will continue to gain share over time. We also continue to work on our functional equivalency efforts for money funds. The CFCC application ended the quarter at about $1.1 billion, while the OCC application stands at about $250 million. We continue to work through the SEC process to facilitate money market use in both the OCC and for 15c3-3, which is broker cash.

Overseas we recently announced a new initiative in Europe called Cash Funds International, CFI. We have partnered with 2 premier institutions, BNP Paribas Asset management and Henderson Global Investors, to launch this new multi-currency cash management product designed for institutional customers in Europe. CFI combines a Federated offshore U.S. Dollar fund with our partners Euro and Sterling funds for use by corporate treasurers, pension managers and other institutional investors. With regulatory changes, such as BASEL II, we expect to see opportunities for money market fund growth in Europe. On the institutional cash side, we were successful in Q3 in winning the competitive process to retain the TexPool cash mandate, and we continue to pursue these kinds of large cash pool opportunities from other institutions.

Now, turning to equities. Assets have increased by about $8 billion from the prior quarter. Our MDT acquisition added $6.7 billion and has grown to just over $7 billion. The rest of the growth came from market appreciation and from positive flows in separate accounts. If we combine mutual funds and separate accounts, our Q3 net flows were positive. The equity mutual fund outflows decreased again to about half of the level of the prior quarter.

Net flows in our actively managed equity funds are running at a similar pace for the first 3 weeks of October. Certain equity products included in our Power of Income marketing campaign have continued to produce solid inflows, including the Federated Strategic Value Fund, Market Opportunity Fund and the Muni Stock Advantage Fund. The Kaufman Small Cap Fund also continued to produce solid inflows. Outflows remain concentrated in the core equity and large cap value products. In the core space, our MDT All Cap Core Fund dramatically improves our positioning in this important discipline.

Federated began selling the MDT products in mid-July. Assets in the mutual funds grew 30% in the quarter, from about 400 -- from about 300 to about $400 million, with more than half of the growth from net new sales. We are presently conducting a series of road show meetings across the country to highlight the MDT products and people to banks and brokers beyond the major wire houses, and are encouraged by the reception from our clients.

The sales of MDT funds on a comparable class basis were higher than the sales of the Kaufman Funds when comparing the first couple of months after their respective acquisition dates. We are also encouraged by the early institutional response. The MDT All Cap Core product screens very well, and we are finding consultant and client interest in this strategy. We are also continuing to have solid inflows in our Strategic Value Equity SMA product. Net sales were $190 million in the third quarter. We are excited about the potential for new distribution opportunities for our SMA strategies as a result of the MDT deal.

Let's turn to the fixed income side. Net redemptions decreased from the prior quarter, and flows are positive for the first 3 weeks in October. The net negative Q3 flows included a $94 million redemption at the end of the quarter from a client shifting assets to a Federated separate account here in Q4. We had a positive flows in our total return and total return bond fund -- government bond funds, and our fixed income performance remained strong in most products. As of October 25th, our overall managed assets were approximately $227 billion, including $165.5 billion in money markets, $39.4 billion in equities, and $21.8 billion in fixed income. Money market mutual funds have averaged about $149 billion so far in October.

Turning to investment performance, the third quarter was solid for most of our actively managed equity funds. Two-thirds of the funds were in the first or second quartile for the quarter, and nearly half were in the top quartile, and 4 funds were in the top 5% of their respective Lipper peer groups.

Highlights include very competitive performance in the Strategic Value Fund, the Capital Income Fund, Muni Stock Advantage Fund, and the Equity Income Fund, which continued to show substantially improved performance. Our large cap value funds also showed marked improvement, finishing in the top quintile for the quarter, while the flagship Kaufman Fund had another top quintile quarter. Finally, the Contrarian Market Opportunity Fund performed as expected in an up market quarter, as its relative returns placed it in the fourth quartile following its top decile second quarter showing in the down market environment. We again stress that relative rankings for this fund are much less important than the consistent long term record of positive returns over cycles.

On the fixed income side, 39% of the funds were top quartile in the third quarter, and 53% are top quartile year-to-date, including our Total Return Bond Fund and Strategic Income Fund. Looking at 9/30 Lipper rankings for Federated's domestic equity funds, 53% of the rated assets are first or second quartile funds over the last year, 51% over 3 years, 55% over 5 years, and 59% over 10 years. For bond assets, the comparable first and second quartile percentages are 83% 1 year, 78% 3 years, 83% 5 years, and 68% for 10 years. Let's discuss the distribution.

In the wealth management and trust market we added 2 new institutional cash management customers with assets at quarter end of approximately $250 million. We also saw solid growth in the equity managed account product, with assets up 7% in the quarter, and up 21% year-to-date, to over $635 million. In the broker dealer channel, the Kaufman Small Cap Fund was added to both of the funds wrap programs of a leading wire house and a top bank. In addition, we had a number of products added to the wrap program and preferred list of a leading regional broker. And our Market Opportunities Strategy was added to the wrap program of another major wire house broker.

Distribution of the SMA equity product continued to increase. Assets from broker dealer grew 20% in the quarter, to $1.5 billion, and are up 47% year-to-date. In addition, the MDT acquisition has helped by adding solid new products and by opening up new sales opportunities from the brokers familiar with the MDT separate account mandates.

In the Edward Jones organization, our sales remained weighted towards the Kaufman Market Opportunity and Muni Stock Advantage Funds. We estimate our market share of fund sales is between 2% and 2.5%, slightly above 2005, and below the level for the first half of '06. In August, Federated was reclassified as 1 of 5 focus firms, rather than 1 of 8 preferred firms, as we had previously been classified. These designations are reviewed annually, and we intend to pursue preferred status once again in '07.

In global institutional channel, we have had a significant pickup in our RFP activity from institutional interests in the MDT All Cap Core Strategy, which I previously mentioned. We also added 2 new portable alpha accounts, with funding of about $76 million. On the global front, we just launched 3 new equity funds for distribution in Germany and other countries. This is the Kaufman Strategic Value and Market Opportunity Funds. We closed a new $1 billion high grade asset-backed CDO just yesterday, and are exploring additional CDO opportunities for '07.

Finally, we continue to see interest on the M&A front, and continue to have active discussions for both consolidation and Center of Excellence acquisition opportunities. Now for the financials, I will turn it over to Tom. Thank you, Chris. And good morning, everyone. The press release detailed the unusual expense items related to insurance recoveries recognized last year, and the charge taken in Q3 for costs related to the settlement distribution process.

These items impacted mainly professional service fees. The cost to fully complete the distribution process and to resolve outstanding civil litigation remains undetermined, as does related insurance reimbursements. For Q3 revenues increased about 3% compared to Q3 '05 and the prior quarter. The year-over-year increase was due mainly to higher money market and higher equity assets, largely from the MDT acquisition. Lower revenue from lower fixed income assets partially offset these increases.

On the expense side, increased compensation and related expense from the prior quarter was mainly from MDT, approximately $3 million, and also included about $1 million in severance expense. The year-over-year increase was primarily from MDT, as well as higher stock-based comp expense -- and higher stock-based comp expense from the adoption of FA S 123R and from higher outstanding restricted stock awards. Marketing and distribution expense increased from Q3 '05 and from the prior quarter, due largely to money market fund growth, in particular, in the broker dealer channel.

Systems and communications increased from MDT and from a variety of other items. Office and occupancy also increased from MDT and other items. The 2005 expense was low due to the insurance reimbursement. Amortization of tangibles increased mainly from MDT. The operating margin for the quarter was 30%, including about 1.4% from the charge related to the regulatory settlement distribution process, and the severance expense. We are continuing to look to grow margins, particularly if markets remain favorable, money market assets continue to grow, and equity and bond product sales continue to improve.

On the balance sheet, cash and short term items -- or investments were $114 million at the end of Q3. In July, we used $102 million for the up front portion of the payment to acquire MDT, and we will pay an additional $8 million in the first half of 2007 to complete the acquisition. The first potential contingent payment is due in Q3 2007. And we are in the process of completing a new corporate credit facility with $200 million of availability that -- and that facility will have a 5 year term. That completes the financial discussion, and we would now open the call up for questions.

[OPERATOR INSTRUCTIONS] Ken Worthington, JPMorgan.

I would love to flush out your comments during your prepared remarks on distribution of MDT Mutual Funds. I guess, which funds are actively being wholesaled right now? Maybe what percentage of your third party distributors are actually ramped up at this point? And how are they doing in the Jones channel?

On the first, it is all of the MDT funds.

Okay.

So, there is no -- yes, and there is 8 of those.

Okay So they are all being actively wholesaled now? Okay.

Yes, that is correct. And the sales efforts, as I mentioned, have been pretty successful on a comparable basis with Kaufman, so we are pretty happy with that. Ken, we noted that the 2 MDT funds that have been around the longest and have the 5 star institutional rating, are now in our group of top 5 selling funds. So I think you can assume they are being sold throughout our distribution, including Edward Jones.

Okay. In terms of the European cash product, how quickly do you expect that to grow? And maybe you can just tell us about the economics of that product, maybe how the economics compares to the domestic funds?

Well, let's talk about the economics. It would be like an institutional cash arrangement in the United States. So it would be along those lines. In terms of when we would expect cash. It would be more like a '07 type event. Naturally, we are just announcing this, and we have got some more work to do on the product. We have got the sales literature going, and we are excited about it. But I don't think we are going to see big flows coming in, in this quarter. And Ken, it is really a question of how that gets rolled out through the distribution over there.

We have very high quality partners, and the product was rolled out in mid September at a treasurer conference in Italy, and it has been very well received. But it will be a question of what the allocations to money markets are, and then how much of that allocation goes into the U.S. Dollar product. Currently you have about 10% of European corporate treasurer money that goes into U.S. Dollar products. But we think a platform like this will make it more convenient and more accessible. But there is a lot of money over there. It's much like the U.S. market a couple of decades ago, in that it is presently weighted towards the banks. And we think these type of applications will be pretty well received.

Great and then lastly, on the CDO fund. I think you said you raised a billion dollar fund this quarter?

Yesterday.

Yesterday. Can you talk about maybe the CDO funds that you have raised in the past. If I remember, there was some positive earnings implications, and then there were some negative earnings implications from the CDO funds, that I think were eventually closed down. Can you just give us a reminder of what happened in the past, and if anything is different with the way the current CDO fund is organized.

Yes. To answer your last question, yes, this one is different than at least 2 of the previous ones in a significant fashion. The equity portion that we are investing is around $1.5 million. And this is a very high grade product. And so, the risk profile on this is much different than the risk profile on 2 of the -- the first 2 that we did were high yield products. And we invested significantly more dollars, 9 and $10 million in the equity positions there. We are still managing those 2 products, but the equity portion years ago, we took a write-off on.

I think that's what you are referring to. The third one was a mortgage one that lasted a little less than 5 years, and we we had a positive return on our investments there. And we are looking to expand this business, as Chris mentioned in his remarks, because we think that have learned pretty well how to structure these, and what to do, and think it can be a positive experience into the future for us. And Ken, just to follow-up. Those kind of changes are reflective of what has happened in the market for CDOs. The high yield deals, there have been very few of those done over the last couple of years, and eventually they will be done again. But the market has been dominated by the high grade, asset-backed and loan-backed deals, and the credit quality in those deals tends to be better.

What are the fees on the CDOs? The CDO funds?

They are about 7 basis points of management fee. So it would be much different than a separate account of that size.

Great. Thank you very much.

Bill Katz, Buckingham Research.

Can you start with - I am sorry, you were going very quickly - your comments on E.D. Jones and your relative positioning there? And then sounded like there was a deterioration, correct me if I am wrong. And if that's the case, can you give me a percentage of how much they have been contributing to organic growth over the last year or so?

Well, what happened at Jones was that, as I mentioned, we were reclassified from being on the preferred fund list, to the focused list. And there were I think a total of 5 on the focused and 8 on the preferred. And frankly, we would be better -- we would prefer the preferred. But we are still focused. And that distinction has nothing to do with Jones' recommendations on individual funds. It only has to do with the overall character of how they describe a fund group.

So, that's essentially what happened there. The relationship with Jones remains very strong. And in fact, they have continued to comment that they look forward to continue to grow our relationship in the future, et cetera. And remember that the reason for this kind of a move, as they said to their people, was that there were certain segments of our offerings that they were not happy with. The same ones we've talked about before, namely in the large cap value and the blend space. So that's what occasioned that. The money market fund assets remain strong, the fund remains strong. Assets were up $3 billion there, and that is the lay of the land. Now, you also asked about the market share? Yes.

Bill, from a sales standpoint, they would be about a mid single-digit percentage of the stock and bond fund sales. The change happened in the first part of August, the sales in August were about the same as they had been the prior month, in September, and October, they are down. But we think it is too early to really see what is going to happen longer term here. And again, the individual products there that have been popular, like Kaufman and Strategic Value and some of the income funds, we believe will still be utilized by the Jones reps.

Okay. I probably know the answer to this -- I should know the answer to this next question. But, can you just help me understand just what is going on that gives you confidence that you will have the yield advantage shortly, relative to where interest rates are right now for the money market business?

Well, what it depends on, is whether or not you have any slope on the short-term yield curve. If it stays flat, then you don't catch up. If you get a little bit of slope to it, then if you have a longer average maturity than 1 day, then per force, you will have a higher yield at that point. So, it is related to what the slope of that short-term yield curve looks like. And our people think it will get a little slopey here in the fourth quarter, but you can never tell.

That is not different for your competitors, right?

No, everything is the same.

Last question is one that seems to be coming out of your incremental growth opportunities at Kaufman. Just sort of curious as to any capacity constraints you might have in that franchise.

Well, in terms of the small cap fund, we have said often, that when that fund, the small cap Kaufman fund, gets to $2 billion, we are going to start to evaluate the situation. And the evaluation of the situation means, that when the portfolio managers determine that they think it is in the best interest of the shareholders to close the fund, then we will close the fund.

In terms of the other fund, the big fund, we have had no indications that the portfolio managers feel in any way constrained about maintaining and enhancing the performance. In fact, the recent evidence would support this, as they maintained another very good quarter. So, we don't foresee a constraint on the size at the bigger fund, but do have a pretty good target on the smaller fund.

Okay. Thank you.

Daniel Goldberg, Bear, Stearns.

On the functional currency equivalents, you gave us, I guess, the updated numbers on the CFTC and the OCC. It looks like, if my notes are right, the CFTC number is actually down from the second quarter a bit. The OCC is slightly up. And so, can you comment on that? And then can you also just give a sense, do you really think that the 15c3-3 is making progress? Or has it kind of been at a standstill with the FCC?

We always think that we are making progress on the 15c3-3. And it is very difficult, because we are not just going to get into every move we make, and every discussion, and every meeting. But we are confident that we are going to out last them, because the marketplace, the customers, and the overall efficacy of the program makes a lot of sense. But we can't control the outcome, and so that's why we keep mentioning it each quarter. Now, in terms of the other 2, it is just the ebb and flow of cash flow that alters those numbers as we go quarter-to-quarter. That's right. And on the CFTC, it has been between a billion and pushing 2 billion over the last couple quarters.

So it's really kind of stayed in the bandwidth. On the OCC front, we talked in earlier calls about trying to help with an accounting issue that the brokers have faced there, that restricts the use of money market products as a credit or an offset on their balance sheet to their customer-related liabilities. And that has been a limiting factor for a more rapid expansion of the OCC application. But we are working to change that, and we have support from the brokers for changing that, and we think that that would accelerate the growth in OCC.

Okay. And then on the 15c3-3, has it been the SEC just kind of lagging or not responding, or is it something kind of structurally that is taking longer than I guess expected?

I think the SEC has had a busy plate. And it is a question of priorities from their point of view. We have met with commissioners, with staff. And I am not going to try to characterize how the SEC examiners and employees are looking liking at this issue, because we are working together with them on it. And as I say, we remain optimistic. But to go beyond that is pretty challenging, because we want to accomplish this thing in a very professional, straightforward way.

Okay. And then in terms of the continued out flows on the equity and fixed income funds. Any more color there? And kind of how should we think about that as we try to model out those businesses going forward?

Well, in terms of -- I can't answer exactly how to model out. But in terms of the flows, as we mentioned here, the fixed income mutual fund flows have gone positive, and some of the more color that we've usually talked about has been, don't forget that the ultrashort funds had been at a high of over $4 billion, and now are in the hundreds of millions. And so that whole bunch of billions has rolled off, and it has rolled through the negative flows on the fixed income side. So that amount is just about gone. And all that really was, was a long cash play, which made sense for investors at that time.

On the equity side, we are optimistic that we are going to end up with positive flows. There is enough of good evidence of that. It hasn't happened on a long term basis yet. But, we are confident with the products, the performance, and the distribution that we are going to get the flows righted, in the near future.

Okay. Great. Thanks a lot.

John Fox, Fenimore Asset Management.

I have a number of questions. First on the MDT, Chris, you said that the growth from when you close to the end of the quarter was about $100 million in assets, and half of that came from performance. So half came from inflows. Is that correct?

I think you are talking funds.

Yes, on the mutual funds, yes.

Just on the funds, John, and it was actually a little more than half on -- from flows.

Okay. So, 60 million, whatever. And on the equity separate account side, what were the flows for MDT in that area?

The MDT flows were actually slightly negative. And the reason is, that the All Cap Core Strategy, we've capped that in the primary distribution channel where the bulk of the assets were raised prior to acquisition. And that is in the SMA wrap programs at a couple of the major wire houses.

And the reason that we are doing that, is to diversify the client base, and to offer the capacity that is there into other applications, like more traditional institutional, separate accounts, and mutual funds. So that's been a part of our strategy with MDT.

Okay. And maybe for Tom, can you tell me what the total stock compensation expense was, say this year versus last year, including restricted stock options, et cetera?

John, let us -- we'll pull that number. And we will get back to you. We'll either get it on the call or come back to you with it.

That's fine. And could you just talk about the marketing distribution expense, and what does it take to get leverage on that line? I mean, you had positive flows, as you said, on equity when you combine mutual fund and separate accounts, and almost $5 billion of money fun d flows, but the M -- marketing expense seems to continues to stay high. Are the corporate money fund flows higher margin? Or what has to happen to get some leverage there?

Well, I will comment first, and then Ray will follow up.

Okay.

The more money market assets that we get, and the relationships that we have, is just -- it requires more marketing and distribution payment. And we are to some extent, happy that we are getting the assets. But we also realize that we have to make those payments. It is one of those things I described in the past as a success item.

Sure.

In terms of the details and how they go, and why we are having more there maybe than usual, would be that the Alliance deal that we did a year or so, or more ago, and picking up -- that's been growing for us pretty decent. And the arrangements there are just required to pay the brokers basically the distribution cost.

Right. So that would be mix of just the Alliance -- the old Alliance assets continuing to grow?

Right.

John, just within the specific change from the prior quarter, there was some portion of that that was related to some adjustments in accruals and probably constituted about 0.5 million, or so. Maybe a little bit more than that. So the growth in sequential quarters is not necessarily a trend or a new run rate. But having said that, it has obviously been a line item with pressure on it over time, as you've noted.

Right. Is the corporate, if the institutional money comes back, we get the yield curve, is that money "higher profitability" or -- ?

Not necessarily. It has the optics on it on the income statement are different because it will not hit the revenue the way a retail broker dealer product does with more revenue, but then more through marking and distribution, since those funds are structured for intermediaries to use.

Corporate won't have as much revenue but the dollar amount of operating income would be comparable, even though the margin impact -- the margin impact actually would be better on the corporate side.

Okay. And then, if MDT is fully successful and gets to maximum contingency next year, what would that be in dollars?

That's about $40 million.

Okay. Great. Thank you.

That is based on revenue growth, so there would have to be a pretty substantial revenue growth to max that payment.

Okay. Thanks.

John. Laurie Hensler, the controller, is going to give you your numbers.

The stock comp numbers, year-to-date '06, 7.7 million. Year-to-date '05, 2.8 million. 3Q '06, 2.8 million. And 3Q '05, 1.3 million.

Okay. Thank you.

Niamh Alexander, CIBC.

I'm just trying to get a better understanding here of the direction of the margin in the business. How it is changing with the acquisitions. I am estimating the Kaufman being around -- the highest C earner contributes around 20% of group revenue. And like a bigger proportion of operating profit. How should we think about operating margin with these new acquisitions, particularly kind of outside of the money market space? And just can you help me get a better understanding maybe of Kaufman's operating margin? Thanks.

Let me just talk about the new ones first, Niamh. The numbers are in there -- in the press release for MDT for the first quarter, which wasn't a full quarter of operation. It was a couple of weeks into the quarter. But -- and if you cut through those numbers, you would get about $1 million of operating income from a little bit under $7 million of revenue. So as we said, last quarter MDT initially is not accretive to the margin.

And then further I would say that from an earnings standpoint, with the impact of the cash that was used for the acquisition, you would get to again, where we had guided to, which is basically neutral from a book earnings standpoint, accretive to cash by the amortization amount, which we also flagged in there. So clearly we expect to, and need to grow MDT in order for it to actually be a contributor, a net contributor to margin. Now, in terms of Kaufman -- .

Wait a second, Ray. More on MDT. When we are in, trying to acquire something, like MDT, which is a great operation, with a great performance, and a competitive situation, we try to structure it so that we can win and acquire it, and also have it be successful to us. And in order to do that, you have to base it on growth and contingent payments. And we push ourselves as far as we can to not -- it is one of our goals not to have dilution. And so we think we have done that, but pushed it right to the edge there. And we have to have it grow for it to really be successful and a big contributor to us, at least in the 3 year time period.

Niamh, from a Kaufman standpoint, we don't really measure, so I wouldn't have a number to give you there in terms of margin. I would tell you that obviously the costs goes throughout the organization. As it has been a top selling fund, there are sales and distribution costs. But I would not be able to give a specific margin on it.

Okay. That is helpful. Thank you. And I guess, just to follow-up, 2 quick questions. 1, with regard to the Kaufman senior management. Are there plans or discussions underway about a non-compete there? And then also moving on to acquisitions, obviously, you have quite a lot to do with MDT to ramp it up, and early indications are the sales are looking good.

But can you discuss with this money market space, are you kind of seeing fewer opportunities there now that we are getting closer to maybe a more favorable yield curve environment? Or if you are looking to maybe do something that might help build on the SMA platform from here? Thanks.

In terms of the acquisitions, the opportunities for money funds are not really based on the kinds of things that you've talked about in terms of where rates are and where things are looking. They are unique opportunities that come up. And it is a lot like having a bunch of unique children who do different things at different times. So it is very hard to place those opportunities at specific places on yield curves, or during Fed moves. And it is very difficult to find opportunities like the Alliance, you don't fine the $20 billion opportunities that often.

That having been said, we continue to look understand rocks and to try to find these kind of things. And we talk to various people about ideas along these lines all the time. In terms of other acquisitions on the separate account space, we are very much looking at growing the MDT and combining it as we did with the sales forces of our SMA force and their SMA force, under the leadership of Mike [Bapert], the MDT individual. And we are very much focused on expanding those relationships, as I mentioned in my remarks. So we are not currently looking head strong into finding other SMA opportunities. Overall, there are other opportunities for us that we also continue to look at. But once again, I don't have specific names for you.

That is helpful, thanks. Any did you have any update on Kaufman, with regard to the non-compete?

Yes. The continued payment ended. We completed 5 years and made the last contingent payment to them back in May. And earlier than that, we went through and organized our relationship with all the people in the Kaufman, in terms of compensation and restructured that whole thing with them. And so, that concluded with things that were all acceptable to us and to them, and it did not include any new contracts, including non-competes. So we have what we had when we did the deal.

That's very helpful. Thanks for your time.

Prashant Bhatia, Citigroup.

Of the 4, 4.5 billion pick up in money market assets, how much of that was from the Alliance product?

Well, that's hard to say precisely, Prashant, because most of it is from the broker dealer channel. I just don't have the number offhand to give you from Alliance versus everybody else.

Okay. That's fine. And then you talked about the TexPool mandate that you won again. Can you just remind us how much in asset is in that, and did the economics get -- were they similar, better, or worse on the renegotiations?

The basic size of the TexPool varies from something during the year of near 12 billion, gets up to 15 billion, and goes in ebbs and flows based on the flows of the various municipalities, of which there are 1,600 or 1,700 in the state of Texas. So that's kind of the deal. And then, in terms of the contract, there was a very modest reduction in our fee as part of the negotiation and bid process that we went through. But from our point of view, it is pretty comparable to where we have been historically.

Okay. And on the new credit line, I think the prior line that you had had some restrictions on buyback. Do you think the new line would relax some of those restrictions?

Yes, actually, we -- in the process of doing the new line, we asked the bank to remove that before we closed that deal. So we have already eliminated the restrictions on buybacks and dividends.

Okay. And just finally. You have got some target date funds launched. Can you talk about the sales process behind that? That seems to be a product that is gaining a lot of traction in the industry. What are you doing on that end?

Well, they are just, as you know, they have just been launched. They are an ETF oriented offering. And we are getting it out to our sales force, and we are seeing some sales activity. But I think we have got to do better to get it to participate. I know that some of the leading competitors are doing quite well with the funds in this space. And we aim to compete with them on a heads up basis. So it is very much in its infancy right now, and very hard for us to characterize, well you know, how much are the flows going to be, or something like that. But it is something that we want to participate vigorously in the market with.

A good sign there, Prashant, is that they have come out, it's really been now, some number of months. . But the early performance has been strong in those products.

Okay. Great. Thank you.

Marc Irizarry, Goldman Sachs.

My first question is somewhat of a higher level industry question, I guess. But the Pension Reform Bill has a part of it that suggests that the target date fund business, which you just talked about, is going to grow, relative to the money market business in the 401-K channel. Can you just remind me how much you are exposed to the money market business in the 401-K channel? And then I have a couple of follow-ups. Thanks.

It is very difficult the way we deal with intermediaries to know precisely how much of the $149 billion of average money market fund assets are in 401-K. And so, that is a real tough one, because we don't do the 401-K processing. And once you are dealing with someone on an anonymous basis, you simply don't know. The second point, I would challenge a little bit the idea that the target funds are a direct competitor somehow to the money funds inside a 401-K.

The people who want in their 401-K to have a steady net asset value component, are going to want to have a steady asset component. And yes, if some people have too much there and then move out, I think that will be a move that you won't really see in the numbers, because with the basic book-club-of-the-month treatment being put into 401-Ks, meaning that you have to say no, you are automatically yes unless you say no, I think you'll see some increases. And so it would be very hard to detect that kind of flow.

So you are not concerned about the increasing fiduciary obligations of these plans to -- when people are automatically opted in, they are put into target date versus money market funds. You don't see that as a big issue?

n a regular 401-K, when you are automatically signed up, the fiduciary obligations rely --- are primarily the individual for his own self. Because they have to make the decisions on where to put the money. The company or the offerer of the 401-K is not the one making those decisions. And so, I wouldn't exactly be concerned about that. But the way you put it, I think that if people were looking at their 401-K, the target funds are a very sound way to go, in order to manage that 401-K.

Okay, great. And then separately on MDT advisors, if I look at some of the most recent quarterly performance data in the separate account channel, it looks like the performance has slipped a little bit. Any color as to how you would balance distributing that product more widely versus the returns that you can expect to generate, and especially relative returns in the institutional channel? Thanks.

Historically, there have been pauses in the outstanding performance of almost any fund, including our friends at MDT. And the sales picture goes along because of the entire methodology of the MDT process. And we have a lot of confidence in that, as well. And so when the market is in transition, they can have some portion of time when the performance isn't what has historical record has been. And I think the clients that are looking at this in terms of institutional or -- institutional or being put on wrap-type platforms, or for that matter, the funds themselves, understand what is going on in this [inaudible] process. Remember, it is a fundmental analysis, even though it is a [inaudible] process. And so, we have a lot of confidence that they are going to continue to go through and maintain their excellent performance for the long term.

Okay. Great. And just on your cash flow and uses of cash. It looks like you bought back a decent amount of stock this quarter. Can you just remind us of your priorities with the cash? Thanks.

Okay. In terms of priorities with the cash, I would say our priority is to continue to score on all 3 streets. And all 3 streets are dividends, buybacks, and acquisitions. And it is very difficult to then say, oh well, we have one that is rated higher than the other.

We are going to continue to score on all 3 streets. We think we have done a pretty fair job -- the share buybacks was just under 800,000 shares this quarter. The dividend that was approved is a pretty strong dividend, with about a 2% yield on it. And we continue to make payments and buy, in terms of acquisitions. But in terms of a direct priority schedule, that is something we don't look at. We are more opportunistic than that, as relates to scoring on each of those streets.

Okay. Thanks.

Cynthia Mayer, Merrill Lynch.

I am wondering some of the competitive moves you have seen in the money market space in terms of fee cuts, have you seen those reverse yet?

It is hard to say Cynthia. We have seen the spread in yields has come in a bit. What you tend to have is among institutional prime products, our funds are a couple basis points below the Fed funds rate. There are some others that are a couple of basis points above. It is just meaningful at this point because of the straddling that line. But I would tell you that it has come in a bit.

Okay. Yes, I thought it was interesting to hear you say that your flows -- sounded like you were saying your flows had been delayed a little bit because your yields aren't competitive yet with repos. And I'm wondering, if you look back in time, can you point us to a similar moment where we can look and see that phenomenon? Maybe in the last rate cycle?

I don't know if we could get you there with the precision of where we sit today relative to the Fed funds rate. Back in '94, I guess, was the most analogous rate cycle. And we had substantial growth once the Fed had stopped the typing cycle back then. We would have to go back and pull some of the numbers. But when you step back and look at this over a broader period of time, assuming the Fed stays on pause mode, and we have some level of steepness to the money fund yield curve, we think that we will get there, in terms of having the yield over the spot market. And the positive that's out there that we've been talking about for quite some time is still out there. And will be unless the rate environment were to change substantially.

Okay. And last question. Just a follow-up I guess. Which is, you mentioned that you were trying to use the capacity in MDT's All Cap for institutional, not SMA. And I was just wondering why couldn't you do both? I would think an all cap would have plenty of capacity.

More specifically on the SMA front, we are still offering that in some SMA applications. It is really in the sub-advised portion that we closed it. So there is still -- we are still offering it outside of a couple of programs. And from a capacity standpoint, we had talked on -- at acquisition, that the MDT folks, based on their present model, think that there is about 25 billion based on the way they manage the money now and how the models work. And so we'd like to see if, assuming we could grow it to that level, that you would see something like a third, third, a third, between the traditional SMA, between the institutional accounts, and between mutual funds.

Now, those are nice targets to have. Of course, it will -- I am sure that the actual will be much different. The other thing we think is that over time, the model continues to develop, and what is potentially a constraint now, may not be in a few years when we hopefully, reach those kind of asset levels.

Okay. Thanks. I guess just one last question, which is on the CDO. What determines how often you can do those?

Availability in the marketplace, working out a [inaudible] with the underwriter, investors willing to invest, and the good thing about this, is that about the time we were closing this one, we were coming up with ideas for the next one.

So, when can we model that one in?

I don't know when you can model it in, but that's a good question.

Cynthia, we worked on this one for almost 2 years. And structuring it and dealing with who is going to buy it and why, and how we want to manage it. And then, with the spreads and how that was going to work. Various things delay it along the way. Hopefully, we have a lot of those things worked out and can move forward in a quicker time frame.

Okay. Great. Thank you.

Robert Lee, Keefe, Bruyette & Woods.

I have a couple of questions. Just going back to the capital usage. Understanding traditionally you have done all the above with your capital, is there a certain level, and maybe we're there, where you like to run the Company with $100 million in cash. So as we think about cash usage going forward, it is going to be mainly off the run rate? Or how should we think of that?

I'd follow up Chris' answer which was, we kind of look at it opportunistically. And we have had discussions on borrowing. And I think on the last call, somebody said, "Well would you borrow to buy your shares?" And Chris answered, "Yes, we would." Let's look and see where things are, what we think in terms of acquisitions, what we paid. And what would we do.

What is a comfortable situation? It is obviously comfortable having cash, but you see we increased the line from 100 and -- the credit line from 150 to 200. So, we are thinking of expanding things there.

Okay. And Chris, I have a question on sort of a new product front. Are you in, or have you given any thought to getting into more of what I'll call the securities lending side of the business. I mean, a lot of really the big trust banks manage a lot liquidity from their sec lending business. And I know there's a lot of third party agents out there who are in the business. Is there any opportunity you have seen there at all? Or maybe you are in that business to some degree.

Well, in part, there is securities lending money in the customer base. We are not that focused on it, because of all the hot money we know about, that's about the hottest. And/or the most rate sensitive I should say. And so we don't try to stimulate the cash that is attendant to the sec lending as a business for us.

However, you never know when one of the arrangements, acquisition opportunities or other things that you may be looking at,might steer you in that direction. So, we are not getting into the sec lending business. P.S., we obviously do securities lending on our portfolio of securities, like others do. But I don't think that's the tenor of your question. And in terms of attracting the cash, there is some of it there, but it is not exactly the A-type money that we would like to bank our future on.

Okay. Just one last question on the MDT. You talked about starting to get some acceptance with consultants. Can you maybe just give us a little more color on where you think that institutional process is? Is it right now you are just sort of in the conversation stage? Or are you starting to see actually some RFP activity?

We are starting to see action, and we are actually getting in some finals. And so we can start to talk about it. So there is actually life there that is real. And so, hopefully, we will be able to talk in subsequent calls about where we actually win things. I mean, getting into finals is great. But this is not a style point game. There have been some wins, Rob, they are smaller ones at this point. But again, the reception has been good.

All right. Great. Thanks, guys.

Bill Katz, Buckingham Research.

Thank you, and thanks for indulging me.

Welcome back, Bill.

Thank you. Good to be back. Can I have a break-down of your money market assets by distribution channel?

Yes. The wealth management and trust would be about just over $56 billion. The broker dealer retail would be a little over $58 billion. The capital markets is a little over $24 billion. And the corporate and some other institutional money would be about 8.5, pushing $9 billion. And all of those totals are at quarter end, Bill.

And just a bigger picture, Chris. Just sort of curious with the news around BISYS, and I guess yet another regulatory scrutiny going on with some of these sort of processing arrangements, which seems to be focusing on more the bank-owned asset managers rather than the publicly traded ones. Does this change your preference for doing roll-ups for smaller-sized bank asset properties right now?

No, it really doesn't. And we note there have been other competitors who have decided to come into this. And the reason is, that we get into these businesses because the banks are our customers, and have been our customers since the mid 70s. And so, we got into doing that kind of work for them as customer service, and if it is now time to unravel them, then we try to help them get out of it as a customer service. So from that perspective, we would remain enthusiastic about approaching banks on doing roll-ups with us.

Okay. Thank you.

At this time, sir, you have no further questions. Do you have any closing remarks?

No, that concludes our call. Thank you for joining us.

Thank you for participating into today's conference call. This does conclude your call for today. You may now disconnect.