Federated Hermes Inc (FHI) 2008 Q3 法說會逐字稿

Greetings and welcome to the Federated Investors Q3 2008 earnings conference call. At this time, all participants are in a listen-only mode. A 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. Ray Hanley, President of Federated Investors Management Company. Thank you Mr. Hanley, you may begin.

As usual we will have some remarks to open up the call, then we will open up the call for your questions. Leading today's call will be Chris Donahue, Federated's CEO, Tom Donahue, Chief Financial Officer, and also we have from the Corporate Finance group, Dennis McCauley Lori Henceler, and Stacey Friday. And we are also joined today by Debbie Cunningham, who is our Chief Investment Officer for the Money Market area, and will also participate in the Q&A.

In terms of forward-looking statements, let me say that certain statements in our 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 be materially different from any future results implied by such forward-looking statements.

For discussion of the risk factors, please see our filings with the SEC, 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.

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 recent business performance, and then turn the call over to Tom to discuss our financials.

Starting with the cash management business, money market assets grew by $17 billion, or 6% from the prior quarter, and have increased by $78 billion, or 37% since Q3 of '07. Money market funds grew by $19 billion in the third quarter, with the bulk of the increase occurring in September, including the addition of $12 billion in initial assets from the Putnam transaction on September 24th. Now we estimate that about two-thirds of the $19 billion money market fund asset growth in Q3 was organic, and about one-third was the net result of the Putnam transaction.

Seasonal money market separate account decreases of about $2 billion occurred during the third quarter. Average money market fund assets decreased slightly from Q2, reflecting both the solid average assets in the prior quarter, as well as the timing of the Q3 inflows. We have continued to see money fund growth in October with assets ranging from 260 to $280 billion, and averaging about 271 billion.

Money fund asset growth has been strongest in our wealth management and trust channel. We have also seen solid growth in the broker dealer channel, and we believe that our market share grew during the quarter, from either side of 7%, to a little over 7.5% percent in the late September/October timeframe. Within money market funds the bulk of the inflows have come in our Treasury and other government money market funds. These funds grew in Q3 by $35 billion, or about 28%, and have continued to grow in October adding another 18 billion, or 11% growth.

Prime funds decreased by about 10 billion, or 13% during Q3, with most of this occurring in mid-September. In October the assets in prime funds have remained in a narrow range of plus/minus about 1% from the 930 level, and we have had several days with positive flows into our prime funds.

On the Muni money market fund side, assets decreased about 16% in Q3, and have increased about 6% so far in October. As you are aware market conditions were unprecedented in the third quarter. Our investment managers and traders in the money market area have continued to do an exceptional job, in navigating the difficult market conditions successfully for our investors and our shareholders.

The credit culture that we have developed over decades, and our many long-term client relationships, served our business well during the stressed periods, particularly in September. We maintained frequent contact with our clients. They understand how we manage their cash, and we believe that this foster's confidence and a greater degree of stability, compared to others in the cash management business. Though we did not and do not have credit issues in our money market funds, the general lack of liquidity in the credit markets was a challenge in the third quarter. Conditions have improved here in October, and we expect further improvement as confidence returns to the system.

Measures taken by the Treasury, the Fed and the SEC, are well-designed in our opinion to address liquidity, and have already helped considerably. The newly announced Fed money market investor funding facility, combined with previously announced asset backed commercial paper program, and the Treasury money market insurance program, are designed to improve market liquidity, and promote investor confidence in money market fund investments, during a period of unprecedented market stress.

Federated Investors supports these efforts, and we believe that they will help market conditions for money market funds, by helping restore stability and confidence in the short-term credit markets, and in the overall financial system. As you know, like banks and insurance companies and other financial entities, money market funds depend on trust and confidence in the financial system, in order to be able to function properly.

These programs are designed to be temporary measures for extraordinary market conditions. And we anticipate that they will not be necessary, when market conditions improve sufficiently. They are part of the broader effort to return the short-term credit markets to more normal conditions, as part of the overall repair of the capital markets. As indicated by the concerted efforts of the Fed, the Treasury, and the SEC, money market funds are a vital part of our capital markets, and will continue to be critical to the operation and the success of our capital markets.

We believe that the core structure of the money market mutual fund, has been and will remain essential to their use by investors. Core features including of course dollar in, dollar out, the maintenance of $1 NAV as a primary goal, diligent independent credit work to avoid securities that do not meet the standard of minimal credit risk, and other key components of 2A7, relating to quality and duration, are essential to the success of these products. Our clients take comfort in investing with a firm with substantial resources, skill, strength, and a long-term track record of successful money market management.

We have developed proprietary credit rating capabilities, and we have played a critical role in the development of this $3.5 trillion industry, including the development of it's regulatory and operating framework. Our funds have operated successfully through varying market conditions for more than three decades, including this most recent period of unprecedented stress.

This is not a guarantee of future success. Investors understand that money market funds are investment products. These investment products enable fund shareholders to access the benefits of a large high quality money market fund, including daily liquidity of par, diversification, credit analysis, competitive yields, and convenience. This is the core value proposition of the money market mutual fund, and we believe it will transcend the difficult market conditions that we have experienced.

We also believe that Federated will benefit from consolidation, as institutions and other investors re-evaluate their cash management providers, with a view towards concentrating their business, with the highest quality and best positioned managers. The transaction with Putnam demonstrates the advantage of Federated's large well-diversified cash management platform.

We have seen heightened interest from firms considering exiting the money market business, as they realize they do not have the scale, the resources, and the client base necessary to successfully manage money funds, especially when market conditions are difficult. We can't predict the timing, the size, or the impact of these various arrangements, but we do expect to see additional growth opportunities through consolidation.

Now let's turn to equities. Our assets here decreased about 15%, or $6 billion during the third quarter, and are down another 7 billion so far in October. This is due largely to market depreciation. For 2008 year-to-date through October 22nd, our equity assets are down approximately 18 billion, or 43%.

Net equity fund redemptions are higher in the third quarter, against the difficult market background. About one-third of the equity fund net redemptions came from passive index funds. Kaufmann products collectively moved from inflows in Q2 to outflows in Q3. We had modest inflows into balanced and core equity products, and the MDT mutual funds had positive net sales.

Net outflows in our equity funds are running on a higher pace for the first three weeks of October, compared to Q3. Though we caution as always about drawing conclusions from limited time data.

Turning to equity separate accounts, outflows in this area were driven by SMA products. MDT institutional accounts had modest net inflows, and we continue to have success with MDT for new institutional accounts. Q3 saw four more wins that are expected to fund for over 400 million. Overall equity separate accounts including SMA's and institutional accounts had $426 million in net outflows in Q3.

On the fixed income side, Federated continued to navigate difficult credit market conditions very successfully. Bond fund net fund sales were solid at $528 million, led by strong inflows into our total return bond fund, and into our Ultrashort bond funds. Separate account outflows were due largely to the planned sale of assets from the $1 billion distressed asset account we added last quarter, which declined about $200 million.

Fixed income fund flows are slightly negative here early in Q4, due to outflows in Ultrashort bond products, while the remaining bond products collectively remain net positive for sales. As of October 22nd, our managed assets were approximately $355 billion, including 307 billion in the money markets, $24 billion in equities, and $24 billion in fixed income. Money market mutual fund assets stand at about $280 billion.

Now looking at investment performance and using the quarter end Lipper rankings for Federated's equity fund, our comparative performance results are solid, with 76% of rated assets are in the first or second quartile over last year, 74% are in the first or second quartile over three years, 81% over five years. For bond fund assets, the comparable first and second quartile percentages, are 71% for the one year, 81% for the three years, and 84% for the five years.

Let's talk specifically about distribution. In the wealth management and trust market, combined net sales of equity and bond funds were positive. We continued to have success with the total return bond fund in this channel, and money market products continue to increase. In the broker dealer channel, money market assets increased 6 billion, with the disruptions in the markets most likely leading to higher cash balances in these accounts.

In the global institutional channel, we have had success with MDT strategies for institutional accounts, as mentioned previously. We continue to have success adding mandates from state governments, with two wins for about $500 million in Q3, that we expect to seed during the fourth quarter.

On the acquisition front, we continue to progress towards the planned closings on the previously announced Prudent Bear and Clover Capital acquisitions. We expect both to close in December. We are also on track to add about $1 billion in municipal assets from Fifth Third Bank during this quarter. We continue to look for potential alliance in acquisition opportunities.

At this point, I will turn it over to Tom to discuss our financials. Thank you Chris. For Q3 revenues increased 7% compared to Q3 '07, and were about 1% lower than the prior quarter. The growth from Q3 '07 was due mainly to higher money market assets, partially reduced by lower equity assets largely from market declines.

The decrease from the prior quarter was primarily due to the decrease in average equity assets, and to a lesser extent a decrease in average money market assets, partially offset by one additional day in the third quarter. The further drop in equity assets in October will meaningfully pressure revenues and earnings. While we continue in October to have significant inflows in our money market fund products, growth of about $20 billion this month, does not offset the loss in value of over 7 billion in equity assets.

During Q3 Federated incurred about $100,000 in incremental fee waivers, in order to maintain positive yields on certain government money market funds, that were impacted by the extraordinary demand for Treasuries in the market, and a subsequent decline in yields. The assets of those affected funds total about $13 billion. We have incurred about $300,000 in these waivers so far in October. Depending on market conditions, we could see additional waivers in the fourth quarter, this is highly dependent on the yields for short-term Treasuries and Treasury-backed repos. Market conditions have improved this week, with Treasury yields moving back up to the point where over the last three days, waivers were not necessary.

On the expense side, compensation and related was impacted by higher bonus and base pay compared to Q3 '07. [Top] expense related to the Q3 special dividend, also impacted the variance from both Q3 '07 and the prior quarter. Marketing and distribution expense decreased from the prior quarter, due mainly to lower average money market and equity fund assets. Amortization of the deferred sales commissions declined from the prior quarter, due mainly to lower average equity assets in our B share products.

Nonoperating expense increased from the prior quarter, due mainly to higher mark to market investment losses of $900,000 on product seed investments, and $600,000 of recourse debt expense on our new term facility, which began on August 19th. Our tax rate was lower in the third quarter, due to the impact of estate tax law change enacted in the quarter. While the initial effect was a lower Q3 rate, we continue to expect to see a go forward tax rate of about 38%.

On the balance sheet, cash and short-term investments were $60 million at the end of Q3, and recourse debt was $160 million. We continue to generate strong free cash flow, and expect that we will continue to use cash and our revolver to fund our announced acquisitions, dividends, share repurchases, capital expenditures, and debt repayment.

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

Thank you. We will now be conducting the question and answer session. (OPERATOR INSTRUCTIONS).

Our first question comes from Robert Lee with KBW, please state your question.

Thanks, good morning everyone.

Morning Rob.

First question on the money fund business, I am sure this is on a lot of people's minds, but when the dust settles from all of this, you have obviously talked about more interest in people getting out of the business, but do you think there will be any kind of fundamental change in the business?

I mean, you have heard people talk about everything from capital requirements to other things, I mean, do you think this will change at all how you may need to manage your own capital, maybe rebuild cash levels, keep, or something, or keep a cap on the amount of debt you put on the business? I am trying to think of how it may change going forward, and how you think about managing your own business and the capital levels?

A couple ways looking at that Rob. First of all, I think that the beauty of the money fund has proven itself over several decades, and therefore it's underlying efficacy if you will is solid. Now will things change in how they are perceived and how they're done, I think so, and I think that will be part of the consolidation.

One of the lessons we have learned is the rather serious importance of a diversified client base, as a factor that we used to talk about, but never really saw the beauty of, until you see the kinds of disruptions that have occurred in the market so far. So it means to us that before we thought you had to be big and well-diversified, and now we think that is even more so true.

On the basic subject of capital and how that will all work, the game in the money funds will remain the same, that your job is to provide daily liquidity at par, and to get the credit right first. And nothing really replaces that in the scheme of things. The money funds are not guaranteed and have not been guaranteed. We have this temporary insurance policy right now to restore confidence, which is fine. But that is why we devote so much time, energy and focus on maintaining the $1 net asset value, precisely because they are not guaranteed.

So we think that we are very well-positioned to operate these funds. We have a diversified asset mix, which has proven very resilient here during the third quarter. We have very strong balance sheet, and very low debt outstanding. And so we think we are in pretty good shape to be able to run these businesses, and utilize the capital markets, because I think they will be restored as well into the future.

Maybe a follow up on the two transactions you have pending, that you expect to close this quarter. Because of the supreme pressure on asset levels which maybe it is affecting the Prudent Bear fund less than the other one, but are the deal terms set, is there kind of renegotiating potentially going on? I am assuming at least in the value shop, that the assets that they deliver will be lower than they were when you struck the deal?

Let's talk about the Prudent Bear first, Rob. I just was looking at their numbers this morning, I think the fund is up year-to-date by over 30%. So that fund has grown. So we are pretty excited about that.

Our sales people are kind of chomping at the bit to get it to be able to go out and sell it, so we are, we are very excited about moving forward with that product, and we will bring people in here, we have got a lot of people moving to Pittsburgh to become part of our team there. And they haven't called us to renegotiate to up the price, no.

On the Clover Capital, which we again continue to be excited about and again I was looking at the performance numbers this morning, and they still have long-term excellent track records compared to their peers, so we are still very excited about doing that deal, which we expect to close in December some time.

In terms of deal terms there, we have, it is set up that, there is some period of time where we take the average assets, and then that determines the revenue, and we will pay kind of the going rate. So no, we don't, we try to structure these deals, so that once we come to agreement, market fluctuations are not going to change whether we do the deal or not. They just will change, the price will adjust up or down. And also of course it depends on getting their customers customer consent to agree to the deal.

Okay, great, thanks guys.

Our next question comes from William Katz with Buckingham Research, please state your question.

Okay, thank you, good morning. I just wanted to follow-up on the last set of questions on the money market side. Curious if you could talk longer term about the economics of the business? It just seems to me there is a premium for scale, the cost of the insurance, maybe a higher cost for credit and regulatory environment. Can you talk about how you sort of see the economics going forward? Then I have an unrelated question.

Bill, the economics of this business we think are still strong. I think that you may see less enthusiasm for people moving money to lower priced ala carte vehicles, that explode on the scene here and there. And I think that you will see more attention to daily liquidity of par, versus what the yield bingo game might result in. And this will be a plus for long-term players with lots of resources and focus on this.

I think that the consolidation that we see going on is another big positive in that business, especially from our point of view, because people want to go with the type of organization that has been successful, and is devoted to those types of principles. So longer term even if, like we are paying I think it's the rate of 4 basis points for the government program, that really hasn't diminished interest in funds, or in the basic idea of what they do, which is an investment operation that provides a cash management service.

And nothing has changed in terms of people's fundamental need for the convenience that these funds have offered, since we brought them out back in the mid-'70s. In fact, they need them even more, and many of the banks are even less enthusiastic to have that money on their balance sheet. So the outlook is still very strong.

Just on that point, before I move to another topic, I am sort of curious, given that you have seen an increase in deposit cap for the banking systems at $250,000 from $100,000, in what seems to be a temporary move by the Government action on the money market business, is there a longer term disintermediation issue that you are worried about?

Not really. The $250,000 cap we think was designed primarily in order to establish a broad based confidence in the system, and we really haven't seen too much movement especially in our retail funds, where that would be most, most effective. And of course they have said that the 250,000 cap is temporary, just like all of these other things, you can make your own judgment about what happens there.

But our customer base going through intermediaries are more interested in the long-term nature of developing and maintaining a good strong cash management service, and the movement of a 250 cap, to 150 or 100, or leaving it at 200, really hasn't affected us that much. We wouldn't be concerned about a disintermediation because of it.

Okay. Just one more question on the money markets. If I look at the way the flows have been going just even on a year-to-date basis, it seems like there has been a real flight to the I guess the safer companies including yourself, which I think collective are up about 20% for the year, up about 8, so there has been clear market share gains. Are there any scale issues even for Federated to be considered in some of the funds?

I am going to let Debbie talk about that. My answer will await Debbie's answer.

At this point, there are flows of assets that have come into industry, that we have effectively been able to put to work in the marketplace. There has been consternation in the Treasury market on flight a quality basis, and some of the returns that we have received have been quite low on those instruments, but at a point in time when people were more concerned about safety and liquidity, that is ultimately afforded by the Treasury market, that is something that was a willing trade off from their perspective.

That as Chris mentioned that market has improved at this point, and part of the problems that caused it to be so slow in yield, and lack of supply if you will, over the last maybe six weeks or so, is being mitigated by additional issuance coming forth from the government, from the Treasury, as well as from the agencies for the government funds that can utilize those, and maybe even some of the FDIC insured products that will also have government guarantees behind it.

I think what we have dealt with in the context of additional flows is quite manageable at this point. Given the increase in supply in those particular sectors of the market, I think it's outlook is still pretty positive.

On the prime and municipal side where there has been shrinkage in assets, there the issuers have had some problems making sure they were able to get funded when their traditional suppliers, i.e., prime and tax free money market funds, have not been as flush with cash as has historically been the case.

They have drawn on their bank lines, they have gotten additional relief in the context of federal programs that are available to them, and that is working itself out in a pretty positive way too in the marketplace. And I think importantly those funds are stable to growing again also, so they are helping that part of the capital market improve, and sort of resume it's normalcy at this time.

Bill, the answer that I was going to start with was that back in the late '70s, the money market funds had the money, and the securities didn't even exist. That became very, very powerful and an important aspect of mutual, of the money market fund business. So that when there is the demand for the cash by coming into the money fund, we are very well attuned, and able to create the paper, and create the other side of it if that is what it comes to. So we don't generally look at it as capacity issues. And then I would just say ditto to Debbie's comments on a functioning market being important to allow that to occur.

Okay. Just my last question is more strategic in nature. Just sort of curious as to the timing of the special dividend and the inherent leverage put onto the balance sheet, albeit small, could you sort of walk through what your thinking was as it relates to that move, a switch to a more capital management general?

Yes, the dividend we looked at that, and just felt that with tax rates where they were, that it was appropriate to return capital to the shareholders, if you are going to get raw about it, we weren't particularly thrilled with where the price was, and how we are going to reward our shareholders. We thought it made sense to pay them for the quarter $3 dividends.

In terms of putting leverage on the balance sheet, we absolutely looked at that, and felt that borrowing approximately 140 million in a term loan, and having cash on the balance sheet, and having our revolver $200 million in availability, allowed us to pay the dividend without changing the dynamics or the structure, risk structure of the firm, or the flexibility of the firm, and also, we knew at the time that we were going to be having a few more deals, we had already announced Prudent Bear, and we thought Clover was going to come down the path as well. So that basically was our thought process.

Okay, thank you very much for answering all of my questions.

Our next question comes from Craig Siegenthaler with Credit Suisse, please state your question.

Good morning.

Hi Craig.

First question really hits on the fee waivers, this is really the second quarter this has occurred. I think it happened in the first quarter of '08, and it happened again this quarter, while the nominal level is still quite small. I am wondering is there risk in the fourth quarter or next year, if this becomes a significant problem, and also is there any offset for this on the expense side? Then us being investors trying to track this intra-quarter, can you really reference us to any fixed income index or metrics, that we can kind of track intra-quarter.?

Craig, it is Ray. On the first part of your question we did have some nominal waivers back in March, and we talked about the approximate $100,000 in Q3, and around $300,000 for the first part of October. Back in 2003 when the Fed funds rate touched down at 1%, my recollection is we had about $1 million per quarter of waivers. But you had a traditional, more traditional relationship there between the yields on the money market funds and where the Fed funds rate touched down.

What we are seeing now, and what we have talked about a bit already of course, is with the extraordinary demand for Treasuries, the waivers that we have seen to this point have come in the government funds, and have not really borne a relationship to where Fed funds are. And in fact, we have not waived on the prime funds, because those yields have stayed well in excess of the Fed funds rate.

So the dynamics are a bit different this time than they were back in 2003, and where it goes from here, really depends on predicting how the prime part of the market reacts, and what happens on the government side. Debbie I am sure would have some better thoughts on that front.

In terms of offset, there really is no operating offset to that. I would point out that the funds that tend to be affected here are funds that are structured for use in the broker and intermediary channel, and so the intermediaries participating in the absorption of those waivers. When we talk about these numbers we are really only talking about a fraction of the necessary waiver, with the rest borne by the intermediary.

Still kind of short-term Treasuries that the metrics attract, not really Fed funds?

Short-term Treasuries is definitely something that you want to look at, because that is how funds have been affected, those that can only buy Treasury securities or repo backed by Treasury securities.

I think going forward it is probably a good indicator, as well as looking at sort of credit spreads, and making sure in that regard that they remain at a level that peaks the prime funds and other products beyond the Treasury products out of that sort of a waiver position, because they are higher than the funds rate ultimately anyway.

Your treasury business has grown much faster than your commercial paper business over the last year. I am just wondering how big is that now?

The Treasury and government funds are about 180 billion.

Got it. And then based on I think it was two questions ago, you kind of got into the risk, or you guys said that is not really risk, but the potential for capital charges in this business, the potential for needing a bigger capital base to support your money market funds, some other competitors would say that might be the option, there is room for consolidation. Just to be clear, you really don't think that is a risk one year out? You don't think the business model is really going to change?

I do not, and what that relies on is the strengths of our beliefs in the credit processes that we have put in. If you get into all of the accounting noise on those kinds of things, don't forget that if you want to make preemptive attacks on that, what you are talking about, you have got to have probable and estimable I am told, in order to have that stick. And we are thankfully in a position where we find that neither probable nor estimable.

Got it. And just a final question, on the Prudent Bear and Clover Capital acquisitions which close this quarter, when are you thinking about taking cash off the balance sheets and funding those, what type of deal accretion are you thinking about in the fourth quarter in '09, and also what shift to AUM is that going to be?

The Prudent Bear will be around 2 billion hopefully, by the time we close. And the assets of the Clover, I think at the end of, in September it was around 2.6. Now that is not adjusted for the last, 2.6 billion, that is not adjusted for the last 25 days. In terms of accretion, I think we have talked about those things kind of Ray is going to go through those.

We have talked about each of them as sort of about $0.01 in the first year of accretion to book earnings, probably collectively between the two of them more like $0.06 to $0.08 in terms of cash earnings.

Great, thank you very much for taking my questions.

Our next question comes from Prashant Bhatia with Citigroup, please state your question.

Hi. Just in terms of the cash at the corporate level, what is the minimum you think you want to have there, relative to the $60 million that you have now?

Well, we look at it in terms of the revolver and the cash, okay, so we have basically availability today of 200 million in the revolver. And we have kind of said we wanted a minimum of 100 million in availability, is how we have looked at it for a long time.

Okay. And the cash needs for the acquisitions?

Well, depending on what happens by the time we close there is around 45 to 46 million for Prudent Bear, and I think we announced somewhere around 36 for Clover, again depending on the adjustments at closing.

Okay. So when you look at the buyback right here after the recap, is that kind of on hold for a little while, or is that something that --?

I think hold is not the right word. I mean, we obviously, we bought 50,000 shares in the past quarter. So hold is not the right word.

Okay.

But you look at our track record of what we have done, and generally when we have paid a dividend, we have got two deals coming along, then our past track record, we haven't been big time buyers of shares when we used up a lot of the capital on other things.

Okay. And then back in early 2000 when we were at 1%, there was a lot of discussion between the money market industry and the Fed. Is that discussion taking place again now, and do you think that it is possible for the Fed to go below 1%, and if they did what is sort of the contingency plan there?

We did have discussions with them the last time on this. And part of the understandings that both of us came to, was that the money market funds are an essential ingredient in the capital markets. And so going below 1% for some extended period of time would cause a certain amount of consternation to money fund operators, but really wouldn't be disruptive to the function. You go below that for any extended period of time, and you would start to impact a lot more waivers. So that the discussions were pretty thorough there.

Now ongoing since that time, and especially during these times, Debbie and her cohorts and others here, have had very frequent conversations with the various people, all the way from the SEC, the Fed, and the Treasury, and I will allow Debbie to comment on how that would intersect with the lowering of rates, of which we do not have control.

I think at this point, we are very much in constant discussions with the various regulators, on different ways of providing liquidity to the money markets. They view that as an ultimate goal, to allow the money markets to function naturally with an appropriate amount of liquidity. They have found I think much to everybody's sort of surprise, on the positive side of this nasty stressful market, that there are a lot more tools, than just simply lowering the Fed fund target rate.

They have done lots of different things in the context of adding additional facilities, providing relief to different parties, utilizing collateralization from non-traditional securities, different things that have historically never been thought about, discussed or touched from their perspective. It was just simply the rate mechanism that was utilized. I think across the board once we are finalized with the period of stress that resumes in some amount of normalcy back into the marketplace, it is a much stronger environment from a regulatory perspective, because of the understanding of these new tools, and how they work.

Okay. And do you think the recent actions there to unfreeze the CP market, is that enough, is that going to work, or is more needed?

I think all these things have been various pieces of the puzzle. I think the NAV from the Treasury was one from a confidence building perspective that was extremely positive. I think the ABCP liquidity facility was one that worked extremely well. It is winding down at this point, it is under 100 billion from where it was at it's peak initially of 182 billion.

The commercial paper funding facility which is for issuers is just coming to bear this coming Monday the 27th, there was a big announcement yesterday from GE Capital, which is arguably one of the highest quality and largest commercial paper issuers in the marketplace, they are supporting this facility, so I think others issuers will jump on board behind them.

The new facility the money market insurance, or the money market investor funding facility also coming on board sometime next week will be beneficial. But they are all parts of the puzzle. I think not a single one of them would have had the overall effect that we needed, which was a return to normal funding, and that is effectively what they are looking to achieve. They are continuing to measure that on a day to day basis, if more is needed they will go down the path of finding what that additional capacity might be. At this point it is looking to every possible avenue, and putting it together in this mosaic, to form something that creates positive confidence and overall liquidity in the sectors.

Okay. And then just on the insurance for the money fund, is there concern that that may actually become permanent, is that something you would oppose, because it seems like you have got a huge competitive advantage of scale, and the insurance kind of neutralizes that advantage, if it were to become permanent. Is that something you would oppose?

When we were first informed about the existence of the insurance, and that it would be offered we did not think that we needed it, and didn't especially savor the idea of the shareholders paying for it. On the other hand there was great wisdom in Secretary Paulson, in deciding that he wanted to answer the question over the weekend, hey, what about money funds, he wanted to be able to say, money funds are insured next question.

So just as Debbie said, that was addressing in an overall way a confidence. And so do we think that is necessary for the long haul, no, you asked would we oppose it, we would have to look at it and see what was being talked about, because the issue of trust and confidence and functioning capital markets is very, very important. We still don't think we need it, we haven't changed that out, and as you point out, we believe we're in a little bit of a competitive advantage there for right now. But we would certainly evaluate that, if that came down the line.

Okay. And then just one final on the prime fund, how much do you typically have in short-term government paper, and if you could just compare that with what you have currently allocated to short-term government paper?

I think you are probably asking that in the context of a proxy for liquidity?

Right.

In which case we generally, because we manage all different types of funds, we have strictly Treasury funds, we have strictly government funds, and we have strictly prime funds, we try to manage them very purely within their discipline. So for instance, within our government agency funds, you will rarely find Treasuries. Within our prime funds, you will rarely find government agencies or Treasuries. Instead what we look to find within that own sector's class is liquidity in a higher sense from the instruments within that class.

So for instance, for our prime funds at this point, in an effort to increase the liquidity within those particular products, rather than buying Treasury or government agency securities, we in fact have just increased our overnight position in what would be traditional instruments that we would use within those portfolios, i.e., commercial paper or CDs, that type of credit instrument, so that our clients are still getting the benefit of the credit fund, which is whether they are buying, yet they are also assured of additional liquidity, because of the overnight nature of those issuers that we are buying at this point.

Okay. So maybe asked another way, what percentage rough numbers is overnight allocated, versus what would have been typical when the environment wasn't as stressed?

I would say across the board we have increased our liquidity positions in our prime funds anywhere from 5 to 15%, depending upon the underlying base of shareholders. That is very important as Chris noted in his initial remarks, we think we know our customers well, and certain funds have very little need, and certain funds have a little bit more need. So across the board between 5 and 15% increase in what we would normally have in overnights.

Thank you, that is helpful.

Thank you. Our next question comes from Ken Worthington with JPMorgan, please state your question.

Hi, good morning. In this kind of market, what is the philosophy about expenses and margins? Like your business mix is much more secure than your peers, but it is still a challenging market. You mentioned that equity assets are down a bunch, what are you thinking over the next couple of quarters, in terms of reacting to what the market is doing?

Yes Ken, we have already reacted. If you look at the press release on page 5, where this runs down our comparison of Q3 to Q2, and our revenues was down, and so was our expenses. Virtually every category was decreased to lead to increased operating income. And so we kind of have, if you remember me talking in the past about success items, it isn't like we had any kind of draconian things happen during the third quarter.

It really follows the way we have the Company structured, that the expenses kind of follow in a band the revenue. So we have already had reaction to that, and it will continue to react like that, both on the downside and the upside. Now the heart of what you are talking about, what are we going to do, in terms of T&E and comp and all of those other things, well the first thing is, we have a couple of deals going on where we are going to actually grow.

So the Prudent Bear we are going to get new employees, the Clover we will get 50 more employees. And we have got a couple other deals that are happening around the country, in terms of state mandates, where we are going to put sales people out in hinterlands, to help grow those products.

So we are actually going to see growth there. Now do we diligently manage our costs and what we are doing, absolutely, we will come into our normal budget process here, that has already started to address things, because the equity assets down what they are, is a significant revenue impact to the Company.

Okay. You did a great job this quarter, but again the markets are just down so much, I wanted to just hear what you were thinking about going forward. So thank you.

Our next question comes from John Fox with Fenimore Asset Management, please state your question.

Good morning everyone.

Hi John.

My main question was on the government funds and the fee waivers, which has been handled pretty well. I guess the only question I have left there, is there kind of a breakeven rate that we can monitor for short-term Treasuries, we kind of think about above this level? You mentioned the last three days has been okay, is there kind of a breakeven level we can monitor, that might kind of trigger the fee waivers?

I think effectively at this point, if you see short-term Treasuries, and you can look at three month bill, you can look at the one year bill, but if you see the money market Treasury securities trading with zero handles, that is generally something that will cause some issues from a fee waiver perspective, when they are trading with 1 handles or above, that is generally a pretty positive thing.

Okay. That is great, thank you. Then I guess I missed, you mentioned 1 billion of muni assets coming from Fifth Third, is that something that is going to go into the fixed income mutual fund line item, or what is that exactly?

That is assets that will be merged into our fund product.

So that is in the fixed income mutual fund line?

Both fixed income and money market.

Okay. Great. And that is 1 billion closing this quarter?

We hope so.

Okay. Thank you.

Our next question comes from Cynthia Mayer with Merrill Lynch, please state your question.

Hi good morning.

Good morning.

In terms of the consolidation in the industry is it your sense the other big players are also looking to buy assets and gain share actively, or do you think it is really more a matter they will be happy to take any share gains just passively, as there is sort of a flight to the bigger providers?

I can't really speak for other players. There are certain of the other players that we know about that really don't engage in these kinds of transactions. But that isn't to say they wouldn't have increases in assets, because clients can find the firms anyway. So I really can't say what the other firms were doing on that.

I guess what I am asking is, if you are interested in buying money market assets, what kind of competition do you think you will see, and what kind of pricing do you think you will see?

Well, sometimes in these kinds of circumstances, the pricing isn't really the issue. In other words, sometimes there really isn't any price paid. It is more or less what is in the best interests of the shareholders of the funds, in order to resolve the situation.

In other circumstances it is related to payments for assets, that happen to stick around for services rendered. So once again I can't, I don't know about any competition. We are talking to some people, and what is going on on the other side, we just don't know about. I would expect that there would be other people interested in doing what we are doing, but I can't address it.

So basically it sounds like what you are implying is you might be able to acquire some more assets without a lot of upfront cash, so the slightly extra leverage you have wouldn't necessarily affect your ability to acquire money market assets?

You can go back and look at our past money market transactions like Alliance, while there was some upfront there, the structure was to pay them as Chris said, contingent payments if the money stays over a long period of time. Right. That is the way we do those kind of transactions.

And did the Putnam fund come in for free?

Free, no.

No, I mean what was the transaction.

There was no upfront payment to Putnam.

Right.

Remember what the Putnam was, the transaction was we took securities into, our funds gave shares for securities and cash to their clients. At a $1 for $1 basis.

I am just wondering if there was like a five-year trailer of some kind on that?

No.

No, okay. Okay. And just I guess one more Fed funds question, which is the old dynamics seem to be when rates went lower, flows would go into money market funds. I am just wondering if you think that would still hold here, or if all of the turmoil in the markets have changed those dynamics?

Well, all of the turmoil in the markets have changed dynamics, because the old line thing that you are talking about was basically a yield move. When the Fed was reducing rates, so our rate would be higher than the spot market, or the repo rate, or the Fed funds rate, or whatever rate somebody was looking at. Well, those were all rate things. And people are now a little more concerned about the security and safety of their cash. So there is a little bit less of that.

On the other hand as the market strengthens, people will begin again to make moves based on those yields. So it won't be a zero factor, but it certainly won't be as strong as it had been in the past.

Got it. And maybe just one more question, which is just given what is happening in the overseas markets, and with currencies, are you seeing any more interest from overseas investors?

You mean overseas investors coming into our money funds?

Yes.

Well, we haven't seen a whole lot of that money coming in as of yet. There are certain things that have to occur inside funds, in order for them to participate, in terms of tax reporting, and the structure of the funds.

Okay. I know you have some overseas funds too, but the interest there hasn't been particularly strong.

That is correct.

Okay. Thank you.

Our next question comes from Mike Carrier with UBS, please state your question.

Thanks, just one follow-up on the money markets. Given all the initiatives that the Fed and the Treasury have put in place, if you look at the past initiatives that are actually now in place and operational, any of the new ones that are set to begin whether it's Monday, or in the coming weeks, do you feel like the markets, like the money market itself, in terms of yields has already priced that in, or do you think based on what you saw in the past, once it actually does take effect, you will have more of a benefit, in terms of the money markets running a bit more smoothly?

I think one of the things that is going to affect rates next week, and it has already been doing so through this week and the end of last week, is this commercial paper funding facility, which is the one that is administered by the Fed in New York. And it is for issuers, and it effectively allows issuers in the CP market, so as I said today GE announced that they will participate in it. So if GE is unable to place $100 million of CP in their normal mode, i.e., going to money fund investors or whoever else they would normally place that paper with, they can then go to this facility that the Fed is providing, and place the paper there. There is a set formula from a rate perspective, as to what they will be charged by the Fed in that placement of paper.

I think that set formula off of something called OIS, which is an Overnight Index Swap rate that you can look up on Bloomberg, and is trackable. I think that is a great floor that has been set, if you will, by this facility, that is allowing LIBOR on a day to day basis to trend toward. LIBOR has been drastically affected over the last month and a half by various things in the marketplace, and just as recent as a week and a half, because of that facility I believe specifically, rates have been trending down.

I think that facility opening next week being utilized, being reported on, will continue to allow that drop in LIBOR to occur next weekend, and thus positively affect the marketplace. The money market investor funding facility, which doesn't have all of the specifics about it available yet. I also think it had a nice confidence boost that was provided to the marketplace upon it's announcement. But when it begins to be utilized by the participants in the marketplace, I think that will provide a little bit more rationale if you will, to a more normal operating market.

Okay, thanks a lot.

Our next question comes from Marc Irizarry with Goldman Sachs, please state your question.

Oh, great, thanks. Chris, obviously this is both an absolute and relatively very strong time for your business, relative to other asset categories. What is your appetite and what is your framework, when you think about doing some sort of transformative deal, to take advantage of what may end up in hindsight being an extraordinary time, to sort of diversify your business?

Our attitude remains the same as I guess it has been for many, many of these calls. That given the right type of transaction we would certainly look and entertain any of those kinds of ideas, whether they were trans for martial or not.

And part of the reason for that is that you have a lot of change in the marketplace, a lot of players with a lot of good ideas, and we have talked to a lot of them over the years. So we would remain open for those kinds of ideas. As I have said often on these calls, a CEO of a public company simply doesn't have the right to to just sit back, and declare victory and say no. So we are always open to looking at those kinds of ideas.

Okay, great, thanks.

Our next question comes from William Katz with Buckingham Research, please state your question.

Hard to believe I have a follow-up with all of these questions on money markets. I am just sort of curious, I had a different take on the insurance, I want to get your perspective. If in fact insurance were to become permanent, is that a cost-buster for smaller players, so that the larger players ultimately win anyhow?

It could be, but maybe not. It all depends on how sensitive, and how important the yield becomes. The current cost is now 4 basis points. I can make no comment about whether that will be the future cost or the insurance cost, that was something that was, that they came up with more or less over a weekend.

So whether that would actually be the thing that broke down the smaller fund players, I don't know. It certainly is not helpful to a smaller player, because they have got all of these other things going on, and now they have this additional expense on top of their machinery. So it is not helpful, but I don't think it would supply any deathnel to them. I mean the fact of the insurance would probably be a help for them, just the fact of the insurance.

How do you get the 4 basis points, I thought it was between 1 to 1.5?

It is 1 basis point per quarter.

Okay.

So it hits the yield 4 basis points.

Okay, thank you.

Thank you. This concludes today's question and answer session. I will turn the conference back over to Ray Hanley for closing comments.

That concludes our call, thank you very much for joining us today.

Thank you. All parties may now disconnect.