Federated Hermes Inc (FHI) 2008 Q2 法說會逐字稿

Greetings and welcome to the Federated Investors Q2 2008 earnings conference call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (OPERATOR INSTRUCTIONS). As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Raymond Hanley, President of Federated Investors Management. Thank you, Mr. Hanley, you may begin.

Good morning and welcome. Today we plan a brief presentation before opening up for your questions. Leading today's cal will be Chris Donahue, Federated's CEO, Tom Donahue, Chief Financial Officer, and with us is Denis McAuley and Lori Hensler from the Corporate Finance Group.

Let me say that certain statements in the presentation including those related to money market assets, investment performance, sales, new products and acquisitions constitute forward looking statements which involve known and unknown risks and other factors that may cause the actual results to differ from any future results implied by such forward looking statements. For a discussion of the risk factors see Federated's SEC filings and other reports and as a result no assurance can be given as to future results and neither Federated nor 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 Q2.

Thank you very much, Ray. Good morning. I will begin by reviewing Federated's recent business performance before turning the call over to Tom to discuss our financials. Starting with the cash management business, money market assets decreased by $6.4 billion or 2% from the prior quarter and increased $78 billion or 40% since Q2 of '07. Seasonal separate account decreases accounted for most of the change from the prior quarter decreasing about $4.7 billion. On this matter, as we have discussed previously, the $30 billion that we manage in money market separate accounts is nearly all from large state mandates and, as such, we tend to have inflows in Q4 and Q1, as tax payments are made to the states, and outflows in Q2 and Q3. This is a pattern that has been observed over a number of years. And with the addition of the State of Florida accounts last quarter, the dollar amounts of these swings are likely to be larger going forward.

Regarding money market mutual funds, they decreased by $1.7 billion or less than 1% from the prior quarter. Average fund assets for the quarter were up, however. Looking at the quarter in more detail, our money market fund assets were up slightly in April, we saw solid inflows in May and then outflows in June. We have seen growth in money market fund assets so far in July. July assets have ranged from about $241 billion to about $246 billion and have averaged about $244 billion. The modest Q2 money fund asset decrease occurred mainly in the retail broker dealer channel while institutional assets increased slightly. Each area performed in line with industry results and we believe that our market share stayed about the same during the quarter. Credit concerns remain a significant market issue. We believe that our credit culture and skills are a competitive advantage that has been strengthened by our performance over the last year as our experienced team of money market portfolio managers, analysts and traders has successfully negotiated difficult market conditions. We remain comfortable with each of our money market fund investments and have continued to see the winding down of the Sigma investments, as expected, with all payments received when and as due. Our remaining exposure is $450 million, with the final notes maturing in mid-August.

Turning to equities. On a combined basis, equity mutual funds and separate accounts had positive flows for the second quarter. Separate accounts showed positive flows while mutual funds were negative though continuing to improve. Assets decreased slightly from the prior quarter due to market depreciation. Among equity mutual funds, the InterContinental Fund remained our top-selling product on a net basis in the second quarter. Kaufmann products had net positive flows on a combined basis as inflows to the small and large cap funds were greater than the modest outflows to the mid cap product. MDT mutual funds produced solid gross and net sales. Outflows remained concentrated in large cap value and in flexible portfolios with the contrarian market opportunities fund showing net outflows in the second quarter. Index funds continued to show outflows as well. Net outflows in our equity funds are running on a higher pace for the first three weeks of July compared to the second quarter.

Turning to equity separate accounts. We continued to have success with MDT strategies for institutional accounts with three more wins in the second quarter and we expect these to fund for over $200 million. Funding of prior MDT institutional wins drove Q2 net inflows in this area. In addition, the MDT/SMA strategies produced net inflows in the second quarter. Turning these flows positive has been an important goal since we re-opened these strategies in early '07. Overall, equity separate accounts including SMAs and institutional accounts had $209 million in net inflows in the second quarter.

On the fixed-income side, Federated continued to navigate difficult credit market conditions very successfully. After turning positive in Q1, our Q2 fixed-income net fund sales accelerate to over $800 million. And this was led by strong inflows into our total return bond fund and into the ultrashort bond products. Fixed-income separate accounts showed $1.1 billion of inflows from a run-off portfolio of distressed securities from the State of Florida that will decline over time through expected asset sales. Fixed-income flows remained solidly positive here early in the third quarter.

As of July 23, our managed assets were approximately $333 billion including $271 billion in money market, $36 billion in equity, $25 billion in fixed-income. Money market mutual fund assets stand at about $241 billion.

Looking at investment performance and using the quarter end Lipper Rankings for Federated's equity funds, 38% of rated assets are in the first or second quartile over the last year, 74% three years, 78% five years and 68% for ten years. For bond fund assets the comparable first and second quartile percentages are 72% for one year, 83% for three years, 79% for five years and 77% for ten years.

Specifically addressing distribution, on a combined basis, net sales of our stock and bond mutual funds turned positive in Q2, with good results in each of our distribution channels. In the wealth management and trust market, combined net sales of equity and bond funds were positive. We had a particular success with the total return bond fund in this channel including a significant wrap program win during the second quarter. In the broker dealer channel, net equity and bond fund sales were also positive. Money market assets decreased during the second quarter but have regained ground here early in the third quarter.

In the global institutional channel, we have had success with MDT strategies for institutional accounts, as previously mentioned. We've also had success in Florida since winning the LGIP mandates last quarter. In addition to the distressed bond portfolio I mentioned earlier, we received a mandate for a new $550 million cash management pool added on July 1, and this is separate from the LGIP A pool and we are also talking to Florida about other opportunities. The original LGIP mandate is performing well and we have been successful in launching an extensive communication program for the participants. We are also actively seeking new cash management mandates from other states.

On the acquisition front, as you probably are aware, we recently announced the deal with David Tice & Associates for the $1.7 billion Prudent Bear Family of Mutual Funds. We expect to close this transaction late in the year, at which time the Investment Management team will join Federated bringing with them a long-term record of success. Along with two excellent funds with strong performance records, the deal will add investment expertise and will enhance our ability to expand into alternative assets. We continue to evaluate candidates for both center of excellence and consolidation deals.

For the financials, I will now turn you over to Tom.

Thank you, Chris. For Q2, revenues increased 12% compared to Q2 ' 07 and 2% from the prior quarter. The increases were mainly due to higher money market assets, reduced mainly by lower equity assets from market declines and, to a lesser extent, changes in the mix of equity assets. We had a couple of notable items in the second quarter. We booked and expect to receive an after-tax gain of $2.8 million in discontinued operations from the 2006 sale of our trade clearing business.

On the expense side and primarily in the professional service line item, we added $2.2 million pre-tax to our estimate of the cost to complete the distribution of the 2005 regulatory settlement and incurred $1.8 million pre-tax cost related to the fund prospectus modifications which we talked about last quarter. We expect to have additional costs for this item in the third quarter of approximately $1.2 million.

Compensation and related decreased from the prior quarter due mainly to seasonality from payroll taxes and 401K contributions and to the Q1 true-up on 2007 incentive compensation expense. Marketing and distribution expense increased from the prior quarter due mainly to the growth in average money market fund assets.

On the balance sheet, cash and short-term investments were at $155 million at the end of the second quarter. We continue to generate strong free cash flow and expect that we will continue to use cash for acquisitions, dividends, share repurchases and capital expenditures.

Chris mentioned the Prudent Bear acquisition which we expect will close later this year. We will pay $43 million up front and can pay an additional $100 million over four years based on reaching significant revenue growth targets. We will have further color on the impact of the deal after it closes. Our best estimate today based on the asset levels in the press release and assuming closing the deal in 2008, the deal will add about $0.01 per share to book earnings in 2009 and about $0.06 to cash earnings in 2009.

That completes our prepared remarks and we would like to open up the call for questions now.

Thank you. Ladies and gentlemen, we will now be conducting a question and answer session. (OPERATOR INSTRUCTIONS). Ladies and gentlemen our first question comes from the line of Craig Siegenthaler with Credit Suisse . Please

Good morning.

Morning.

First question is kind of more of a macro question. Just wondering how in this cycle maybe changes in fed action here either up or down or -- maybe a pickup of inflation could impact your money market business? When you look at the historical cycles FED going higher is a negative thing for money market flows If they hold or go down it might be positive. Wondering your thoughts.

You have generally outlined the usual affect from FED action. It is important to remember, however, that there are other factors there as well. The most important of which is that the lion share of our money market business is cash management service that is needed regardless of the actions of the FED. The actions of the FED tend to, if you will, affect the top half of our bars in terms of our assets. Now, in terms of FED action, it is our view that we don't think the FED will reduce further and when as and if they start increasing, it will probably be later in the year if this year.

So another factor, remember, there is as long as those moves are measured meaning in the 25 and 50 basis points type moved, the money market funds don't fall meaningful behind the market so as to cause regular cash management customers to alter their cash management activities. It may, of course, affect short-term players, SEC lending people, maybe even some corporate treasurers when you get 5 or 10 or 15 or whatever basis points off of whatever they perceive to be the spot market. Overall, yes, the FED has an affect and you have correctly outlined it. There is one other affect that is important in this too and that is the slope of the short-term curve. If the short-term curve has some steep to it, some positive slope to it, it enables the fund manager to develop a portfolio that can compete successfully even though rates are increasing. That is another factor that has to be added into the equation.

The other issue is if inflation is increasing could the stable value nature of your money market could that make it more attractive than long duration bond products actually have capital losses? That would coordinate with the FEDs raising here.

Generally speaking, our clients look at the money market fund as a cash management vehicle. The extent to which inflation may or may not take off and money markets are perceived as a better value because they pay the interest, that's a possibility but that usually doesn't drive the truck of flows here.

Got it. And just one more question, your fixed-income platform, it seems performance is better. Is there anything that is driving flows, new distribution channels, new products that have been added, is it your performance, your distribution specifically or is it more of a retail macro impact to the industry.

I think it is a proper confluence of excellent long-term consistent product in the core funds that enlivened that particular marketplace and you combine that with the team that has been here since the mind of man runneth not to the contrary with sales people that have been through these cycles before and have been able to present these products successfully in the past. You have a confluence of all of those factors, that's what it is. The new products are not really the drivers, although we are seeing assets in our fixed-income SMA and things like that. The main show is the total return bond fund which is a standard bearer here at Federated. I would add the long-term is outstanding. The record with the last year with the credit markets issues has also been outstanding and we think it differentiates us.

Great. Thanks a lot for taking my questions.

Our next question comes from the line of William Katz with Buckingham Capital Research.

Good morning.

Hey, Bill.

Couple questions on the money market business. Take it one layer deeper. It seems like the snap back of where you stand right now in terms of money markets is lagging some of the observations being made by some of your peers who said the same thing end of the quarter a lot of volatility and things snap back decisively. When you say around 241 right now, trying to understand how much of that might reflect the seasonal run off you mentioned in your prepared remarks versus less growth. The reason I ask it sounds like the first time in a couple quarters now that your market share is steady rather than taking share. Is there a more pronounced slow down going on than meets the eye?

You are dealing with tenths of a point in terms of the market share. I can't make much of that. Even going quarter to quarter on market share is very, very difficult. We don't perceive our ways in any way, shape or form as losing ground here. That's our best guesstimate of where we are when we don't have the numbers. We are sort of rounding off what we think the numbers will be and that's what we have concluded for this call. On the 241, that's a one-day total and there is a lot of risk in one day totals. We look at our daily volumes and we can have multi billions go in and out every single day for a thousand different reasons and that's why we always caution not to make too much of it. I wouldn't combine those two, Bill and conclude that something different is happening here. It just ain't true.

The institutional account in the terms of the state of Florida in terms of the work out. Can you give me a sense of the economics behind that in terms of the revenue yield or what type of performance fee you might have in place with the state as it relates to work out and what kind of incremental pipeline do you think might be out there in your ongoing conversations with them?

On that particular portfolio, all the Florida money is in a similar band width as we have talked about before. If you translate it to basis points it would be in the 2 to 2.5 basis point range and you can apply it across all of our state business that is like that and -- It is cash. That's cash. That's correct. And this portion of fixed-income. In terms of additional mandates, we have a lot of discussions going on with other states and across asset classes, I would add. We would hope to have some additional good news in the future on that front.

Okay. Thank you very much.

Thank you. Our next question comes from the line of Cynthia Mayer with Merrill Lynch.

I was wondering if you can talk a little about Prudent Bear, which channels you see the most opportunity in and how quickly you think you can develop products which will actually make a difference in net flows?

Taking the second part of that first, we don't envision at this point new products. We envision the two products that they have being brought in. As you can see from what we have done with Kaufmann or from MDT over time, we come up with new products but the first focus is to get these excellent products organized in the Federated Group, which means do the closing, the do you diligence, et cetera and then do the training, the road show and explanation to the client bases and see these products take on in our distribution before we would even think about new products. Now, which areas? We think it could easily be across the board in terms of where these products would take interest because don't forget, these products are basically a portion of people's investing, investment dollars and so it can find a proper home in both wealth and trust, as well as in the broker dealer area. The institutional will be its own challenge. Those products aren't exactly designed for that but there is some modest interest there as well. But that isn't the main focus at this point.

Is it something you can get the Jones Channel to take an interest in?

Well, we have to see about that. The Jones has a very solid system of evaluating those funds and then putting them on their list and we would certainly plan to do that. They tend to focus on the main show of value oriented growth and income funds. That is the principal ingredient in their investment triangle and this type of activity would be a very small portion of anything that they would really sell even if it were able to get onto their lists.

A little too niche, okay. Can I ask a quick question on the administered assets. It looks like they went down. I'm wondering if there is anything behind that and what sort of impact, if any, that that would have.

The impact for any changes in the administered assets would be very modest. We are down to a literally a couple of third-party complexes for which we provide fund administrative services. I would not -- there would not be much impact to any changes in that category.

Great. Okay. And I'm just wondering, you have mentioned -- last thing you mentioned something about I guess a pipeline of wins to be funded. Did you give the amount for those?

200 million was what had funded but we didn't give a number for a future. We keep working on them.

Okay. Thanks a lot.

Thank you, our next question comes from the line of Mike Carrier with UBS. Please proceed.

Thanks guys. One question on the money market flows. It seems like in June there is a lot of -- I don't know -- different trends going on in the market and given what happened in the equity markets you would have kind of expected -- this goes for the industry as well as for your flows -- just to be stronger. There is a lot of stuff like corporate tax month but you also had the expectations for potential higher rates. Just trying to figure out what exactly was going on in June that led to that and obviously you said that it bounced back in July and just trying to figure out what the trends or what has shifted in terms of the clients ' minds.

You have touched on some of them and you have characterized it correctly. It was a mixed bag of activities that caused the variety of actions in June. You did have corporate taxes. You had -- at least some of our people believe there is some evidence that some people who had gone onto higher quality went back from where they came because of the size of the spreads and some of their improved confidence -- don't make that bigger than what I'm saying -- it is just the hence of the start of something like that, you also had some times during June where on reflection the 30 day LIBOR rates were very competitive with many of the money fund rates, which could attract some people to move as well. You really did have a mixed bag of features going on in the money market fund business in June.

And then just the money that was going out, if money was going out of equities and money was going out of money markets, for you guys the area -- the ultrashort fund seemed to be gaining, did you see money shifting into that as a different product it takes some of the money or was it just leading all together?

What is always hard for us to do is precisely follow the switch. All of these accounts deal with us on an omnibus basis and there are many accounts underneath. Yes, we did see money go out of some of the government money funds and we did see money going into various of the ultrashort. I can't fully say we know which clients went along and it was a direct exchange. We suspect there is a handsome amount of that going on but we can't identify it precisely.

That makes sense. One last question on the growth in revenues versus assets. You obviously have with equity markets down and then the increase over the last 12 months in money market funds, you have the natural mix shift in terms of lower fee products. It seems a little more pronounced. I'm trying to figure out, besides the increase in the state of Florida and some of those lower fee products, is there anymore intense coach of competition on any certain products that we should be looking out for that we should see further fee pressure?

I think you have outlined pretty much the range of features to that realization rate. The competition just continues in terms of money market funds and marketing and distribution but there is nothing new or revolutionary there. It is repeating the same old thing of dealing with our clients on that side.

Okay. Thanks.

Our next question comes from the line of Robert Lee with KBW. Please proceed with your question.

Thanks. Good morning. Couple quick questions, a bunch of them might have been answered. Going to the M&A environment -- Chris, I know you guys have always looked at filling acquisitions and bolt on acquisitions. I'm just curious what your current appetite or thoughts are around -- there clearly has been a lot of speculation about larger properties potentially having to be sold as banks and others need to shore up their balance sheets and -- maybe talk a little bit about how you look at that, number one, you are you seeing those books come across your desk. Number two, if there is any appetite in your organization for tackling something that might be fairly large?

Okay. As soon as you say banks you are in a wide range of potential deals. As you know, we have attempted to buy the -- we will call them -- the intermediate sized assets of various banks, some of which have been in the newspaper recently for years. In fact, we created most of them. So we continue to be interested in all of those deals as they come up. These with all function as what you are referring to as bolt on or as what we refer to as roll up type operations. In terms of larger deals, we would certainly look at those as well and there may be opportunities for big hairy deals that we would think worth while and we would look at everyone of them with open enthusiasm to see if it would be a proper confluence of the shareholders of, Inc., and the shareholders of Federated as well. As I said on here before, we don't look at it as sitting around and saying no. We look at it as evaluating to score on those two streets, namely the shareholders of, Inc., and the shareholders of the funds.

Fair enough. This is a generic money fund question. If you were to be auction preferred market which has been pretty frozen and you have had some close end fund managers come up with new security structures they are trying to make enticing to various money funds, I guess mainly on the MUNI side. Is it at all possible to comment on what your people are thinking about, are those structures, any of them appear feasible and attractive at all?

Well, we have been working with many of those providers in order to make sure that the structures are compatible with 2A7 and that we would be enthusiastic to purchase those on our side. Think about it from their perspective. They do not want to create something that only in their mind solves the problem. They want to create something that really truly solves the problem. Meaning, that you can in fact position those securities with the money funds. Our lawyers, PMs and analysts have been working with the various people trying to solve these issues in order to make sure that that happens. We would view those securities, I believe with open arms and if they meet the kinds of things we have talked about, it wouldn't surprise me to see us owning a bunch of them in our money funds. Don't forget that the whole existence of the auction rate preferred securities was a way to get away from money funds, get higher yield and avoid the strict towers of 2A7 and now it is coming back home to papa.

Thanks a lot.

Our next question comes from the line of Michael Hecht with Banc of America Securities.

Good morning. How are you doing?

Great, Mike.

I wanted to come back again on the money fund slow trends and -- I guess outside of the rate environment some of the cyclical drivers, I think you touched on this, just continue to seem a little bit counter intuitive, with the risk aversion or flight of quality that's out there with all the volatility in the markets and maybe one way to get a sense of it. Can you give us a sense of what the flow trends were in the government funds versus your prime funds in the quarter?

Mike, the government funds were really where we had some outflows. The prime flows actually had in flows. On the government side, we are talking low single-digit percentages and the same on the prime. In total, there wasn't much change in the money within particular months we had big ups and then outflows but on the margin it would have come out of government funds and we caught some of it back into prime funds. I would also say the MUNI funds were up, interestingly given the noise around that market. Our tax refunds actually had a pretty solid quarter.

Okay. And then I guess with some -- a lot of the outflows that you saw in the quarter, coming out of some of the lower yielding separate account money funds, would it be reasonable to see some upward pressure on revenue yield in the second half, which have come under pressure, some of this money has come in?

As we commented, that is normal seasonality and what we would expect would be in this quarter, that will decline further because it is not a big tax collection quarter. As we get to the fourth quarter and the first quarter, then we would expect to see that money flow back in as it has over the -- all the years that we have managed this type of money.

Okay. And then thanks for the update on SIGMA. I was hoping to get a rough sense of [SIG] assets, overall. SIGMA was the only big non-sponsored bank saver and the rest are all bank sponsored and therefore consolidated bank on sponsoring bank balance sheets and any other exposure updates?

There is nothing else that doesn't have a bank sponsor beyond SIGMA and SIGMA, our exposure there is down to a couple of weeks.

That's cool and just to follow-up on the acquisition question maybe to take a different stab at it. What other products or gaps are you looking to fill at this point? On the equity side, in particular including some areas where you guys have had some performance issues, like on the large cap value side and maybe a little more color on how your growth offerings are fairing today.

You mentioned and we have mentioned it on the call before, the large cap value remains an attractive project for us on the M&A side. We continue to look there on the product side. And we think we have a great array of growth products. So we wouldn't be hunting for M&A opportunities there, if that's what you were getting at, Mike.

How the flows turning? I think the performance has gotten better but is it paying off in flows, yet or is it too early on the growth side?

We talked about the Kaufmann flows in Q2, were are net positive and that would be the flagship of growth. I can't tell you we are seeing an acceleration there. So it is -- those would be the products to watch.

And then last question, how is the pace of discussions for potential money fund acquisitions and do you expect any pick up on deals there over the next 12 or 18 months there?

We continue to see see some deals and we are optimistic that we would be able to complete some things there. We don't have anything to announce right now but there is a continuing interest in people who have smaller money fund operations to understand that this is real work that requires real staff and you got to get this stuff right in order to play this game during difficult times. As you might suspect, that causes some people to think that maybe they are in some other business better. That's why we would remain optimistic that we would be able to complete some deals over the time frame you talked about.

Great. Thanks, guys.

Ladies and gentlemen, there are no further questions at this time. I would now like to turn the floor back to management for closing comments.

That's concludes our call and thank you for joining us today

Ladies and gentleman, this does conclude today's teleconference and you may disconnect you lines at this time. Thank you for your participation.