Federated Hermes Inc (FHI) 2009 Q4 法說會逐字稿

Greetings and welcome to the Federated Investors Q4 2009 quarterly earnings call and webcast. 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, Raymond J. Hanley, President for Federated Investors Management Company. Thank you, Mr. Hanley, you may begin.

Good morning and welcome. Today we planned some brief remarks before opening up for your questions. Leading today's call will be Chris Donahue, Federated's CEO, Tom Donahue, Chief Financial Officer. We also have Debbie Cunningham, the Chief Investment Officer for our Money Market Group, and we have [Dennis McCauley], [Laurie] Hensler and Stacy Friday from the corporate finance area.

Let me start by saying that certain statements in the presentation, including those related to assets, investment, and financial performance, constitute forward-looking statements which involve known and unknown risks that may cause actual results to be materially different from future results implied by such forward-looking statements.

For a discussion of risk factors please see our SEC filings. No assurance can be given as to future results and neither Federated nor any other person assumes responsibility to the accuracy and completeness of such statements in the future. And with that I will turn it over to Chris.

Thank you, Ray. Good morning. I will start with a brief review of Federated's recent business performance before turning the call over to Tom to discuss our financials. Looking first at the cash management portion of our business, money market assets decreased by about $5 billion or 2% from the prior quarter. Money market funds decreased about $6 billion and were partially offset by an increase in cash separate account assets.

We have seen significant asset movements in our money funds over the last several weeks. We saw about $5 billion of inflows during the last week or so of December followed by outflows during January to date of approximately $22 billion. These outflows were concentrated in the middle of the month, a period where we generally see cash movement related to tax payments and other uses of cash. During the week ending January 15th outflows totaled about $15 billion. Money fund assets have been essentially flat since mid-month.

Now in addition to regular uses of cash, the outflows included the withdrawal of assets that came in late in the year, which we expected. We also had some client specific actions that were planned for this period. In addition, market condition including rates and yields, regulatory uncertainty, and competition from our bank products were factors. Importantly, our client base remains in tact.

Low interest rates continue to impact yields and fee waivers for money funds in Q4 and the waiver impact is likely to increase in Q1 as rates fell further in January. However, we believe that we will begin to see some upward movement in rates over the next couple of months, initially within the current zero to 25 basis point Fed funds target range. As such, we believe that we will begin to see less impact from money fund fee waivers in the second quarter. Tom will provide more specific information in his remarks.

Our cash management business continues to be very well-positioned. We expect this business to continue to grow over time with higher highs and higher lows during particular cycles. Looking at this most recent cycle, our money funds grew by about $173 billion in '07 and '08 combined. In '09 and here so far in 2010, we have seen about $68 billion leave our money funds.

Now, the SEC's adoption of new money market rules was a welcome development. We believe that the changes announced will strengthen the regulatory framework that money funds operate within and do what all of the regulators and governmental officials have said is their goal, enhance the resiliency of money funds.

It was clear to us that the SEC carefully considered the comments made by Federated and others in arriving at these changes. We anticipate that these changes will not materially alter the way we manage our funds or even the yields of our products as we have generally applied these standards already. We are encouraged by the process and expect that any future changes follow the path of preserving the key characteristics of money funds that enable those products to play a vital role in our Capital Markets.

Now beyond cash we have a broad array of solid products in both bonds and equities. Our sales growth in '09 of 64% for combined bond and equity mutual fund gross sales was a result of a combination of solid performance and successful product distribution. We gained market share in '09 of gross sales for bond funds and for equity funds utilizing the industry's most recent data.

Now looking more specifically at equity assets, they increased slightly during Q4 to just under $30 billion at year-end. Equity flows were positive. We continued to have success with alternative strategy mutual funds with good results in particular from the Prudent Bear Fund.

The strategic value dividend oriented fund continues to show solid flows as does the Kaufman Small Cap Fund. Bond fund sales continued to dominate industry results in the fourth quarter. Federated's fixed income products again showed strong sales results, gaining share against strong industry flows.

The composition of our fourth quarter bond fund flows improved compared to the third quarter. Though gross bond fund sales decreased from the prior quarter, the drop was due mainly to lower sales of ultra short products. Gross sales of all other bond fund products increased 6% and net sales of these products were up 25%. Ultra shorts were about 40% of the fourth quarter gross bond fund sales and 24% of net sales. Comparatively, in the third quarter ultra shorts were 48% of gross sales and 58% of net.

Total net bond fund sales were strong at $1.3 billion for the quarter and reached $6.8 billion for the entire '09 season, more than four times higher than '08 sales. For the fourth quarter all categories of bond funds showed net inflows.

As announced on Wednesday, we launched a new closed end bond fund that raised $178 million in a differentiated strategy utilizing Treasury instruments. We are pleased to add another closed end fund and expect to be active in this area going forward.

We also added $241 million in fixed income separate account net flows in the fourth quarter and believe that our consistent performance over the full cycle has positioned us for further growth in this area. So far in January bond fund flows remained solidly positive, while equity fund flows are modestly negative. As always, we caution about drawing conclusions from limited data.

Turning to investment performance and looking at the year-end Lipper rankings for Federated's equity funds, 22% of rated assets are in the first or second quartile over the last year, 62% three years, 81% five years, 79% 10 years. For bond fund assets the comparable first and second quartile percentages are 28% for one year, 68% three years, 76% for five years, and 80% for 10 years.

The decrease in one-year equity assets in the top quartiles from prior periods was largely due to the defensive positioning of certain funds relative to the large market up swing in 2009. Within fixed income the decrease in one year Lipper rankings reflects in large part the success we had in '08 with the high quality of our products, returns in '09 favored lower quality products. Our three and five year records are strong and we are above the benchmarks in most of our taxable income strategies on a one, three, and five-year basis.

As of January 27th our managed assets were approximately $370 billion, including $294 billion in money markets, $29 billion in equities, $47 billion in fixed income, which includes our liquidation portfolios. Money market mutual fund assets stand at about $260 billion. Now, so far in January our money fund assets have ranged between $259 billion and $281 billion and are averaging about $268 billion.

Regarding acquisitions. With the integration of Clover Capital and Prudent Bear largely completed during '09, we are not looking for acquisitions targeted to specific investment expertise, though this type of deal always remains a possibility. We continue to evaluate multiple acquisition opportunities to add assets and clients, including money market consolidation deals.

We are actively seeking acquisitions or partnerships outside of the United States as a part of developing our strategy to expand a global distribution. As always, we really can't predict the probability or timing of any potential deal. Tom.

Thank you, Chris. Federated's total revenues decreased by about $48 million or 4% in 2009, due largely to the impact from money fund yield waivers. These waivers reduced revenues by about $121 million in 2009 compared to the $4 million reduction in 2008. Revenue growth, excluding the impact of waivers, was due to our diversified business mix as higher money market and fixed income revenue partially offset -- was offset by lower equity revenue.

The Q4 revenue impact of money fund waivers to keep yields positive or zero was $57.5 million, largely offset by $42.6 million in related lower marketing and distribution expenses. The impact to operating income from these waivers was $14.9 million compared to $8.6 million in Q3.

For Q1 volatility in the rates for overnight repo complicates waiver calculations. After averaging about 10 basis points for Q4, Treasury-backed overnight repo rates were literally zero for the first couple days in the first quarter and averaged just about five basis points through January 15th. Since then these rates have been between 10 and 14 basis points.

We believe that these rates will move up a bit more over the rest of Q1. In this rate scenario, and with recent asset levels and mix, the operating income impact in Q1 from these waivers would be approximately $17.5 million.

Lower rates on T bills and prime paper compared to Q4 also impacted Q1 potential waiver impact calculations, as older paper continues to reset at lower rates. Looking at the rest of the year, we expect rates to move up -- to move into the upper half of the current zero to 25 basis points Fed Funds target range over the next several months and expect the Fed to begin increasing the target rate during the latter part of Q3. Under this scenario we expect money fund yield waivers to increase in each the second, third, and fourth quarter of the year -- to decrease in each of the second, third, and fourth quarter.

As we have consistently emphasized with -- a wide range of outcomes, including higher impact for these waivers, is possible, factors that impact the waivers include -- yield levels available in the market; changes in assets within the funds; actions by the Fed, Treasury, the SEC, and other governmental entities; changes in the expenses of the funds; and our willingness to continue to waive.

Terms of sensitivity, we estimate that a 10 basis point increase in yields would reduce the waiver impact by about one-third, while a 25 basis point increase would reduce the impact by about two-thirds.

Turning to operating expenses. 2009 levels decreased 2% from 2008 due largely to lower marketing and distribution expenses related to money market fund yield waivers. We were successful in managing expenses in 2009 and exceeded our targeted range of savings. When comparing '09 and '08 keep in mind that the Clover and Prudent Bear acquisitions closed in December of '08, so very little expense was booked during 2008.

For Q1 remember that the launch of our new closed end fund will impact earnings. We anticipate approximately $2 million to $2.5 million pretax or $0.01 to $0.02 EPS impact from the deal related expenses in Q1. From a revenue standpoint we expect our net management fee realization rate to be in the mid-40s.

We announced a special dividend of $1.26 in addition to the $0.24 regular quarterly dividend. We look at the special dividend as a way to reward shareholders for the success of the Company in navigating difficult conditions in 2009. For Q1 a special dividend will reduce EPS by approximately $0.04 per share due to the impact of the two class method required for calculating EPS.

On the balance sheet cash and short-term investments were $122 million at the end of the year and recourse debt was $126 million. We also repurchased 50,000 shares in Q4 and 829,000 shares during 2009. We continue to generate free strong free cash flow and expect to continue to use cash and loan facilities to fund acquisitions, dividends, share repurchases, capital expenditures, and debt repayments. We would now like to open the call for your questions.

(Operator Instructions) Mike Carrier with Deutsche Bank.

Thanks, guys. Just first on the fee waivers, when we do start to get rising rates, just want to make sure that the revenue and expense sharing with the distributors, nothing should change on the way down versus the way up in terms of the potential positive or relief that you will see.

And then I guess some in the industry have been talking about trying to recapture some of the lost fee waivers over the past year. Any sense of that or do you think competition will be too intense that you won't be able to really recapture it?

Hi, Michael. We don't think about recapturing past waivers and we see it going up, the fees or the reduction of the waiver going up in the same methodology that it went down.

Okay. And then just on the special dividend, given where your guys' cash levels are and still some uncertainty around regulation of the money markets and then also the macro environment, just want to get a sense how the thought process went, because I think it was a little bit surprising just given that the dividend's a little above where the cash balances are. Granted you're going to be generating cash throughout the year, but just a sense because it just seemed a little unusual in terms of timing.

Well, it is a special dividend, so it is unusual. We kind of take a long-term perspective on this and go back and look at our -- this will bring us to having returned and used our capital in terms of dividends about $1 billion since we went public, in terms of share buybacks we're almost up to $1 billion, and in terms of acquisitions we're at about $750 million.

So we kind of have a three pronged approach there and don't have the belief that we need to hold onto our cash. And we look at the share price and aren't really -- we don't really believe that that reflects the value of the Company and so how can we reward shareholders with what we believe they should be rewarded with and paying a dividend to them is one of the answers.

Okay. Thanks a lot.

Michael Kim with Sandler O'Neill.

Hi, guys, good morning. First I apologize, but I missed what the $0.04 item was. Could you just go over that again?

Sure. When we pay a dividend, we have to -- accounting rules tell us that we have to use a two class share methodology because we have restricted stock and so it is a noncash charge that we have to reflect, basically a onetime based on this special dividend of $0.04.

Obviously a Q1 item, Mike.

Got you. Okay. And then in terms of the fee waivers, does the $17.5 million estimate for this quarter assume that rates stay flat from here or are you baking in some kind of higher rates for the rest of the quarter?

It starts with where the rates are now. We expect two things to happen. As the paper in the funds now matures, we're typically buying new paper at slightly lower yields than we were, say, in the fourth quarter as the rates kind of gradually tick down and we saw more of that early in January.

We have seen over the last, since the middle of the month the repo rate has come back up anywhere from 5 to 9 or 10 basis points to get up between 10 and 14 basis points. And there are some technical reasons why we have a fair degree of confidence that the repo rates are going to go up further beginning in February and Debbie can speak better to that.

There is supply coming into the marketplace from the Treasury in particular. They have been a net paydown, in a net paydown situation for short-term debt over the course of the last four or five months. That will reverse itself in February. There is a good amount of planned short-term Treasury issuance that will occur.

That additional supply in the marketplace should in and of itself, if everything else doesn't hold true, but if that comes to fruition as it is expected, should cause rates to come back up a few basis points.

Okay. And then more broadly on kind of the institutional side of the business, do you feel like you're big enough to win some of these fixed income replacement mandates where some of the more entrenched managers have underperformed and are at risk of being replaced? How much of an opportunity is this area given your strong performance track records?

We think we're in pretty good shape on those and have collected a series of mandates in the $100 million type size. So we're pretty optimistic about our chances there and it is the long-term consistent performance over cycles that puts you in that spot.

Okay. And then just final question on kind of the SEC meeting earlier this week, it did seem like they indicated that they will continue to evaluate some of the more controversial proposals out there, so just be curious to get your take on how you're maybe handicapping the likelihood that we do see some type of transformational reform, particularly now that maybe Volcker is back on the scene to some extent?

Considering sin is not the same as committing sin, Jimmie Carter to the contemporary notwithstanding. And so I think they -- Mary Schapiro has made it clear that they're going to continue to look at an array of issues. We don't place much likelihood at all on changing the NAV to a fluctuating NAV.

No matter how often someone talks about doing it, you have to face the reality of the importance of these funds in the Capital Markets in terms of the securities that are owned by a $3.3 trillion industry. And you also have to acknowledge the fact that about $325 trillion has gone through money funds since the SEC's successful initiation of rule 2a-7. So this is a systemic liquidity enhancement. And you also have to note that there has been over the last, say, 24 years about $450 billion paid to investors more than they would have gotten in the MMDA's.

So, yes, you can consider all of these things and that's fine, but we don't place much weight on the idea that they're going to change the NAVs. What we have seen is a regulator, especially the SEC and especially on 2a-7, that over decades has consistently gotten it right because of aggressive study back and forth and considered judgment in the end and that's what we would look forward to here into the future.

Okay. Thanks for taking all my questions.

Roger Freeman with Barclays Capital.

Hi, good morning. I guess just back on the special dividend, how do you valuate doing a dividend versus say a stock buyback, because is seems like at this valuation that that could have been a reasonably accretive transaction.

We run all the models on the buying shares in terms of our forecast and good potential risks. And like I say, we kind of look at it on a long-term view and say that we have done about $1 billion after we do the dividend of each, so it's kind of comparable and different times we have made different decisions.

And it looks like buying the shares back hasn't, at least in the last quarter, what's that going to do for shareholders and it seems that returning the money to them directly through a dividend is a more tangible thing, at least that's our view of it this recent time.

Okay. There is probably a difference between as an ongoing share repurchase and a sizable one, but, I mean, it's kind of curious that the stock's bid down a bit this morning, but okay, that's helpful.

I guess the other question -- so do we take this and coming, sort of come back to the regulatory question that you have a lot of confidence that there -- we won't end up with any sort of capital requirements supporting money markets that you would want to hold onto cash at this point?

The answer to that is yes. We do have a lot of confidence that that will not happen, despite protestations and commentaries by others in the marketplace. And part of the reasons for that that you have to ask yourself, does this -- is this business supportable by a 10% or real bank capital on it.

Go ask JPMorgan what their situation would be with $400 billion in money market funds as to how that business would function if they put real bank capital requirements on them. The need for it is a little odd when you consider that the money funds don't do the leverage thing and they surely don't fail the way banks fail. Even in the reserve situation they got $0.99 at the end.

Now it wasn't a pleasant result because of the delay, but don't forget that in the Putnam situation it was all able to be resolved within the context of other money funds and some cooperation from various regulators. So when Mary Schapiro is summarizing the various things that she is looking at, capital wasn't one of the ones that she listed during her call earlier this week.

So it is again one of those things that gets mentioned out in the marketplace a lot and you can have a lot of fun with it, but we don't think that it is going to come about.

Now a footnote. Mary Schapiro did mention, of course, the private liquidity facility to provide liquidity to money market funds in times of stress. That's a quote. And so there may be some modest capital requirements in however that ends up being structured, but that's all that I can say about that so-called liquidity bank.

Got it, okay. That's why I am asking, I figure you should know.

Roger, I had one more comment. From a Company access to capital, the amount of debt that we have for our earnings and cash flow is pretty small. We cover -- your interest coverage ratios are huge and our EBITDA to debt is very small and obviously we can borrow a lot more money if we want to.

Right. No, that's a fair point. In fact and just judging from the special dividend here, it sounds like that you're not averse to running with some leverage.

The amount of leverage we have, I don't really view running with leverage. When we were a leverage buyout Company 15 years ago, we had some leverage then.

Well, it's different. Yes, exactly. Okay, last question. Can you just explain just in terms of sort of flow dynamics, as you look at -- as you point out, right, the -- there were outflows in the ultra short bond fund during the quarter, as you had money coming back into money markets in November and December.

What are the different dynamics there, because presumably, right, cash goes from money markets into the bond ultra short funds to capture a little bit of extra yield. Is that money then going out to other riskier assets and then what's coming back into cash? Can you just sort of help me think about that?

Roger, it's Ray. Just one clarification -- the ultra shorts had inflows in the fourth quarter. They were down (multiple speakers).

In December. I think in December it was out -- outflows.

Yes, it may have been during month of December. But for the whole quarter there were inflows.

Yes.

And, yes, there is some relationship between the money moving around there and you can look at last, the last low rate cycle in '01 to '03, our ultra shorts went from about $1 billion up to about $4 billion and then shrunk back down to $1 billion.

So we expect some volatility in the flows there, both up and down, and, yes, we do see some of the money shift from cash to ultra short to pick up a bit of yield, but also edging out a bit under the risk spectrum and interestingly picking up -- moving into a product with a fluctuating NAV in order to do that.

So investors understand that trade off and they use that when they're willing to do it in order to pick up more yield. However, you can see the vast majority of the cash management asset still stays in the money market fund.

Yep. Okay. Thanks.

Ken Worthington with JPMorgan.

Hi, good morning.

Morning.

Maybe first the outlook for investment in the business in 2010. Do you kind of feel that you're returning to investment mode or will return to investment mode or is it still prudent to be in kind of a belt tightening mode for the next 12 months?

Well, I don't know exactly what you mean by investment mode because during '08 the fourth quarter we closed on two deals right at the same time when we were looking at our budgets for '09, which involved some significant belt tightening, which we articulated before.

So here as we look at 2010, as I mentioned, we're looking to do some shopping internationally and would be open for business on things domestically as well and haven't hit the pause mode on that side of investment at all. And yet we're still pretty persnickety on the expense side, but unlike last year there may be some relief in terms of some very, very modest hiring here and there, if that's what you meant by investment.

So like investments in technology, ratcheting up marketing spend, that is really where I was going in terms of the investments.

Ken, our look at technology, it's the one area that we continue to invest in and did not cut back, even last year, and we have the same thought process, there are just things we have to do and to move ahead and continue to improve. So on the technology side we will still continue to invest as we did last year.

Thank you. And in terms of the fee waivers, I assume the fee waivers are hitting both the investment advisory fees as well as the service fees. If that's correct, can you give us the breakout in terms of the waivers to those lines this quarter?

Ken, it was weighted just a little bit more to investment advisory fee. If you take the waiver amount about 55% of it would have been investment advisory fee and about 45% would have been in the other service fee line item.

Okay, great. And then lastly, I am going to beat the dead horse on the special dividend. But if you're taking a long-term view on the stock and you want to reward investors, it seems like is the fact you're paying a dividend, it almost seems like you're not endorsing the stock right now. Why is my rationale wrong?

I think you look at different types of shareholders that are in different spots in their ownership of the stock. Some shareholders gain a nice advantage when you buy stock and we have done $1 billion worth of that. Other shareholders who choose not to sell precisely because they're in it for the long haul are -- very well receive an additional dividend.

So it is different shareholders in different spots and it is obvious that if you choose to hold your shares, yes, you think the reduction in total shares outstanding, et cetera, is a positive, but it is also a positive to actually receive a dividend. And of all of the shareholders that I have talked to, generally speaking they're very positive about receiving a dividend, especially if they're long-term holders.

Okay, thank you very much.

Michael Hecht with JMP Securities.

Hi, guys, good morning. How are you doing?

Good.

So I just wanted to go back to -- and maybe this is for Debbie, just some thoughts on the outlook for structural reform of the money fund industry and in particular implications from, I guess, the recent proposed legislative reform and tax levies on the large banks and maybe the impact you expect that to have on the repo and reverse repo markets, which are obviously closely tied to the money fund industry?

Sure, Michael. We are actually working with the Federal Reserve Bank in New York in a tri-party repo working group and this special financial crisis responsibility fee or tax that was announced flies in the face of everything that we have been doing over the last three or four months with the Fed in attempting to stabilize and continue to allow the repo market to go forward in a positive fashion.

Also I think if you looked at yesterday or maybe it was the day before's news items, the Treasury came out and basically said they are not at all happy with this potential fee, especially in the context of the repo market, and were looking to find carveouts in the proposals to remove repo from that particular fee. And they have a very vested interest in doing exactly that, given the amount of funding that occurs in the repo market with Treasury collateral.

So our thought process is at this point in time that if it did come to fruition, obviously it reduces the amount of paper that's available in the marketplace for certainly prime funds to buy and potentially for government funds to buy also in the context of the repo side of the equation.

It would mitigate or -- it would narrow the differentiation between the two types of products, governments and primes, but in an overall response at this point from the market, as well as from other regulators in the marketplace, we don't really think it is going to hold up in the form that it was initially previewed to the marketplace.

Okay. That's helpful. And then maybe just one more to follow-up on the guidance, which I guess relates to the fee waivers. But just generally in terms of your thoughts on interest rates, I mean, you guys it sounds like you're saying we're going to be closer to the upper end of the zero to 25 current range that we're at today in the second quarter. What gives you the confidence that we're going to have that kind of lift in rates in Q2?

Well, two things in particular. Number one would be that the fact that there is Treasury supply coming during the month of February and just adding supply into the marketplace when demand remains to be high tends to lift the rate a little bit.

Secondly, with the FOMC statement on Wednesday, although they did not indicate an end to their purchasing program for their government agency and government agency mortgage-backed mandate onto the Fed's balance sheet, they in fact said they're reviewing not going to those, their maximum levels that they had announced previously.

So our thought is that they are going to stop the purchasing of those securities, number one, out of the marketplace and as soon as they do that, begin very shortly after that the reverse repo process where they take that collateral that is sitting on their balance sheet and start to reverse it back into the marketplace so that funds again have usage of it, again increasing supply.

Bringing us back into that marketplace where rates, even though that you're still in that zero to 0.25 range, end up on an overnight basis up near the 20 to 25 basis points range where they were for most of 2009 and not in the single digits to low teens where they have been in the latter part of the fourth quarter and the early part of this first quarter of 2010.

Okay, great. That's very helpful. And then maybe one for Chris. Just in terms of the outlook for the money fund space and in terms of consolidation, as you're out talking to different, particularly on the money fund side, folks that may have their money fund business up for sale, what are some of the critical issues? Is it just lack of scale. Is it some of the potential regulatory changes?

I mean, it sounds like you guys, your business is already in line with some of the proposals from the SEC, but I am guessing others aren't. Or is it a fear of potential capital charges that is kind of driving some of the potential consolidation?

I would say it isn't fear of capital charges so much as it is are they focused on this business as a core element of their strategy and are they really willing to devote the resources that are necessary for the long haul? This is the overwhelming way that people end up separating themselves from their money market fund business.

We have noted that it can be issues of size. However, as I've mentioned on these calls before, if a purveyor of a money fund controls the redemption process, then they can successfully run a money market fund indefinitely. So then it has to be something else that is really at work.

And when you have a confluence of the CFO, the CEO, and the people running the business to determine that this is not a core element of their strategy, then you have a trade. And you have seen some people, some big people decide, well, maybe we're going to sell this and then decide, no, we're going to keep it because we're willing to commit the resources to make it a successful and competitive business.

Okay. That's helpful. And then can we get just an update on, I guess, the mix of the money funds across bank trusts, the Capital Markets, broker-dealer and kind of corporate other channels and I would also be interested in that same mix across prime, govies and tax free buckets.

Mike, we don't have that at hand. I can follow-up with you for that, but what we have seen in terms of looking at the decrease is it has really been across channels and we'll see if we can pull those numbers while we're still in the Q&A. If we can we'll give them to you now. If not, we'll follow up with them.

Okay. And I just have a couple more on the expense side. So in terms of comp expense, I guess for next year what's the best way to think about the outlook for comp as a percentage of revenues, a percentage increase, and what's the expectation for, I guess, headcount growth next year and where did you end the year in terms of heads -- employees?

The outlook for comp, there isn't anything like the full realization of the 50, approximately 50 people that came on board in mid-December of '08 with our acquisitions. That was fully in the '09 run rate, so there is not that kind of a step up which was really what drove the '09 variance that you saw versus '08. Obviously in Q1 you will get a reset of payroll tax and 401(k) employee benefit costs and historically that's been a couple million dollars, but beyond that -- and that's just typical seasonality.

Beyond that there really isn't anything that we would point to in terms of an unusual expectation of change in comp. Headcount went down a little bit in '09 to around 1,381 people, down 10 or something like that simply because we were -- it was less in terms of replacement hiring.

Back on the prior question of the breakdown of assets as regards bank trust, et cetera, in Q4 we, ended Q4 with $124 billion in bank trust and that compares to $121 billion in Q4 of '08. In what we call Capital Markets, I will give you the numbers then I will tell you what Capital Markets is. It was $58 billion at the end of Q4 in '09 and $86 billion at the end of Q4 in '08.

What Capital Markets is is basically half bank trust and half corporate. It is that department of the bank that has larger clients inside of it. Broker-dealer was $75 billion at the end of '09 and $88 billion at the end of '08. And then a category we call corporate and some others was $24 billion at the end of the year off of a peak of $31 billion from the year before.

Those are money market.

Money market assets.

And, Mike, on your other part of your question by type, at the end of the year we were about $46 billion of Treasury, $105 billion of government agency, $97 billion of prime, and $34 billion in municipal. Now that would just be for money market mutual funds.

Right. Okay. No, that's very helpful. And just last housekeeping one for me and if I missed this, on the tax rate, it has been pretty consistent around 37% plus or minus. Is that a good expectation for next year?

It is actually been around 36%. I think the way it is moving right there. That's a good rate to use going forward.

All right, cool. Thanks a lot guys for taking all my questions.

Thank you.

Marc Irizarry with Goldman Sachs.

Oh, great, thanks. Chris, a question just on the -- back on the SEC proposals and the industries and how they -- the rulings compare to the industry stance. It looks like electronic processing at prices other than $1 the industry, which I assume you support -- supported the industry, that was denied and also the shadow NAV came, I guess, as a little bit of a surprise to some industry participants. I guess the question is were you surprised by those moves and do those indicate further progression towards floating NAVs.

The proposal -- I think the first part of your question, the proposal that the SEC put out was that the industry has to be capable of actually computing to the third decimal place. And this is obviously to make a situation like reserve work a lot better if you can't do a Putnam situation, which basically was baked into the rules that the Putnam situation is now okay with the rules as written.

So the fact that you have the capability of moving into a third decimal point for times when the NAV is cracked does not mean that they do not allow you to continue to run the $1 NAV when that's appropriate. And in fact part of the reasoning that the SEC gave for the second part of your question, which is the shadow work, to date money funds have been filing on a twice a year basis their shadow price and it is public in a certain way, but you had to know how to work DOS in order to figure it out.

So the new requirement of a 60-day delay on publishing it monthly, the SEC said the purpose of that was to get people familiar with the fact that these funds are not guaranteed and that they are run at $1 under 2a-7 and amortized costs and that they are investment products. And that was part of the learning experience or teaching experience that he SEC wanted to do.

And the reason it is a 60-day delay is they don't want people playing games with it and so this was their way to teach what they thought was important to teach. So teaching people that to me does not mean that they're going to go to a variable NAV, which is not going to enhance the efficacy or strength of money funds.

Can I add one thing to that, too? I also believe that historically the SEC, as Chris mentioned, received mark-to-market data or shadow pricing data for each fund in the industry twice a year. They did so in a format that was not easily transferred into any kind of comparative mechanism from their perspective.

By collecting monthly data for every fund going forward, what I think that allows them to do is build their own database of NAVs across fund types, across fund families, across historic time periods in relation to changes in interest rates and changes in market conditions and in their own mind build a database that verifies that the $1 NAV is in fact justified.

Because over the course of the 35 years of the industry essentially there have only been one or two institutions on one or two occasions where that $1 NAV on a mark-to-market basis has been compromised. So I think this will help them in their argument against why a fluctuating NAV in fact is not needed going forward.

Okay, great. And then some of the other proposals changed, some of the -- band illiquid securities and, I guess, band tier 2 securities. It looked like the industry had hoped for less restrictive terms. Can you tell us what percent of your funds' holdings are illiquid securities across all the funds? And then also what percent of your funds are currently in TR2 securities? And if you can breakdown the types of securities across the fund complex, that would be helpful. Thanks.

Sure. From an illiquid security perspective across the board we have about 1% in illiquid securities at this point. So the SEC going from 10% to 5% is something that we actually advocated and thought it made a lot of sense, especially in the context of what their original proposal was, which was to cut it out completely.

Importantly, although 1% doesn't sound like very much, historically there have been times when that number has been 4% or 5% and, generally speaking, what we used from an argument perspective against why it should not be eliminated is that often times, or not often times but occasionally what comes to the market initially as an illiquid private placement type of security often times then grows into something that becomes very liquid and very much accepted in the context of the overall market.

A couple different examples of those on the taxable side of the equation would be asset-backed commercial paper and on the tax free side of the marketplace would be tender option bonds. So that was the argument that was used and although 1% doesn't sound like very much now, didn't want to completely take it away as something that might find the next part of the marketplace that eventually turns from an illiquid security into something that's very well accepted.

In the -- for the second part of the question with regard to tier 2, we currently only have four funds that have the ability to use tier 2. Most of our funds are first tier funds as such and they're restricted by their prospectus in that regard. But for the second tier funds that we manage, generally speaking, we hold them at 4.5% to 5%, so near the limit as it existed two days ago.

We will go forward in that those same funds, obviously with a reduction that takes us down to 3% on an overall basis in second tier holdings in those products and that will be done just by the natural course of maturities as most of the second tier paper that we buy within the products is one month and under type of maturities.

So that's very easily achieved to go from 5% down to 3%, but our expectation is that as long as that marketplace and the issuers that we follow within that sector offer good relative value in the marketplace we will continue to maximize our allowances in those funds that can use it and be at that, very close to that 3% threshold.

Okay. And then just a follow-on. What's your weighted average maturity for your funds on average?

On average it is probably about 45 to 50 days right now.

Okay. And then, Chris, what do you think these -- the changes in liquidity and the changes in the types of securities in the funds means for your ability to compete on yield, particularly if you have got some of these funds where you're at the higher end of tier 2 limits right now. What does it mean for competition in terms of competing for yield if some of those securities are taken out?

Well, first of all if you're talking about competition with other money funds, everybody is playing by the same rules, so that is that. Now, obviously, the competition comes from the direct marketplace. However, with our client base overwhelmingly these clients are looking to these money funds at these low or even zero interest rates as cash management vehicles. So that the precise number of basis points doesn't drive the truck for them.

There are cash management systems and cash management reasons why individual clients are utilizing these products and they all remain. So, yes, there may be some impact from going from 4.5% in tier 2 in certain funds to 3%, but it isn't going to be big enough in our mind to distract a client who is otherwise using these money funds for cash management purposes.

Okay, great. Thank you.

Cynthia Mayer with Bank of America Merrill Lynch.

Hi, good morning. Just to go back once more -- one more time to the SEC proposed rules. Do you think they will have any impact on consolidation in the industry, either by making the product somehow more uniform or requiring more compliance than the little players want to do or do you really see no impact on consolidation?

I think the impact on consolidation will be additive, but will not act like a spark or an avalanche. And the reason is that the business reasons why people would be wanting to get out of their money fund business I have already commented on, which have to do fundamentally with their commitment to devote the resources to make it a successful business. And this is additive because it makes it very clear that you have to do some things that we have been doing for a long time.

Just to give you an example of one that no one talks about a lot but is important, which is to know your customer procedures. Now here is one that we have been doing for ever since we started into this business 35 years ago. We thought it was part of the life blood of how you run a money fund. Well, now that has -- is going to be required, so others are going to have to look at that and say, well, what resources do we need to devote to get to this type of requirement of know your investor?

So that's why I say it won't really be a shock and awe kind of a thing on consolidation, but it will be additive to those people who are looking at devoting resources to this business.

Cynthia, this is Tom. You could also have people look at it and say the rules that they just came out with make money market funds less risky. And if the purveyor of that is how much they weigh risk in their decision with all the factors that Chris mentioned, it could tip them one way or the other.

Okay. And just one more, I guess, on 4Q money market outflows. Did you see any shift in terms of outflows to, you think to bank deposits versus the previous quarter and what kind of rate environment do you think would it take to stop that process?

Cynthia, we don't follow the money, obviously, but once it moves out. But I think in particular on the retail side of things through, say, the broker-dealer channels, there is obviously competition with the bank deposit products and in 2009 the rate differential would have been such that that certainly explains some of the outflows.

We can't really measure how much of that would be attributed to bank products. Over long periods of time, of course, the bank deposits and money funds have coexisted and typically the money fund rates have been higher than the bank deposit rates and for those customers who are looking at it through that lens, the money fund typically is ahead. But in this period the bank deposit rates have been higher.

Great. Thanks a lot.

Robert Lee with KBW.

Thank you. Good morning, everyone.

Good morning.

Hi, Rob.

I apologize for going back to this. I had to jump off the call here or there, but just to make sure I understand it correctly, the fee waiver expectation, incremental fee waiver expectation is $17 million incremental pretax in Q1, is that correct?

We said $17.5 million and of course we had -- incremental, no that's the net amount. There were $14.9 million in the fourth quarter. (multiple speakers) is comparable to $14.9 million.

Right, so the $17.5 million is the incremental net increase.

No.

I'm sorry. Could you repeat it again?

$14.9 million in the fourth quarter and we expect it to be $17.5 million in the first quarter under all of those set of assumptions.

Okay. That's why I wanted to make sure I got it right. Okay. In looking at the balance sheet, I am assuming you intend to drawdown, as you said, on your credit facility to fund the special dividend. Are there any other contingent payments from last year's transactions that either you just paid or are coming due, just trying to get a sense on maybe how much you have to drawdown.

We'll have to -- we have the Alliance payment that will come in the second quarter and we expect to have a Prudent Bear payment and a Clover payment and possibly a Rockdale payment. So we have those all factored in in our thought process with paying a special dividend and ability to fund it and also maintain availability of at least $100 million in borrowing capacity.

And when are the Prudent Bear, Clover and I forget the other one, when are those payments? Are those later in the year or are those kind first, second?

Earlier in the year. I say Alliance is in the second quarter and the other two are in the first quarter.

Okay. Great. Actually that was it. Thank you.

William Katz with Buckingham Research.

Okay, good morning. Glad I could get a chance here. Just sort of coming back to the capital discussion for a moment, (inaudible) sort of come out a little differently. I think maybe one of the lessons learned from Legg Mason's experience with their portfolio is they can never have enough capital against the money market business in the short-term.

I just sort of listened to your discussion about tier 1, tier 2, and liquid, illiquid and sort of looked at the math. That portfolio has 1% of illiquid assets. It is still a pretty sizable number compared to your equity base. I am just sort of curious with that plus your comments about the fact that you still think there is a slow grind here in terms of the fee waiver through the rest of this year and your earnings power.

I just don't understand how you made the decision to do the dividend at this point in time. Are you inherently taking some franchise risk here by running so lean on the balance sheet?

We don't believe so, Bill, and the reason is that for 35 years we have developed a lot of confidence that we're not running the risk of blowing up because of a 1% illiquid position, a 3.5% in given funds, or 4% or 4.5% tier 2 position in those funds. It is because we have a lot of confidence in the credit work and the resources that we have devoted to that business. That's what gives us the confidence to do something like pay this special dividend.

We've looked at the cash flow analysis over the next couple of years and feel we have plenty to do what we need to do given all the requirements that we have and we still think we have excess borrowing capacity and we believe we have the ability to finance any deal that we would do in and of itself or with our additional borrowing capacity.

Are there any leverage restrictions that you would get up against in (inaudible) initiatives?

Our current loan facilities have interest coverage ratios and debt ratios that we are not going to bounce up against, at least in our expectations.

Okay. Second question I have is one of your major competitors out there started talking about the long-term prospects for the money market business having deteriorating margins. Just sort of curious what your thoughts are to that notion.

Well, it is hard to deteriorate from zero. We have a lot of funds where we're waiving substantially, if not all of the fees. So, yes, in many of the cases we're paying the administrative fee, but what we would look forward to is that any move inside the band of zero to 25 is going to be a good thing for the income statement of the adviser to a money fund.

And over the long haul, if you think that interest rates are moving up at some point or you're part of the crowd who thinks that maybe they're cooking up some inflation for the longer term, then money funds are a heck of a good thing.

Okay. Just two last questions. You may have said, and I apologize, did you size the absolute level of the ultra short portfolio at the end of the year?

No, we didn't.

Do you have a sense of how big that is?

You hang on. Go to your next one and we'll try to look it up for you.

Sort of a questions for Tom. Quick question, can you tell me what you use in your discounting rate for your cost of capital discussion between share repurchase and dividend?

We change that regularly and I would say we use 12.5%.

Okay. You can send it to me off line if you like, it's no big deal.

Okay, Bill, if we come up with it we'll broadcast it.

Thank you.

Roger Smith with Macquarie.

Hi, thanks a lot. If you do look at the new SEC, I guess, rules on the enhanced disclosure and I know you said that you have been providing this shadow NAV twice a year, could you give us a degree of the volatility or how much that range is in those filings and what you might expect people to see once this comes out on a more regular basis?

Absolutely. Let me just -- we report on a five digit basis and we're not sure what we'll be reporting on with the new rules. Our expectation is that next week we'll have further release of the rules themselves in which will contain the details to such questions as to are you releasing this mark-to-market on a three-digit basis, four-digit basis, five-digit basis.

So we don't know for sure exactly what that is. But for the current time period what we have historically released is a five-digit number and that number rarely exceeds anything that is 0.0015 different than your NAV, so -- than your $1, the two-digit one.

So in terms of a four-digit NAV, that would mean 0.0085 to 1.0015 is the band which within -- which the reporting of that number and our calculations, we do this on a regular basis, it is not done semi-annually internally, it is done weekly. And as such, I would say with a 99% certainty those rates are always -- that dollar calculation is within those two bands.

Okay. Perfect. And then from a regulatory perspective, and I know people keep asking about this capital charges, but could you just let us know like what the next steps are? Is the SEC planning to hold additional hearings on the money market funds or where do we really stand on that front?

We don't know if they're going to hold additional hearings. What Mary Schapiro says is they will continue to pursue looking at the structure of the money funds. I know that they are waiting on the publication of the President's working group on this, but obviously the whole working group thing has been altered by some political changes in Washington as to what they think they can do, what is possible, and what they would want to do.

So it is tough for us to figure out what the next step exactly will be. It would be a better question directed towards them, but I think the next thing to look forward to is the President's working group publication.

Okay, great. That's helpful. And then just so I understand sort of the guidance around fee waivers, it sounds like if we're at the high-end of the 25 basis point range in the second quarter, that -- I am assuming that's really a 10 basis point increase and should we assume one third of the fee waivers go away and how does that sort of trail through the quarter?

Would that -- do we expect that we'll be at that 25 basis points closer to the beginning of the second quarter in those numbers? And did you say that you think the Fed is actually going to raise rates in the third quarter of this year?

Let's break this up. We'll break this question up. There are a couple in there. Ray will take the first part and Debbie will address the Fed view.

What we expect to happen over the rest of this quarter is that the repo, the overnight repo rate nudges up a handful of basis points over the second half of the quarter beginning sometime in mid-February and that's a part of our calculation of a $17.5 million waiver number for Q1.

Obviously to the extent that that happens, it would be in place for the full second quarter, would be our belief, and we would expect further movement up toward the higher end of the zero to 25 basis point range during Q2 and during Q3 as we get closer to the point where we believe the Fed actually would move the target rate.

Right. And when we're actually looking from on outlook perspective at that timing, obviously strength in the economy and what's happening overall is something that we look at and changes on a day-to-day basis. But at this point in time our expectation would be that sometime late summer, early fall is when we're looking to the first Fed rate hike and in anticipation of that we think the market will start to react at some point earlier than that exact timing.

Great. Thanks very much.

Thank you.

We do have another question coming from Craig Siegenthaler with Credit Suisse. Please state your question. Mr. Siegenthaler, your line is live. Okay, it appears we have no further questions. I will turn the floor back over to management for closing comments.

Well that would then conclude our call and we thank you for joining us today.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time and we thank you for your participation.