Federated Hermes Inc (FHI) 2010 Q2 法說會逐字稿

Greetings and welcome to the Federated Investors second quarter 2010 quarterly earnings call and webcast. At this time all participants are in listen only mode. A brief question and answer session will follow the formal presentation. (Operator Instructions). As a reminder, this conference is being recorded.

It's 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. We'll have some brief remarks today before opening up for your questions. Leading today's call will be Chris Donahue, Federated's Chief Executive Officer, and Tom Donahue, Chief Financial Officer. And also with us are Debbie Cunningham, our Chief Investment Officer for Money Markets, and from the Corporate Finance Department, Denis McAuley, Lori Hensler and Stacey Friday.

Let me start by saying that certain statements in the presentation will constitute forward-looking statements which involve risks that may cause the actual results to differ from future results implied by such statements. For a discussion of the risk factors, please see our SEC filings. No assurance can be given as to future results and Federated assumes no responsibility for the accuracy and completeness of such statements in the future.

With that, I'll turn it over to Chris to talk about the second quarter.

Thank you, Ray, and 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 $12 billion or 4% from the prior quarter. Money market mutual funds decreased by $9 billion. And money market separate accounts decreased by $3 billion which was due largely to tax seasonality.

Money market asset changes are best understood within the context of the unprecedented cycle we're experiencing. Our clients added $182 billion to their money fund balances in '07 and '08. And in '09, and through the end of Q2 here in 2010, we've seen about $95 billion flow out. Meaning, by the famous subtraction method, that we are up $87 billion from the beginning of this cycle. During Q2, we saw money market fund assets decrease in April due largely to expected tax seasonality. These assets then increased in both May and June and average assets so far in July are higher than the June 30 period end level. Growth from clients outside of the US has helped with these results. While market conditions continue to be challenging, our clients have remained strong, stable and growing. Our clients have appreciated the strength, the stability and the availability of our products. We remain confident that our cash management business is well-positioned and we expect this business to grow over time with higher highs and higher lows during particular cycles.

We also expect further growth through consolidation. The transaction we announced last week with SunTrust is expected to result in the transition of about $17 billion in money market assets into Federated money market products during Q4. This is an example of our ability to work successfully with long-term clients as they make changes in their approach to cash management. And we expect to see more of these arrangements as banks and other organizations are attracted to our long-term commitment to this business and our long-term record of providing high-quality products and service that they can rely on for their clients.

Turning to money market fund yield waivers, Q2 saw some relief in the impact from these waivers. As we expected, repo rates moved into the upper portion of the 0% to 25% basis point target point range. In addition, LIBOR rates further increased reflecting market conditions that developed following uncertainty in Europe. This helped to decrease the waivers more than anticipated. We expect these waivers to decrease going forward, though at a slower rate than we saw in Q2. Tom will comment further on these in his remarks. Our money market fund share increased in the second quarter to about 8.2%. Up from approximately 8.1% at the end of the first quarter. For reference, recall that in '09 and '08, our market share was about 8.5%, up from about 7% in '07 and 5% at the turn of the millennium.

As we turn to other products, it's worth noting that in the midst of difficult market conditions in Q2, Federated was able to use its broad product line-up to offer products geared to challenging equity markets. A prime example is the set of alternative strategy equity mutual fund products that we've developed featuring the Prudent Bear Fund, which we acquired in December of 08. This fund returned just under 10% for the quarter and produced solid gross sales of $573 million and net sales of $212 million. It has surpassed $2 billion in assets and as of mid-July, had more than doubled in size from the end of 2008. Flows in this product changed quickly with changes in the equity markets. While we stressed to clients we believe this type of product should be a part of every portfolio, its value becomes most apparent during tough equity markets. Other funds with net inflows in Q2, included the Intercontinental, Value, Kaufmann Large Cap and Clover Small Value Funds. With these and other funds, we have solid equity fund products in growth, value, income, international and alternative. And we believe these products will be attractive as equity markets improve and flows pick up.

While overall equity fund net flows were negative in the second quarter, gross sales year-to-date 2010 were up 16% compared to the same period in 2009. Equity fund flows are positive for the first half of July, driven by the Strategic Value and Prudent Bear Funds. Within equity separate accounts, outflows were negative due largely to net redemptions in our SMA products.

Now looking at bond funds, our sales continue to be solid in the second quarter with gross sales of $3.6 billion and net sales of $310 million. Our total return bond fund showed another quarter of solid inflows, about $385 million. Ultra short products, however, were slightly negative, about $136 million, but have returned to positive here in the early flows of the third quarter. Bond fund flows remained positive in the first two weeks of July. Fixed income separate accounts, we had about $1.8 billion in net new funding of institutional accounts in the second quarter. We won another handful of mandates in the second quarter and the early part of Q3 that we expect will fund for approximately $400 million into mutual funds and separate accounts. We expect to continue to see significant wins in this area given our solid performance over the cycle and higher profile after a series of wins.

Going back to the first quarter of '09, we won about 15 institutional fixed income and equity mandates, ranging in size up to $1.9 billion. They include Core Ag, core fixed, some even into our total return government bond fund, corporates, short-term governments, short intermediate government, MDT small cap and Strategic Value. Certainly an array of product offerings.

Turning to fund investment performance, and looking at the quarter end Lipper rankings for Federated's equity fund, 14% of rated assets are in the first or second quartile over the last year, 34% three years, 77% five years, 82% ten years. For bond assets, the comparable first and second quartile percentages are 28% one year, 69% three years, 71% for five years and 86% for ten years. Interestingly, 77% of international equity rated assets are in the top two quartiles for year one, 24% three years, 72% five years, and 72% for ten years. Taking a look at Morningstar rated funds, 35% of rated equity fund assets are our four and five-star products as of 6/30, and 82% are three, four or five-star products. As of July 21st, our managed assets were approximately $338 billion including $260 billion in money markets, $28 billion in equities and $50 billion in fixed income which includes our liquidation portfolios. Money market mutual fund assets stand at about $231 billion. So far in July, our money fund assets have ranged between $231 billion and $235 billion and have averaged about $233 billion.

Regarding acquisitions, we continue to conduct an active search for an alliance to further advance our business outside of the United States as an important component of our strategy to expand global distribution. We remain active in looking for consolidation deals including money market business. As always, we cannot predict the probability or timing of any potential deals.

At this point, I'd turn it over to Tom to discuss our financials.

Thank you, Chris. As expected, we saw less impact from money market fund yield waivers in Q2 and this impacted related revenue and expense items as detailed in the press release. The reduction in operating income from these waivers dropped to $13 million compared to $17.8 million in Q1. Based on current market conditions and asset levels, we expect these waivers to reduce operating income by $11 million to $12 million in the third quarter. We do not expect the impact from waivers to decrease materially from this level until the Fed begins to increase interest rates. Debbie will comment on our rate outlook at the end of my comments.

In terms of sensitivity, we have estimated that a 10 basis point increase in gross money fund yields would decrease waivers by about one-third and this is essentially what we experienced in the second quarter. Looking forward, we estimate that gaining another 10 basis points in gross yields will likely reduce the impact of these waivers by another one-third from our current levels and a 25 basis point increase would reduce the impact by about two-thirds. We caution that a wide range of outcomes as possible factors that impact these 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 the waivers.

Looking at operating expenses, the press release detailed by line item the impact of the insurance recovery on expenses we had booked in earlier periods. Compensation and related expenses decreased from the prior quarter due largely to lower incentive compensation expense, seasonality in payroll taxes and benefit expense and credit from the insurance recovery. Q1 also included a reversal of previously accrued incentive comp expense. We expect Q3 comp expense to be approximately $64 million. Q2 also saw an impairment charge of $7 million to certain assets from our acquisition of MDT Advisors in 2006 which became our quantitative equity team. We have approximately $7.5 million in remaining book value in the amortizable assets from this acquisition.

On the balance sheet, Q2 was the first quarter to include the impact from the $425 million term loan facility put in place on April 9th. As we discussed last quarter, proceeds were used to initially pay existing debt. Net proceeds have been invested in various Federated equity and bond funds with additional investments made to seed potential new products. Loan proceeds and availability on our $200 million revolver as well as earnings and cash flow are available for general corporate purposes, including acquisitions and related continued payments, share repurchases, dividends, new product seeding and other investments, capital expenditures and debt repayments.

We announced last week the definitive agreement reached with SunTrust to acquire the money market business. Pending approval process, we expect to transition the $17 billion through a series of closings expected to occur during the fourth quarter. Beginning in Q1, 2011 we expect to add approximately $0.01 to $0.015 cents per share to our quarterly earnings. Actual incremental earnings will vary and will depend on asset levels, transitions, waivers, the final evaluation for related intangible assets and other factors.

That completes my comments, and I'd like to ask Debbie to give some comments on our rate outlook.

Thanks, Tom, and good morning everyone. I thought I'd list maybe a couple positives and negatives for why interest rates should go up and why they should stay where they are. On the positive side of the equation, currently you have a steeper curve. That steeper curve has been based on wider spreads, as well as expectation of near term Fed tightening. Spreads have remained wider during the quarter and have started to come in in July based on some European debt concerns in the marketplace. And that also has caused that steeper curve to be beneficial, especially to our prime and government funds.

Other countries are also tightening. You have Australia, Canada very close to home, Denmark and others who have been in a tightening mode now for the better part of the last nine months. Staying on the same side of the equation, you do have a slow down in a lot of the economic statistics that we've been receiving over the course of the last three to four weeks. Notably, both housing and employment which are key statistics on that economic side of the equation, have slowed down markedly. You also have had a bit of a mitigation of some of the European debt spread increases that occurred. We'll get a little bit more news on that front today as the European debt stress test for 91 of the banking institutions are going to be released at noon today.

Overall, when we process all of this information, we have pushed our tightening expectation from a Fed perspective into the 2011 time period, just recently. We think it'll be a first half event of 2011. We don't think we'll be going into any sort of a double-dip recession which would push it out even further. But we do think because of some of the factors that I've listed on the negative side of the equation, this tightening process will not occur in 2010, but will rather start in the 2011 time period with a measured 25 basis point per clip Federal Reserve action that will be precipitated by a growth again, a stronger growth in the economic statistics in the marketplace.

Thanks, Debbie. We'd like to open the call for questions now.

(Operator Instructions). Our first question is from Michael Kim with Sandler O'Neill. Please proceed with your question.

Good morning. First, Chris, maybe if you could talk a little bit about the outlook for the money market fund business. It seems like maybe the spread between bank deposits and money market fund yields has narrowed more recently, combined with the fact that the equity markets remain pretty volatile. So just wondering how you're thinking about flows in the near term.

In the near term, those factors are correct and we have seen it, and that's why I mentioned in my remarks that the July average assets are up over and higher than the Q2 average assets in money funds. And that is a factor. But the biggest factor remains our belief in higher highs and higher lows, which means that the base of this business really is as a cash management service. And so, I know your question, Michael, was with respect to the flows over the short-term, and we expect to see them leveling off here, but over the longer term, we still expect this to be a good solid, strong business because of the need for cash management service by our clients. We don't have to get into the consolidation, we already mentioned that point as well.

Maybe moving onto the equity side of the business, do you feel like you've got the performance track records to really benefit from this move back into equities at some point when retail investors do get more comfortable, taking on more risk?

Though we wish the one year records were better, the long records of the key products are exceptional and are well positioned to pick up the flows. And I'm talking here about net flows. We've seen over the last three years excellent improvement in gross sales of our products, which is a way of looking at the acceptance of those products in the marketplace. Now of course, redemptions are a fact of life. And so on the long-term basis, we are very happy with our projects.

Okay and then just finally a question for Tom, any change in how you're thinking about expenses in general now that the markets have come under pressure more recently? Are there maybe areas where you might start to pull in the reigns a bit, just assuming the environment remains challenging?

Mike, we've been continuing to look at things and think that way, exactly as you're talking about it. One of the things I mentioned, incentive compensation went down. The discretionary side of that, we're able to do that.

Okay. Thanks for taking my questions.

Thank you. Our next question is from Roger Freeman with Barclays Capital. Please proceed with your question.

Hi, good morning. Just following up on the money market outlook, maybe from a longer term perspective, and thinking about the higher highs and the higher lows from an industry perspective. Given the potential decline in available assets, given that banks are likely issuing less commercial paper going forward and therefore maybe more competition for the smaller asset base, and of course banks also having to fund more from deposits and maybe being more competitive against money market rates, is that a concern of yours, that money market is a competitive product versus bank deposits over the long run?

This is Debbie, I'll take a stab at that. Definitely we've seen a decrease in supply on the CP side of the equation. That market has almost halved in size from its peak which was in the summer of '07. Having said that, CDs, deposit-type investments, have increased by about three times their size during that same time period. So, although our available supply is coming in a more concentrated form from an industry perspective, ie, it's more related to financial services, banks and other types of financial services companies, than it has been historically, the availability for supply is still very good and it's still out there. Some of the things that have been a little bit challenging over the course of the last several quarters in the repo marketplace has been from a supply perspective. That is starting to loosen up a little bit also. The potential for the Fed to come into the marketplace and begin reversing some of their collateral back into the market and creating additional supply there will be welcome relief. So there are things that are happening that are mitigating some of what has been supply pressures in the marketplace. And overall, while we would wish for more diversification in the supply, the supply itself remains pretty good.

Okay, that's interesting. So it sounds like the increase in bank funding through CDs is a rough offset of what to what they decreased from a commercial paper standpoint. Is that roughly fair to say?

Yes, that's true.

While I have you there, on that outlook around rates and the fee waivers, some of the stats I look at, like effective Fed funds rates, four week treasury yields, et cetera, they're running roughly where they were for all of last quarter. Effective Fed funds rates is 18 basis points right now, and four-week treasury's at 15. Given your rate outlook, it doesn't sound like those are going to move up from your point of view so I'm trying to figure out why the pressure's come off a little bit more in the quarter.

Quarter-to-quarter comparisons are absolutely to the point where we're leveling off or flattening out. Having said that, when you look at the increases that we experienced during the second quarter, we talked about it in the context of how the market had steepened out and the yolk curve had steepened out. In fact, our product yields, depending upon what category you were talking about, whether it was munis, governments, or prime, increased anywhere from 2 to 10 basis points. That was a direct response to that steeper yield curve. Although that curve is not steepening further, and in fact may have flattened a few basis points at the end of June and beginning into July, when you compare that to what we faced, especially during the month of April, it got better. The steepening part occurred mostly in May and June. That's where we expect, still progress to be made in the context of overall fund yields which then also makes progress on the fee waiver side of the equation. What we experienced, though, on a velocity basis, too, that steepening of the curve and increase in fund yields, in the second quarter, won't be experienced again in the third quarter, but we don't really see them going down either.

Okay and then, another ten basis point increase, you're talking about another one-third benefit. Wouldn't it be a little bit higher at this point because it would be one-third off of a smaller base because you already got a one-third reversal?

You also have the mix of the underlying products. Remember, you have a sharing factor here with the distribution fees and so the underlying math is simply a bit different on the product mix as you get further into a different mix of products as the rates go up.

That's what I was wondering about. It sounds like there was a little more sharing of the benefit with the distributors on a second.

And remember, too, Roger, these are just rough guidelines. We're just trying to get people directionally correct.

I know, all right, great thanks.

Thank you. Our next question is from Mike Carrier with Deutsche Bank. Please proceed with your question.

Thanks. First is a question on the long-term side of the business. Obviously the fixed income flows across the funds and the separate account's doing well. In the equity supplemented accounts, it seems like we've had out flows in there for quite a while. Just any update on what's driving that, what can be done to maybe try to do that. And then just some of the products that may be working versus the products you're still having some issues with.

On the SMA, I'll quickly mention first that the fixed income SMA continues to grow, though they are small and coming off a small base. The negative flows, as I mentioned, were in the equity side, and that continues to be driven overwhelmingly by redemptions from our MDT SMA purchase. And these things just continue because of the relative performance of MDT quant model, both in the downdraft in '08 and the updraft in '09. And although they're doing better now, the redemptions still continue. They have maybe six out of seven of their mandates are ahead from inception but on a current basis it's still a challenge because of the '08 and '09 performance. Historically, when they have had tough performance before, they have bounced back. This model's been around for 15 years and has worked well. So like other quant managers, we are working with them and believe in their long-term viability, but I can't here say that we're going to see a reversal in that trend of negative flows on the MDT separate account equity business.

Okay. And then just one more on the P&L. If we just look sequentially, and obviously one quarter doesn't make a trend, but if we just look at the revenues being down a percent, yet you got the benefit from the reduced fee waivers, if we look at the expenses, those were up 3%, almost entirely driven by the sharing with the distributors. So just going forward, given where the asset base is, is there anything else that can be done on the expenses? Or, during the quarter, were there any expenses that were just elevated given where asset levels ended from an average to period end. Just want to try and understand if that expense base can go lower, given the new level of assets.

If you take out the distribution line item, which is what it sounds like you're trying to talk about, because if waivers go down, that line item will go up if assets stay the same. You can see that's what happened sequentially. But there's lots of things that we can do and are trying to do. Following up from comments earlier, we instituted a lot of expense savings efforts here in end of '08 and through '09 and we're trying to maintain those. We reduced a lot of products that weren't making it and we didn't see that they were going to continue to be viable, but we're also starting new products, so there's a balance there. Overall we're not seeing a huge amount of increases across the board in any areas and we don't expect to. We're trying to maintain basically the level that we're running now. I don't know if you have anything else to add to that.

No, Mike, I think we feel like the expenses are, if you were to look at margins excluding distributions, our margins would be pretty competitive. Basically it's a top-line thing that we would expect growth in the top line to be the thing that would push the margins, not so much reducing the expense-base.

Okay. Thanks a lot.

Thank you, our next question is from Robert Lee with Keefe, Bruyette & Woods. Please proceed with your question.

Thank you, good morning everyone. I was just curious, Chris, in the equity SMA business, could you maybe give us a sense of -- and I apologize if you mentioned it earlier -- but the size of the book that is still at-risk there?

Okay. Let me just turn to a page on that. When we purchased the MDT business, it occasioned our total SMAs getting to about $10.5 billion. And they are running at about $5 billion now. So the MDT strategies are about $2 billion of that $5 billion right now.

Okay, great. And maybe shifting gears a little bit to capital management. Obviously you put the debt on the balance sheet, as usual, talking about in the market, if you can find the right property, doing consolidation deals and what not. But given your willingness in the past to pay a special dividend, and given the uncertainty as to where tax rates on dividends may end up starting in 2011, is it off the table at this point, given your interest in international acquisition that another special dividend couldn't be possible as it gets to year-end and tax rates change? Or is that just something you think about in the mix of things?

I'd go on the last part -- in the mix of things. We don't really take any of these ideas off the table. On the other hand, the idea, the international acquisition, is surely in the top position, and depending on what it is, or how it is structured or what it costs or how it works, it would willingly and enthusiastically crowd out other ideas if that were deemed appropriate. But we don't really take anything exactly off the table. And you can tell that looking at our charts on how we've done as acquisitions, dividends and share repurchase, and you've heard me say for 45 phone calls that I like to score on all streets. So by this time you figure you're going to get the same answer and here I repeat it again.

I'm just hoping to make it 50. One last question. I'm sure you guys haven't really had a chance to absorb it, but I'll ask it anyway. I think it was yesterday morning, you had the new proposals, the 280-page report on 12b-1 fees or proposals come out. Just initial sense, glancing at it, if you think there's anything that you'd think is a meaningful change that really would affect the way you do your business, first take.

Yes, there could be some meaningful changes in that. The real question, though, that you have to look at is nomenclature. In other words, categories and names matter. And our view is that when the 12b-1 fees were running at a billion a month, last year they were less than that, maybe a total of 9 or something, those fees are for legitimate and proper services. So now comes the question of how you structure them in a way that makes sense to the regulator. Point two is don't forget that the origin of 12b-1 is an SEC hall pass to the industry, which, PS, we opposed when it came out because it represented using fund assets for distribution. And so now the challenge is to put the genie back in the bottle and that is becoming a bit of a challenge.

So what we're looking at is how do you preserve legitimate business expenses and charges, and add to the SEC's legitimate desire to have transparency, understanding, disclosure on what's going on. So within that context, we're not thinking it's going to injure our business at this point. Remember that within the overall context of the overall 12b-1, the first 25 basis points is acceptable to the SEC in that arrangement. I have not read the whole thing yet. When they first came out with it, it was just the three-page item that they put on their website. Nonetheless, those are some initial looks at it.

Next thing is that I think there's going to be a 90-day comment period. And believe me, there are going to be comments on this that I think will accurately and appropriately reflect what is going on legitimately in the marketplace and I believe there is a sound way to get everybody what they want. Transparency, understanding, and legitimate expenses being covered in a legitimate way.

All right, great, thanks for the comments. That was it, thank you.

Thank you, our next question is from Ken Worthington with JPMorgan. Please proceed with your question.

Good morning. Maybe first for Debbie. What are you doing in your money market funds in terms of duration in investments? With LIBOR up, how are you thinking about financial services paper coming out of Europe? Does higher yields offer good value for your funds or are you really trying to avoid that kind of risk at this point?

From a duration perspective we've been neutral for the last two quarters at this point. We had had longer duration targets in most of 2007, 2008 and even into all or most of 2009. We pulled that back a little bit, and it served us well in the context of the steepening yield curve that occurred in the second quarter of 2010. Our expectation is that that's on hold again at this point. So for now, again, we're still in that neutral phase, but the potential for going a little bit longer, given what we think is a longer period of time before the Fed actually starts tightening, and the curve has already done part of the job for them, that still is a debatable and discussed item at this point. But right now we're neutral across all our products.

From a European debt perspective, we own European banks within all our money funds -- taxable, tax free. They're counterparts to repo within our government funds. So we have exposure to European institutions, banking institutions. None of the sovereigns, but banking institutions across the continent. During the '07 and '08 credit crunch time periods, what we effectively did was shorten the duration on many of those products. So if we had historically been comfortable using one of those names, at six months we tightened it down to three months. If we had historically been comfortable using it at three months, we tightened it down to one month. Over the course of this year, year-to-date 2010, that process has begun to be reversed. For the institutions we're dealing with, what we've seen over the course of the last three months in the European debt situation really hasn't changed that. The ones we're dealing with are very global in nature. They're not the Spanish savings banks, they're not the smaller German Londis banks. They're the very large global players in the marketplace, and as such, although their spreads have widened out in sympathy with some of the others and we've taken advantage of that, we don't find this to be truly a setback in the context of their overall credit profile and our metrics of how we are viewing them.

Okay, great, thank you. And then I know you gave more of a short-term outlook on fee waivers. Maybe thinking about fee waivers a little bit longer term, is the worst over or is there the potential that we get an increase in fee waivers before the recovery is complete? And what I was thinking there is LIBOR is up on some of the stress in Europe as you get closer to a recovery. You would think that that risk would diminish and LIBOR would fall, therefore potentially necessitating a drop in yields and an increase in fee waivers again. What are you guys thinking there as you look out over maybe a couple quarters towards the eventual recovery?

Ken, it's always possible and that's why we go through the litany of factors that can affect it. If yields were to come in meaningfully and not be offset by increases in other portfolios, then sure, that's possible. But to really get to your question, you're into where we think the rates are going to go and in Debbie's answer before, we talked about not expecting them to come in meaningfully, but of course that's a possibility.

I think at this point too, Ken, if you do have reduction in the concern about the credit metrics in the marketplace and as such spreads tighten based on more comfortability that that's on a solid footing and good path going forward, that effectively comes hand-in-hand with a better economic set of factors. And as such, maybe what the yield curve looks like is the same, but with more of the steepness due to positive economic metrics and the thought that the Fed will tighten sooner rather than later, rather than concern from a credit market's perspective and spread being the chief reason for steepening.

Outstanding. That is exactly what I was looking for. Thank you very much

Thank you. Our next question is from Cynthia Mayer with Bank of America Merrill Lynch. Please proceed with your question.

Hi, good morning. Just wondering if you could maybe talk a little about the SunTrust deal and how much competition you saw and in general how much competition are you seeing for deals like that?

You never know who else parties you're talking to. We try to deal with mostly our clients who we've had long-term relationship with. There were a lot of rumors on the SunTrust deal that you read about in the paper where they were talking to other parties. We just worked along methodically in what we were trying to do, so in the end I really don't know what was going on with somebody else. We came to our conclusion and signed the deal and are looking for more of them. There's not very many transactions where the other side says it's only you and you're the only player who's getting to look at this. It's just not the way that it works.

Okay. And why do you think there haven't been more of them given the pressure of fee waivers and all the regulatory uncertainties? What do you think is holding people back?

One of the keys I've mentioned on these calls before is that when you -- maybe control is too strong a word -- but when you are of and concerning, and have your fingers on the ability to redeem, you can therefore not redeem. And therefore, if you're in control of the redemption process, you can run money funds for some extended period of time without a problem if you don't blow the credit. And so, the jobs continue, the income continues, and everything marches along, even though the CFO or the whomsoever decides that this really isn't a strategic-type business. So it takes a long time.

Point two, we started putting banks into these businesses in the late '80s and we have been unravelling it over the last several years. So it took a long time to get banks into the business and I think it goes at a similar pace on the way out. And as each regulation comes in, then it adds another piece of weight to the decision to exit. That's why we look for more. But, in answering your question about why people haven't done it, I think those are the two principal reasons, that if you're running the redemptions you don't have a problem, and it took a long time to get in and it takes a long time to get out.

Cynthia, I'd just add one more compliment or pat on the back for us. It is difficult to go through a complex like SunTrust, it's difficult for them to figure out all the nuances and we're willing to put the time and effort in to work with them in order to maintain their clients being treated properly.

Okay. And maybe just in terms of the other acquisitions you mentioned, more transformative potential acquisitions, you mentioned that the net cash from your recent financing leaves you some room for that. Can you maybe quantify what you view as available and talk about whether it's enough for what you have in mind?

We pretty much view that the entire proceeds are available in addition to the revolver that we have and that we could borrow more on top of it. We have 22 or so banks that were in that group and they would readily up their positions for a bigger deal.

Okay. And maybe just to follow-up on the MDT, I know you had nagging outflows there for a while. What are the fees on those versus the rest of your equity products?

The fees generally on SMAs are in the 30 basis point range.

Okay. Maybe just one more on money market balances. There used to be, I think you used to mention a seasonality to money market balances with a sense of the cash management products with some companies building up balances toward the end of the year. Do you see that anymore or has all of the turbulence in terms of the yields really disrupted that?

The statistics on the cash in corporations are, of course, very high. I'm not sure that we would expect that kind of seasonality necessarily. It feels like the macro economics have trumped seasonality over the last couple years.

Got it, thanks a lot.

Thank you. Our next question is from Craig Siegenthaler with Credit Suisse. Please proceed with your question.

Thanks and good morning. Most of my questions were answered, but just had one on aggregate money market levels. I know it's going to depend a little bit on the level of interest rates, but when you think about the $2.8-ish trillion of AUM out there, which is really I think down from a little under $4 trillion, Debbie, where do you think this probably bases out? I'm assuming you think the slope of the next 12 months is probably a lot more narrow than the slope we saw over the last 12 months.

Correct. We feel like at this point, there is really a leveling off of assets, that is the likely expectation going forward. Not only from our perspective, but from an industry perspective. If you look at where some of those assets went, they went into some bank deposit-type instruments that, with the increase in the yield curve that we've seen over the last quarter, has made funds competitive with those products again. That's why you've seen a leveling off of those asset flows. And the expectation would be that that will be maintained. Having said that, any time you go into a rising rate environment, although we're pushing that out into 2011 time period, the fact of the matter is we hit no lower from here. So we expect that to occur at some point in the fairly near future.

Rising rate environments are definitely accompanied on a cyclical basis with a decline in assets from a money-fund perspective, just because of the lag in the funds versus the direct market. Having said that, we think a good portion of that has already played itself out in the 3.9 to 2, the more than $1 trillion that's gone out from an industry perspective already. A good portion of what was in there, also at its peak were what I call non-traditional money market investors. They fled the markets during a time period in 2008 and early 2009 when they were looking just for safe harbor. And I would say certainly the biggest portion of those types of investors are gone at this point.

So it sounds like, from your thinking, we have probably modest downside left, and when rates decide to start going up, at that point it could be a little different than prior cycles just because we're not used to rates being this low. So you might even see a more favorable impact on flows from rising rates than historical precedent.

Correct. Money funds are definitely the vehicle of choice from an ease and usage perspective. And to the extent they are even with or even close to what's happening from a direct market perspective, I think they win the game in that regard.

Okay, great, thanks for taking my questions.

Thank you. Our next question is from Mark Irizarry with Goldman Sachs. Please proceed with your question.

Just a question on the B waivers, obviously you're not expecting as much of a change in the impact in and I guess part of that's related to rates. Can you just discuss a little about what your AUM outlook is that's embedded in the fee waiver guidance and less of a change going forward? Also can you talk about the willingness to extend the fee waivers? How should we think about your willingness to extend the fee waivers?

I'll take the last one, which is willingness to extend the fee waivers, because what this gets to is a long-term commitment to a business. We're in the middle of our fourth decade of doing the money market fund business. And one of the reasons that we were willing to do the waivers in the beginning was for a commitment for the long haul and we think this is still an important thing. And so, as long as the math works as I'm about to describe, which it is, we are okay with doing the waivers. And that is that the short-term interest rates cover the core expenses of the fund. And this is just an average kind of a number, but basically that means the three basis points roughly of third party expenses and the seven basis points of administration in order to keep the functions of the funds alive and well.

So if the gross yield on the fund is 10, and those third party expenses are 10, and that is covered, then we are still quite happy to be proceeding with waivers. And that's what happened. We got close to some of those points in early January, when the then Fed funds rates and repo rates were low single-digits. But it didn't last long enough to affect the entire yield on the fund. So now when we have rates that are periodically in the 20s and mostly in the 18s, you can see that those core expenses are covered. So, our attitude is such that given this scenario, we would continue to waive. And further, from our clients we get the comment that even if funds are at zero, or we've really been having increasing yields here recently, as Debbie mentioned, but even at zero, the clients prefer to have the funds open, evidencing the fact that they're utilized as part of a cash management service. The other part of the question?

The guidance there, $11 million to $12 million is based on assets as they are today.

Okay great. Now can you just comment on some of the SEC rules on the money market fund industry? Are we expecting a second round or second set of rules coming? What's your view on directionally on the business as it stands today and what's going to be mandated or proposed?

I'll talk about it generally and then let Debbie answer how the rules have affected us. The President's working group has been studying, in conjugation with the SEC, various things, but they have not come out. We thought that that would come out as part of the financial reform regulation, but it hasn't. So this is still another effort. The first blush of the President's working group was very precise on money funds saying they were going do things to, quote, enhance the resiliency of money funds. And they are going to keep studying all sorts of different ideas, some of which we, of course, don't like, like variable net asset value and things like that. But, we believe that overall what they did with the 2a-7 rules was an excellent job of putting best practice and enhancing the resiliency of money funds.

Point two, we think it has worked well in the marketplace and that this fact will be very helpful in the next round. And we don't know exactly what the SEC or the President's working group may have in store for the next round. We know that we have been working on this idea we discussed at the last call, which is the liquidity bank, which is a very good private effort, non governmental effort, in order to enhance the resiliency of money funds. Now I'll let Debbie talk about the package of rules and how she and we believe that has impacted the funds and what might be in store there.

Mike, from a standpoint of what's already been enacted or been brought forth to the market but maybe not put into place yet from a time perspective, from a timeframe perspective, if you look at the various sectors of funds, the government money market funds are most affected by the interest rate risk reductions that were put through, specifically the weighted average life calculation. And this has to do with the longer dated floating rate securities from Fannie and Freddie that were historically a large portion of those products. If you look at prime money market funds, prime money market funds are also affected by those same weighted average life calculations, but to a larger degree the prime funds are affected by the 10% and 30% overnight and weekly calculations that are required for liquidity purposes.

And then, lastly, for the muni sector, the muni money market sector, it's the credit quality changes, the reduction in the amount of second tier paper that can be used within those products that will cause the most amount of change or yield loss in the product going forward. In the current environment, where you're still working in an interest rate scenario, that's maybe 20 to 80 basis points in range at this point, there's very little change in overall product yield based on any of these issues that I just mentioned, or risk mitigation items that have been required by the SEC. Having said that, if you get back into a more normalized short-term environment, in the 2% to 3% area, what we're thinking is a result of all of these changes across the board in the various products, is somewhere in the neighborhood of 3 to 8 basis points. Yes, that's a hit when you have looking at something that may have a 1% or 2% or 3% yield, but it's not the end of the world. It's something that still allows these products to remain competitive in their marketplace, yet has gone a long way in reducing the overall risk of the products because of these changes.

Great, thanks.

Thank you. Our next question is from Bill Katz with Citigroup. Please proceed with your question.

Okay, thank you. A couple of your competitors, actually quite a few of your competitors, are increasingly focused on the markets outside the United States and have stepped up their investment spending. Just wondering if you can talk about strategically where you stand in terms of leveraging the non US opportunity set and how you might go about increasing that opportunity?

As we've mentioned, we have an investigative team that has been traveling around the world looking for opportunities and we're able to talk to lots of different people about things. We're not at a point where we can say that we have something lined up, but we do see some excellent opportunities and we remain enthusiastic about doing it. So it's really hard to give a more accurate timing analysis on that, Bill, other than we remain committed to it and are enthusiastic about it.

The other thing I'd add is we've had increased calling effort with clients and potential clients overseas and have had some success there that was reflected in the second quarter where we referenced it in the growth particularly that happened after April. So we continue the ongoing marketing efforts with our offshore products. We've had some success there lately.

Okay. Second question, ties into the first part of the answer of that, Chris. Looking at your balance sheet, doesn't seem like there's a lot of flexibility, given where your net deposition is. If an acquisition were to come along, and maybe you answered this before, I may not have heard correctly, how should we think about potential financing on the transaction at this point in time? Is there enough balance sheet capacity to add on debt or would you have to use equity to get something done at this point?

I would respectfully demure from your view about the flexibility of our balance sheet. I think we have an extraordinarily flexible balance sheet, and that whatever deal we would decide to do would have its own ability to finance itself and add to our financials. I will let Tom comment further.

I agree with you. We borrowed the money, the $425 million in order to basically keep a lot of it here for some kind of deal. What we've done in the interim is invested it in our own funds. So, as I said before, the bank group in there absolutely would increase it on our own if we wanted to and add in the cash flow from what we would buy. I have a high degree of confidence that we would be able to borrow to complete an acquisition. If we got into some acquisition that was a merger of equal type of thing or huge thing, we would start thinking about stock type of transactions there. At least that's will be our first thought process on it.

And Bill, just one other thought. If you look at it from a, typically if we look at borrowing capacity and ratios, our debt to EBITDA would be barely over one time. So our interest coverage is very high interest coverage. So from the way lenders would look at our balance sheet, they would look at us as having a lot of capacity as well.

Just one final one, Tom, I want to make sure I heard you correctly. You mentioned Q3 comp as $64 million? If so, why the sequential increase over the normalized second quarter?

Yes, I went through that. I'm just going back so I don't miss anything on it. We had lower incentive comp, that was the big thing. We had seasonality in payroll and benefits. We had credit from the insurance recovery. And also Q1 had previously accrued incentive comp reversal in it. So it was a lot of moving parts there, Bill. The biggest part is we reduced the accrual for bonuses.

Okay, thanks so much.

Thank you. Our next question is from Roger Freeman with Barclays Capital. Please proceed with your question.

I just had a couple clean-ups from other questions. Getting back to rates on where Ken was asking about LIBOR, if we think about prioritizing the short-term rate measures that are most impactful, can you run through those? I'm trying to figure out where LIBOR factors in because, Chris, when you were talking about rates you were talking about teens which suggests it's more like repo rates and short-term treasury rates, effective Fed funds rates as opposed to LIBOR. What's the interplay there?

The largest portion of our money market assets have some credit relevance associated with them. This would be our government agency portfolios, our prime portfolios, and our tax-free portfolios, all of which have some tie back to that LIBOR curve. The portion of our assets that goes in the other direction oftentimes, if it's a credit related event that's causing the spread widening in the LIBOR curve, would be our treasury assets, our treasury repo and our treasury non-repo products. Those are a smaller portion of the larger pot of assets. The biggest portion of our assets would be reflective and responsive to changes in that LIBOR curve.

Just to put it in percentage terms, if you look at the asset base at the beginning of the month, treasuries would have been about 15% our assets. 85% would be in the credit category.

Okay, that's helpful, thanks. Following up on Cynthia's question, around other money market managers, banks, et cetera, considering exiting those businesses and that being a drawn out process, with the rate hike expectations being pushed out broadly, does that in any way, do you think, on their part, accelerate any thinking they've got around getting out sooner than later?

Roger, I don't think it helps, hurts or does much at all. That point is just not a meaningful factor in their decision process.

Okay, great. And then on the point about a second round of regulations that Mark was asking about, do you think at all that any of that maybe takes a back seat now? I'm wondering at this point with all of the rule-writing that the SEC and other regulatory agencies have to do out of the financial reform legislation, there's just simply not enough staff resources to work on anything else.

I enthusiastically embrace your observation.

All right, we'll see. And then the MDT, when you gave those numbers on the size of that business, what was the base?

It was 6-point-something billion. $6.7 billion at its start.

Up to $10.5 billion.

No, the $10.5 billion was the total size of our business which included Strategic Value SMAs, as well. That was the peak of our total business. Our total business in SMAs have been cut in half, and the lion's share of that came out of the movement from MDT from 6.7 to 2.0 now.

Okay, that's what I was looking for. Two more quick ones. The deal, the debt that you raised, the $425 million, you said you put that into your funds. I guess that, that's part of your flows for the quarter? Is that right? Does that show up in mutual fund flows?

Yes, any purchase or redemption in there would show up in the numbers. Just to go back on the MDT numbers, the MDT in total is over $3 billion. The SMA part is down to $2 billion. It was a little over $6 billion at the time we did the acquisition. But MDT in total was north of $3 billion.

Last question. On the quarter to date, July flows, just tell me if I'm characterizing this correctly, it seems like very much a continuation of late second quarter, ie, money market flows up, ultra short bond up, Prudent Bear up, all the risk aversion flows still favoring you as they were at the end of last quarter, right?

I think that's fair. We've had growth on the strategic value dividend fund, we had a decent map over from one of the large brokers and that product continues to do well too, so you still see demand for income oriented products even in the equity side.

Okay, great thanks.

Thank you. Our next question is from Robert Lee with Keefe, Bruyette & Woods. Please proceed with your question.

Thanks, again, guys. Two quick really, frankly, just modeling questions. Just curious, non controlling interest came in a lot lower than where it's been running for a while. Is there any one-time items that there skewed that downwards?

Yes, Rob. I love accounting. In the lines above the trading securities, we have a product that we consolidate, and we have to consolidate it because of the accounting rules. Yet, we don't own it, and so we take a loss in the trading security because it's consolidated, and then we back it right back out in the part that we don't own, down in the non-controlling interest side of things. So, to say that's one time, if it continues going up, we'll have the opposite reaction.

That's just the mark.

Okay, and I guess the other part of the mark was reflected partially in the $1.6 million loss in investment income.

Right.

Okay, all right. And real quickly, tax rate, has been running a little over 38%, is that a reasonable expectation balance for the year?

It's 37.8% on the income statement here, we expect it to continue to stay right around there, 37.5% to 38%.

Okay, that's it. Thanks guys.

Mr. Hanley, there are no further questions at this time. I'd like to turn the floor back to you for closing comments.

Okay, thank you. That concludes our call. We appreciate you joining us today.

Thank you, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.