Federated Hermes Inc (FHI) 2012 Q2 法說會逐字稿

Greetings and welcome to the Federated Investors Management Company Second Quarter 2012 Analyst Call and Webcast. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation.

(Operator Instructions)

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Raymond J. Hanley, President of Federated Investors Management Company. Thank you, sir. You may begin.

Good morning and welcome. Today, we plan some brief remarks before opening up for your questions. Leading today's call will be Chris Donahue, Federated's CEO, and Tom Donahue, Chief Financial Officer. Let me say that during today's call, we may make forward-looking statements and we want to note that Federated's actual results may be materially different than the results implied by such statements. We invite you to review the risk disclosures in our SEC filings. No assurance can be given as to future results and Federated assumes no duty to update any of these forward-looking statements. And with that I'll turn it over to Chris.

Thank you, Ray, and good morning. I will begin with a brief review of Federated's recent business performance, before turning over the call to Tom to discuss our financials. Looking first at cash management, average money market fund assets were down $8 billion from the prior quarter, while the quarter end totals decreased by $7 billion to $239 billion. The second quarter has some seasonality from tax payments in both April and in June and our market share remains over 9%. The impact of yield-related fee waivers decreased again in the second quarter and Tom will cover this in more detail later. Regarding the market share, it's interesting just to look at the history where it is running at about 9.5% today, at the end of '11 it was running at about 9.4%, 8.7% at the end of '10, 8.5% in '09 and '08, and about 7% in '07, and 5% in 2000.

On the regulatory front, it has been reported that a document outlining new money market fund regulations has been circulated by the SEC Chairman to the other commissioners. While the proposal is not publicly available, prior comments from the Chairman indicate that the proposal includes the choice of floating the NAV or imposing redemption restrictions on money funds in combination with the capital requirement at the fund level. These ideas have been previously floated and even in their discussion forum, they have drawn extensive negative reaction and commentary from money fund investors, issuers, businesses, state and local municipal finance authorities, various members of Congress, US Chamber of Commerce, the ICI, and individual money fund management companies. The reason is it's because it's very poor policy.

I have previously covered these proposals and won't go into a lot of detail today, except to say that so far as they violate the primary tenets of a money fund, daily liquidity at par with a market yield, they will end money market funds as we know them if they are proposed and enacted. The consequences will be severe, including higher funding costs for states, municipalities, and other government entities, leading to either higher taxes, cuts in services, or more money moving into the largest already too big to fail banks. And money moving to far less transparent and less regulated investments, including separate accounts, offshore accounts, and things perhaps we have not even thought of.

These draconian measures are based on demonstrably false premise that money funds are prone to destabilizing runs or somehow backed by the taxpayers. There's no proof that either of these ideas is true. There is, however, the unparalleled 40-year record of successful money management providing real tangible benefits to our financial system. So again, we advocate the regulators study the positive impact of the 2010 Rule 2a-7 amendment and conduct a thorough and rigorous cost-benefit analysis of any further money fund regulations. The facts will then show that further rules are not necessary and in fact, are likely to do serious harm to our financial system.

Now, turning to our equities business. Reflecting industry and market trends, equity fund growth sales decreased from the levels of the last couple of quarters. While redemptions also decreased, net flows were modestly negative. We continue to see demand for income products, particularly the strategic value dividend and capital income strategies; each showing positive fund flows. Our international equity funds also had positive flows with good results from international leaders and international strategic dividend funds. The Kaufmann large cap fund moved into positive flows for the second quarter. At the end of the second quarter, we had eight equity strategies in a variety of styles with top quartile three-year records and six in the top quartile for one year and these include funds like the Capital Income, Pru Bear, Intercontinental and Strategic Value Dividend.

Equity fund net flows are essentially breakeven for the first three weeks of July. Much of the improvement is due to the Kaufmann small cap fund moving from negative flows in the second quarter to positive flows early in the third quarter. Second quarter flows in equity separate accounts were positive, led by the strategic value strategy. We are continuing to see RFPs for strategic value income, both domestic and international, as well as other strategies and the Clover small value equity strategy as well.

Looking at fixed income, net positive fund sales were nearly $2 billion in the second quarter; more than twice the $835 million of net sales that we had in Q1. An institutional win of $500 million that funded into our government ultra-short fund and solid inflows into corporate high-yield stable value and multi-sector products led to these strong results. We also won a large multi-sector mandate that included funding from assets invested in our total return bond fund product, accounting for most of the reported $1.6 billion net exchange from funds to separate accounts. The total return bond fund continued to show positive sales in Q2.

We ended the second quarter with 11 fixed income strategies with top quartile three-year records and 11 strategies reaching the top quartile in a one-year basis. These include funds with a lot of variety like Federated bond funds, a number of our high-yield bonds funds, intermediate government, and emerging market debt, among others. Fixed income flows are running solidly positive for the first three weeks of July. Fixed income separate account net sales were also positive. We added significant new mandate funding in the municipal group, with an increase of $300 million and also added new wins in funding in our high-yield strategy. RFP activity for fixed income remained elevated compared to the levels seen in 2011. We continue to see interest in a variety of areas including stable value, high-yield, emerging markets, total return, core broad, and active cash short duration.

Turning to overall investment performance and looking at quarter-end Lipper rankings for Federated's equity funds, 51% of the rated assets are in the first or second quartile over the last year, 47% three years, 16% five years, and 73% over 10 years. For bond fund assets, the comparable first and second quartile percentages are 43% for one year, 39% for three years, 65% five years, and 65% for 10 years. Looking at Morningstar-rated funds, 41% of rated equity fund assets are four and five-star products as of year-end and 57% are in the three, four, and five-star product area. For bond funds, the comparable percentages are 42% at the four and five-star level and 78% at the three, four, and five-star level. As of July 25, managed assets were approximately $357 billion, including $267 billion in money market, $32 billion in equities, and $58 billion in fixed income, which includes our liquidation portfolios. Money market mutual fund assets stand at about $240 billion of the $267 billion in money markets. So far in July, money market fund assets have ranged between $238 billion and $243 billion and have averaged $240 billion.

Looking at distribution, our results indicate that the investments we are making in sales capacity, advertising, and other areas of sales and marketing are working. Second quarter gross fund sales topped $7 billion, a new record for us. Our year-to-date monthly average gross fund sales are up about 8% from 2011 and up 26% from 2010.

In the institutional channel, where we added three consultant relations positions last year, we have seen higher RFP and other related activity levels and have enhanced critical relationships with institutional consultants. We have added a number of institutional wins in a variety of equity and fixed income strategies in both separate accounts and funds over the past couple of quarters and continue to win new business. We just announced this week that Federated was awarded the contract to manage the $9.5 billion Massachusetts Municipal Depository Trust. The MMDT provides liquidity and bond management and provides these services for the state and several independent authorities and approximately 290 municipalities in Massachusetts. This is an important win for Federated and we look forward to providing Massachusetts with a range of high-quality services. We expect to develop additional state pool opportunities to add to our market-leading presence. We expect to begin managing these assets by year-end. In addition, we expect about $250 million in equity and fixed income separate account wins to fund during the third quarter.

In the broker dealer channel, we have added 14 new sales and support positions so far with another six to come. We continue to build on our success in this channel, where fund sales have grown from about $6 billion in '08 to over $14 billion in 2011 and they were just under $4 billion in the second quarter. The number of advisors doing business with us is up from 29,000 in '08 to 36,000 in 2011 and was close to 38,000 through the second quarter. In the wealth management market, gross fund sales are up 18% year-to-date compared to the year-to-date 2011, with fixed income fund gross sales up over 20% and equity gross fund sales up 8%.

As regard acquisitions and offshore business, the integration of the recently closed London prime rate capital management operation is largely completed. Assets at quarter-end were $4.2 billion. The prime rate capital management client reception continues to be outstanding and we are actively working on growing these relationships and adding additional business. We are looking for additional alliances to advance our business outside of the US and we continue to work to organically grow our offshore business. In the US, we are on track to close the previously announced transactions with Fifth Third, for their $5 billion money business and Trustmark, for their $933 million money market equity and fixed income business. Both are expected to close during the third quarter. We're looking forward for additional consolidation opportunities as well. Tom?

Thank you, Chris. Taking a look first at the money fund fee waivers, the impact to pretax income in Q2 was $17.2 million, down from $22.3 million in the prior quarter. The improvement from last quarter was due mainly to higher rates for treasury and mortgage-related securities and to a lesser extent, lower average assets. Based on the current assets and yield levels, we think these waivers could impact Q3 by about the same amount. Looking forward and holding all other variables constant, we estimate that gaining 10 basis points in gross yields would likely reduce the impact of minimum yield waivers by about 40% and a 25 basis point increase would reduce the impact by about 70%. Remember that the variables impacting waivers can and do change frequently. Revenues in Q2 increased 1% from the prior quarter, due largely to increases from lower minimum yield waivers offsetting the impact of lower money market assets.

Operating expenses increased from Q1, primarily due to higher compensation and related expenses, due mainly to the impact last quarter of a reversal of $1.6 million of incentive pay that was estimated and accrued in 2011. Distribution expense increased primarily due to lower money fund yield waivers. Intangible assets-related expense increased by about $800,000, due mainly to the impact last quarter of a $1 million mark-to-market adjustment of an acquisition-related contingent purchase price liability.

Looking at our balance sheet, cash and marketable securities totaled $327 million at quarter-end and our net debt was about $15 million. Cash and investments combined with expected additional cash flow from operations and availability under present debt facilities provides us with significant liquidity to be able to take advantage of acquisition opportunities, as well as the ability to fund related contingent payments, share repurchases, dividends, new product seeds, and other investments, capital expenditures and debt repayments. That completes my part of the presentation and I'd like to see if Debbie has any comments on the money market (inaudible). Debbie?

From a rate perspective, we have seen continued steadiness, let's say, in US rates. Repo has remained, for the most part, right around the mid-teens. One to six month LIBOR has been generally lower by about 2 to 5 basis points and further, LIBOR out through the 13-month area has actually increased by 2 to 8 basis points. The curve has steepened to (inaudible) with the shortest rates cut slightly tighter and longest rates slightly wider. Treasury bills around 8 basis points at three months and 13 basis points at six months has also held very steady with very little movement, maybe 1 or 2 basis points up or down on any given day. From an outlook perspective at this point, with regard to the Fed, we do think that because the US is slowing to some degree and has been a little bit less robust from a growth perspective then certainly what we saw at the end of 2011, that any tightening from the FOMC won't occur until a little bit later in 2013.

We still are not in agreement with the end of 2014 prediction from Chairman Bernanke. If you look at the information that has come out of the FOMC minutes with regard to who thinks rates will raised to what level, at what time, it certainly doesn't seem like there is unanimity in any form across the various members of the FOMC either. But we do think that the economic growth slowdown that we've experienced thus far in 2012 will impact that and take any kind of initial rate rises later in the 2013 timeframe.

Let me close my remarks with just a little bit of an update from a credit markets perspective. It's been uncharacteristically calm in the credit markets from a short-term basis. US earnings, for the most part, have come through in a very positive pace. Despite the slowdown in Europe, we've actually seen earnings progress pretty nicely in those institutions also. What might have caused some volatility or had some concern in the quarter with regard to the rating agencies in their continued barrage of downgrades and negative outlooks and credit watch negatives for the various financial institutions that are a part of the US money markets. In fact, that also has had very little, if any, impact on the funds and certainly on the money markets in general. A positive impact has been an actual overall tick-up in the amount of commercial paper available, so a little bit more supply in that area. I'll close with Operation Twist continuing to be mild positive (inaudible) to supply in the treasury sector for our government-only funds.

Okay, Debbie. Thank you. We'd like to open up the call for questions now.

(Operator Instructions) Ken Worthington, JPMorgan.

Maybe first for Debbie, can you talk about how interest on reserves would impact the money fund business if the Fed were to take that rate down? How does that flow-through to your businesses? Equally as important, what are your views? Is this something that you view as probable? Neutral? Unlikely? Thank you.

Sure. IOER, let's start with the second part of that first. I think that it is the last tool, it seems like at this point, that Chairman Bernanke would want to invoke as a means of continued easing in the economy. Certainly when addressing Congress last week, it was only, I think, the third time he was asked that he actually even brought it into consideration. I don't think it's one of the top ideas that he would use at this point. Certainly, further Operation Twist as well as QE3, seem to be in the queue above that. Having said that, we're certainly watching what might happen in the US money markets play out currently in the euro-denominated money markets.

Granted, that's a much smaller sector and it's playing out mostly in the context of the euro government fund The ECB lowered their rate to zero, their deposit rate to zero and as such, banks are finding themselves right around the zero rate because they can no longer place paper with the ECB and earn that 25 basis point spread. They're also, in some instances, posting negative rates, although I don't think the market's actually buying negative rates from banks in the euro marketplace at this point. That just has to do with their operational costs that are associated even with having those outstanding deposits. Certainly, when you look at then, the spread for short-term sovereign financing, the European sovereigns that are funding themselves in euros are posting also negative rates. Presumably that same sort of situation would occur, if in fact the IOER went to zero here in the US.

What I think, though, will happen and again, what I think we'll continue to be able to watch unfold is that the reason this is taking place -- the reason they lowered the rates to zero is so that it's easily able for, as the banks get cheaper funding, they're able to then go out and spur loans in the economy, make loans into the economy and spur growth with those loans. If in fact, those loans aren't being made because nobody is funding at the zero or slightly negative rates for the bank, it's conversely having effect that's a little bit opposite as to what the ECB might have initially intended. I think what needs to happen is some sort of equilibrium rate start to evolve that keeps money market participants happy that they are funding the banks at a certain positive level, which will create a little bit more supply, then, for the loan market for those banks to actually go out and actually help move growth forward from an economic perspective.

It's a supply and demand issue at this point and I think although we've had supply and demand imbalances here in the US that have resulted in negative treasury rates, I think they were much more temporary than what we were seeing here in the ECB version of this zero interest-rate environment. Having said that, I think it will still be a temporary event, but one that takes a little bit longer, on a temporary basis, to actually work itself into an equilibrium that makes sense for overall money market participants in total.

Thank you. For Chris, can you give us an update on your thoughts in terms of money market reform during an election season and how an Obama administration or change to a Romney presidency would impact the direction of money market reform? How should we be thinking about how to make our bets depending on which side wins?

The way we look at it is that we do not have the luxury of trying to decide or gain which side will win the election, because the regulatory plans are pretty harmful to money market funds, as I've said many times. Therefore, we really can't try to gain the thing, who's going to win and who's going to lose and then, therefore this and therefore that. Besides, you get into a lot of speculation. We are going to focus hard on repeating the sounding joy of the good public policy associated with money funds. The way this thing plays out in an election year, which was part of your question, Ken. It strikes us as rather amazing that the way this thing plays out is that somehow, the effect of the proposed regulations are going to, if they're implemented, squish money out of money funds and into the larger banks.

56 million people have the money funds and I don't think they're going to be happy with holdbacks, even if they're only a $50,000 investor. Therefore, that's going to be an odd political situation when the earnings that we've talked about that people have gotten from money funds like $500 million -- $500 billion from say, 1980 till today, over what they would have gotten in a bank. That money would then be shifted over to the banks and the money would be shifted over to the banks and it just doesn't seem like the best political answer. I can't control that and I don't know how all the regulators view that kind of a position. But that's the one comment I'd make on the politics of it.

Let me rephrase it, if the Romney administration wins, does money market fund reform wither and die? If Obama wins and let's say we have a change and Mary Schapiro retires or steps down, does that derail the pursuit of money market reform? Or regardless, does it just continue forward no matter who wins?

There could be a tactical change such like you're talking about, Ken. But overall, when we've been fighting the Fed and the SEC on these kinds of businesses for four decades or my whole career, it's hard for me to believe that any one political outcome or any one changing of the guard will eliminate what the regulators want to do, which is regulate these funds act out of existence. I think the threats will continue. Certainly, a different SEC Chairman, who was not totally fixated on money funds and was working stronger on all of the other things that are in Dodd Frank that are required to be done would be better for us in terms of the money fund business.

Okay. Thank you very much.

Michael Kim, Sandler O'Neill.

This is actually James Howley filling in for Michael. I was hoping that you guys might give some color around the flow dynamics in the institutional business this quarter, as well as the outlook or the pipeline going forward? Then any color on the SMA business, particularly as it relates to strategic value and MDT would be pretty helpful.

Sure, James. In terms of the institutional flows, on the equity side, we continue to have strong SMA-based flows on the strategic value dividend strategy. That continues to be a strong plus, down from say, the prior quarter, but still very strong in absolute terms. On the fixed income side, we really had a mixture of pluses and minuses, as we mentioned. We had a $300 million new account on the municipal side that came in during the quarter.

We had a couple of high yield accounts fund, high yield's very strong strategy for us, very strong experienced team, long-term solid record and we're seeing a lot of institutional and retail fund interest in those products. There were some offsets to that, basically from some client's asset allocation decisions moving money around, but that's what was happening beneath the reported numbers on the fixed income side. Just generally for S&A, it continues to be dominated by the strategic value dividend strategy.

Okay. Great. Circling back to acquisitions, I know you guys have been pretty active on the roll-up front for money market funds, as well as a couple of the equity and fixed income deals you've done. Just wondering how prominent you continue to see that be for a source of growth going forward? How would you characterize the opportunity set as maybe you'll get some of these international embedded asset manager properties that are reportedly being shopped? Just trying to get a level of interest there. Thank you.

We'll handle each one separately. In terms of the roll-up opportunities, in the US for money fund assets and other assets as well, they are what we call lumpy sales. It's really hard to project them and it's really hard to build any kind of steady-state thing where you say, oh, well, we expect this many to happen. They just come in lumps. A good example is the Fifth Third one, where it was back in the mid-80s where yours truly and another fellow went out and made the sales call on Fifth Third and now in the third quarter of this year, 2012, we're going to get the assets back. It's pretty hard to predict the timeline on these things. A similar kind of a thing with Trustmark.

All of these people have been clients of ours for many decades and it's really tough to predict when they will decide to go. But we think there are plenty of more opportunities out there. If you collect up the list of money market funds purveyors, there are maybe about 95 on the list, maybe the lowest bottom five really don't have any assets, and a lot of the other ones in the bottom half of that list are candidates for these kinds of transactions. On the international side, we look at every deal that we can get our hand -on the international side and once again, that's even harder to predict as to how that will happen. But as you know, we are adamant in getting arrangements where the culture clicks first and that's the key element.

This is not a deal where you strike an arrangement, spread some pixie dust around the marketplace, declare victory and move on. We've got to live with these things, make them grow, and make them work. That's what that's what takes the time. A lot of big deals embedded in other companies require a lot of analysis and a lot of analysis on these issues of culture. We continue to look for good cultural fits and develop footprints internationally. I know it doesn't give you a lot of meat on the bone of how we're looking at them, but we think there are opportunities for us.

Okay. Great. Thanks for taking my questions, guys.

Bill Katz, Citigroup.

I missed the first two minutes of your prepared remarks, so you may have covered this is doing so. I joined just as you were talking -- at the tail end of your discussion on the regulatory form and it seemed that you still signed some owners changes, if you will. The question is, we heard from Schwab that they suggested that redemption restrictions might be illegal in certain states and it doesn't seem like the regulators are contemplating that aspect. We heard from BlackRock that the SEC seems to be closer to some type of initial proposal, although BlackRock has clarified their comments by saying they're most comfortable with some kind of nominal capital buffer and not at all about redemptions and certainly less so about flowing rate. Given that all as a very long-winded preamble to the question is, at the margin, are you more or less comfortable with the regulatory drift that you're hearing most recently?

Comfort is certainly not the attitude that I would have on it, because the regulatory opposition is pretty well dug in. I agree with the points that you've made, and we also, long before Schwab got into this, filed a paper with the SEC commenting on the state law and internal operations of money funds in terms of approving the kinds of ideas that the SEC and the Fed are talking about; namely, redemption restrictions and how you build them in a state law structure and in an investment company structure. They are all very troublesome and have not been outlined as to how you solve those challenges. We just continue to fight on. It's really hard for us to try and make predictions about how SEC commissioners will vote.

We remain confident that the proper public policy and good public policy will win out, which means that money market funds will continue. The proof of that is our continuing attitude towards making arrangements to take on other people's money funds and to continue to increase our market share. I can't give a specific answer as to how I think the SEC will come out or whether we'll flop over into FSOC or what will happen there. But as I said in answer to an earlier question, it seems like it is our career to continue to fight for the survival of money funds.

Okay. Thank you. Just a couple other questions -- when you roll-up the Fifth Third and the other smaller acquisition, plus now the one up in Massachusetts, can you give us a sense of what the net accretion might be on the full run rate basis to earnings?

Bill, on the roll ups like Fifth Third and Trustmark, we've talked about, in broad terms, about those before. They would come into existing products and so you would really just model those the same way you would model asset growth across the rest of the money fund business. Massachusetts is different, of course. It's a state pool. It'll be treated as a separate account. There's a fixed income component to it. We're really not going to go into fee levels and earning levels from particular client accounts. That's probably about the best that we can do for you there.

Okay. Last question, on the $1 billion transfer from the mutual fund to the [separate] managed account, is there any other backlog to be thinking about that this could be more than a one-off trend? Maybe if you quantify the economic impact?

No. It's - in terms of economic impact, again, it's a client account. Generally, separate accounts are lower than mutual funds, as you know. In terms of a trend, about a year ago, we had one go the other way for about the same amount of assets, in the $1.5 billion range, where because of particular needs of the client they switched from a separate account to a fund. No, these are one offs that are particular to individual circumstances.

Okay. Thank you.

Cynthia Mayer, Bank of America Merrill Lynch.

It looked like you were able to pass a little bit more of the fee waiver along in distributions this quarter. Again, is that just a function of the asset mix?

Yes. That rate that you're referring to, the portion of the waivers that are effectively borne by the distributors through lower distribution expense to Federated, has ranged from a number in the low 70%s, 71% to about as high as maybe as 79% this quarter. It was right about in the middle of that range which, as you point out, was a little higher than the previous couple of quarters. That is really a number that falls out based on the asset mix and the particulars of that number are different for each fund. It's not something that we're actively managing. It's really a question of where the assets fall.

When you see waivers as flat for next quarter, you see that basically as staying the same too?

Implicit in the waiver flat is it's like taking more or less a snapshot of the business and then just doing the math to run the numbers out. Yes, it would imply the same level. But as Tom pointed out, that would be just one of multiple variables that could cause that number to vary.

Cynthia, the one thing we do in there is talk to Debbie and her team about their expectations on rates.

Okay.

So, that's not flat. Although it actually ends up being flat, but that's their view.

Okay. Just generally going back to the redemption restrictions, when you look over your client base, which clients do you think would have the most difficult time adjusting to that? Are there some that for whom you think it would be a complete deal breaker? They really would have to use something other than a money market fund?

Cynthia, basically for our client base, it would end their relationship with money funds almost across the board. It's hard to gauge as to which ones are worse, but I'll give you some examples. You take a trust department who has an omnibus account with us and they have many, many trust accounts underneath. Are they going to say they're under $50,000 and therefore, they're not subordinated? Are they going to have the systems changed in order to do that? Are they going to make a decision when they go to redeem that now they've put their client, if it's more than $50,000, not only into a delayed redemption, but into a subordinated position, so that they're now in a money market fund decision-making a decision to be a first loss insurer for a money fund? These things are impossible under state law for trust departments and impossible for the way they're set up. So, they're gone.

On sweep accounts with brokers or others, the whole concept of a hold-back doesn't exist and so you have to revamp all the systems. Are you going to revamp all the systems? Once again, with all the omnibus account, how is it going to work? You have the same kind of challenges. If you take regular institutional clients like corporations -- take a corporation that's trying to run a payroll. Their idea is not that they have their maturity artificially extended without compensation by a regulation. Their idea is not that they have capital permanently unavailable to them because they're rolling all the time and have to maintain some kind of minimum. None of those things are in the calculation on the money fund. If you take a municipality, they have testified themselves that they're looking for dollar in, dollar out and that these kinds of restrictions would not be palatable to them. It's just another form of doing what the Feds said they were going to do back in July of 2010, which is regulate the money funds out of existence.

Okay. Thanks a lot. On the ultra-short and short-term bond fund flows, those are pretty strong across the industry. Do have a sense of how much of those are just money coming out of money market funds? Any change there or sort of the same pattern as last year?

Let's just address the first one. We can't track and do not know how things flowed from money funds into fixed income or equity or vice versa, because the clients come to us omnibus and what's going on behind the curtain, we just don't know. We're not like a big retail shop where you can see the flows and the exchanges going back and forth. I'll let Ray handle how it compares to last year.

Generally, Cynthia, the flows have picked up in ultra-short. The gross sales in terms of on a monthly average basis were a little under $400 million in 2010, a little over $400 million in 2011 and through the first half of 2012, they're up to about $570 million. I think it is a reasonable conclusion that, given the yield situation for money funds for investors who feel comfortable going out a bit on the curve, they can pick up decent incremental yield in the ultra-short funds. In terms of the net flows, they were up in the second quarter compared to the first quarter, but they've really been running in the $400 million, $500 million, $600 million range for the past couple quarters.

Okay. Last question, does this comp rate, is it a good run rate?

Yes. It's a good run rate. But every quarter, outperformance and what are sales and it could change.

Okay. Thanks a lot.

Matt Kelley, Morgan Stanley.

I was hoping you could give us a sense for the color that you gave on the client base for the color you gave on the client base for if money reform were to come into play. I was just hoping you could give a little bit more color as to in terms of your business response. If the demand is diminished significantly at some level, how the incremental margin may work and what steps you could take to offset some of the lessened demand?

Obviously, we're fighting to not let that happen. But given the hypothetical nature of the question, with the client base basically not able to use money funds as they would be constituted, then we go through a whole panoply of other options for other clients. You can try to come up with separate accounts for some that are large enough to do that. You can expand state pools such like we have with Florida and Texas and now Massachusetts and maybe others can participate in there. You begin to look more aggressively at some offshore options and how they work. You look at ultra-short products. You look at products inside ultra-short and outside 2a-7.

You begin to look at things that perhaps haven't even been discussed yet, which is what I said in my remarks. You begin to look at a lot of different things, but none of them are as good as a money fund in any way, shape, or form. None of them restore the tax-free nature of the tax refunds for municipalities. You don't end up with a stronger diversification, as much efficiency, or as good a home for money funds. On the issuer side, you basically make the whole issuer side a lot more complicated. That's why we think that if the regulators are really focused on the participation of some of the players in the short-term market, then they ought to regulate how much they do in short-term financing and where they do it, how many funds, what percent of that book, et cetera, rather than shoot the money funds so that they can't do it.

That's about as much I can give you on the client base. I think that, for a lot of a lot of them, their only option is going to be to put money the bigger banks. The reason I say that is because when they did the unlimited deposit for zero interest, 75% of the money went into the top 10 banks. That's about as good a reference point as I would have as to where a lot of the money would go that wasn't able to fit into some of these other buckets I'm talking about.

Okay. That's helpful. One follow-up from me on capital management, can you give us a sense for your level of conservatism now? If there's anything baked in for what's going on in the overall regulatory environment and whether that could change into year-end based on potential outcomes on reform?

Yes, Matt. For number of years, we took out over $400 million loan and maintained our $200 million revolver. Now, we've paid down in the last couple years. When we took down the loan, we kept a lot of the money here, used it for seed and investments and other products and so paid a bunch of it down. Remember I mentioned our net debt there is only around $15 million at the end of the quarter and then we have that $200 million revolver.

We have a lot of capital here to address whatever may come up. In terms of what could change by the end of the year, well, let's see what happens and see what we would do. We have share buybacks. We have acquisitions and we have dividends. They're all on the table and we will see what happens and how we respond.

Okay. Thanks, guys.

[Bulan Auskam], RBC Capital Markets.

Quick question, we talk about regulation a lot, but my question is, let's assume that Mrs. Schapiro does not get the majority vote and let's assume that FSOC declares money market funds as systemically important. What options would the industry have at that point to fight any regulatory push?

You have to go through a significant amount of procedure to get to the point of FSOC declaring some money funds, all money funds, or whatever to be systemically important. In the hypothetical you're talking about, the SEC votes two to three and the regs don't get put out by the SEC, they flop it over into FSOC. Now, what happens? FSOC has approved a three-pronged test of Phase I, Phase II, Phase III where they are talking about whether designating individual firms or industry participants. We have filed papers on the legal side indicating that the money funds do not meet any of the criteria. Depending on how you look at Section 113 of Dodd Frank, it's written in terms of 10 criteria to be met or examined and then that was codified into six features by the regulators. You look at those and they are all aimed at large banks with a lot of leverage and points like that, because of their banking situation.

That's why we think that we have a better legal case, that they can't even designate money market funds as systemically important. Then they have to get to the conundrum of whether it's one fund, two funds, or whether it's all funds or the whole industry and that's another level of difficulty. There opportunities for filing papers, hearings and challenges all throughout that process that we would then go through if FSOC were proceeding down those roads.

Okay. Very helpful. Quick question on M&A, I'm sure your looking at different options, evaluating various deals. What do you see in terms of pricing in the market? The question is, what are sellers asking and what are bidders bidding?

Investment bankers know better that answer. I can give you the answer as to how we look at it, the deals we want to do, it's unusual for us to not be able to be comfortable with the price that the market is willing to do. Yes, there are some where we go in and we're viewed as being a lower bidder, but in the deals where we think the culture is right, we're not distracted by what the pricing may be. There are deals that are overpriced and so, fine, but maybe Tom would give you more color on the pricing than I have.

I'd just add in, what we've been looking for, if you are not talking about roll-ups but centers of excellence or things that would continue on, we have had the philosophy with each one of the ones that we've purchased like that, that we want the team to continue and so there's continuing interest in them. So since they're going to continue and have continuing interest, why aren't they being paid overtime for what we acquire? Many times, our discussion with them is, you can probably make more over time if we are able to grow it together than you could just on some upfront payment and so then you get a different look at it that way. It satisfies a lot of our cultural thought process that they fit in with us, especially if they're still working with us.

Finally, I don't know if you already answered that, but I was wondering about the equity inflows into your separate accounts and which strategies got these flows in the quarter?

Yes. We did reference it. It's really dominated by strategic value dividend. That's been a strong flow gainer, both on the separate account in the SMA version. We have seen some more traditional institutional accounts which years ago you would not have seen into that type of a the dividend strategy, but we've seen institutional interest in it, and then of course, strong retail demand.

All right. Thank you very much.

Gregory Warren, Morningstar.

Basically, I wanted to step away from money market for little bit here and ask you guys about the equity and fixed income side of the business. I know in the past you've talked about targeting $100 billion in total AUM and you've gotten pretty close. You're about $82 billion right now. Do you think that target needs to be higher in an environment where potentially reform is out there and you have to potentially keep buffers on the books in order to continue running the money market side of the business? Is it something you can generate internally or is it something you need to go for acquisitions on?

First of all, yes. The targets, once we get to $90 billion, which we've announced in the press release, because all we do is we add for the purpose of getting to $90 billion, the liquidation account, which you probably aren't including your $82 billion. So we're cool with that. But once to get to $90 billion, $100 billion isn't hardly the next goal at all. We are internally figuring out, okay, what are we going to say? If you look at it and say we want to double in five years, you would get pretty much where we would, once we do our internal stuff, but we haven't done it yet on that. The goals will be much higher and they really don't have anything to do with all of the stuff on money funds.

They have to do with the strength of the mandates, the strength of the distribution, and that's what it has to do with. Yes, we think we can do that kind of growth organically. You look at our charts on gross sales, our industry-leading type net flows over the last several quarters and the strength of the sales force, the improvement in their quality and their ability to function in a changing marketplace. When you see their ability to switch from IE risk on to risk off or equity to fixed or income-oriented, you can see a lot of flexibility in being able to respond. These are the things that give us confidence that we can grow these things organically.

You can have a debate about whether, say, the Trustmark thing is organic growth or a lumpy acquisition. As I said, I call them lumpy sales, so I count them as organic. When someone who's a client of yours for 20 years decides to put money back to you, then we consider that organic. You can dispute that back and forth either way, but underlying the machinery, we like to think of ourselves as an organic growth machine and yes, we will cheat by acquisition.

Okay. Maybe a follow-up, too, on that is, if in a world where reforms do happen, you've got a think a lot of people will be coming out the business looking at the cost benefit from running the funds. We've seen that over the last five years already. Would you continue to be a consolidator in this industry? Do you think that would be in the best interest for you guys? Or do you think it would be something where maybe just building out the equity and fixed income makes more sense?

No. We would continue -- I assume you're asking about the consolidation of the money fund side. We would continue to be positive towards doing the consolidation on the money market funds side, because we believe in the beauty and efficacy of the money fund as a good public policy and as a good business. That's why I went through the market share percentages with you at the beginning of the call. When you take the market share from five to nine, over a little more than a decade, it shows a commitment to this business. I told the Senate, when I was before them, that all of the stuff going on, on money funds right now, the fact that the $2.5 trillion or $2.6 trillion stays in the funds is a sign of the resiliency and the importance with which both customers and issuers look at this business. That's what gives us a lot of confidence in doing it.

Yes, reforms happen. In fact, since 1982, many reforms have happened in terms of money funds. Reforms happened in 2010, which did strengthen the funds and enable them to get through, with flying colors, the changes in the marketplace that occurred in 2011. Our goal is to simply go with those changes and avoid killing the funds, which some of the regulators seem to want to do.

Okay. Thank you.

Marc Irrizary, Goldman Sachs.

When I look through the P&L, it looks like maybe some of the other expenses that you're seeing some operating deleverage there. Can you just maybe help me understand when you go forward, like maybe some of the G&A if you will, what the outlook is there? Also as the fee waivers roll-off, are you thinking we should reinvest some of those P&L dollars in growing the non-money fund business or how should we think about that?

Okay. To go through the P&L, we're going to continue to invest in technology and we're doing that the best we can. We've maintained, on a year-over-year basis, the advertising and promotion level. The T&E probably will pick up because of the new sales people that we put into position and still have a few more to hire. The professional service fee moves based on things that I'm not sure we can exactly predict.

Then, are we going to take the money that we make if waivers go away and invest it back into the business? We're going to earn more money and yes, we're going to put it back into the business. Gordie Ceresino, on the international side, is going around, looking at deals and what can we do that? Would we invest there? Yes. I don't know if anybody has anything else.

Great. Thanks.

Roger Freeman, Barclays Capital.

I just wanted to come back, sorry to beat a dead horse on money market, one, listened to Ken's question earlier and your response, some other folks have been talking, is the assumption essentially now that new money market rules aren't going to be proposed until after the elections? Is that because Treasury and Fed have now let up pressure in threatening to FSOC money markets?

I make no such assumptions. As I've said in response to the other questions, the regulators seem intent on imposing these draconian proposals, regardless of election cycles, regardless of political arguments and so I could not make the assumption you did. I would love to, but I cannot.

I'm not making the assumption, it just sounded like that was the assumption, but thanks for clarifying. The second question is, just Schwab, in their business update the other day, essentially in reading through their the comments, my take was they think what you may ultimately get these rules impacting basically prime funds, credit exposed funds and that users of the product would have to decide if they want money market products, they would go to government-backed funds and otherwise, going credit, find other products. I'm wondering, your customer base is a bit different in terms of institutional piece and corporate. How much would just go to government backed funds? And essentially, too, what could traditional bank deposits for liquidity management not cover in terms of the benefits that you do? The biggest thing that comes to mind is credit exposure to a bank, if you're over the guaranteed limits?

Going reverse up the tree of questions, one of the things that the banks can't do is duplicate the municipal tax-free funds and preserve the tax-free nature of that. For our investors on the one side, like trust departments, like broker-dealers, like individuals and on the issuers side, small municipalities all over the country who, right now, gain the advantage of having Federated and the other large players compete for paper where we bid the paper down to 30 basis points. Whereas, if the money fund doesn't exist, then they are beholden to finding a bank and then probably going to rates that are hundreds of basis points higher than that. That's one pretty definitive harm. If you hypothesize something, which we do not, where you eliminate the prime funds, which are $1.6 trillion or so out of the whole market, then you've got to deal with what are you going to do with the issuers and where are the people going to go for the money?

Once again, you're going to be back into the things I've already said on this call several times, all different kinds of pools, all different kinds of money going into large banks, where the money just goes out of the system and over onto the Fed balance sheet. Whereas 100% of the money that we have goes into the system and into issuers and helps with the short-term financing. There are very, very, very legitimate short-term financing needs in this country that the money funds take care of. Just because, at some point, some people take advantage of it, according to the regulators, by over-investing, that doesn't mean that you should eliminate the prime funds. Now, what would happen? I just don't know. I know the unintended consequences would be quite severe and that's why people like the Chamber of Commerce and many of the corporations, CVS, Boeing and the like, have said that they're not in favor of these kinds of regulatory changes.

Got it. You raise good points on issuers and there's clearly impact on that. Okay. Thanks.

Robert Lee, Keefe, Bruyette, & Woods.

I just wanted to follow-up on the announcement of that Massachusetts account, the $9 billion account. I guess it's similar to the state of Florida and Texas that you've done for a bunch of years, but can you maybe just update us on that marketplace? I know those things come up for bid periodically, but is there any kind of change in the landscape like more of those coming up for potential bid over the last couple of years? When you competed for it, besides the incumbent, what's the competitive landscape?

The competitive landscape is very strong. We competed for the Massachusetts deal, I think, at least four times over its heritage. These things do come up for bid. There are many states, I don't know how many, that have these pools and wherever they come up, we bid on them. But it's very difficult to build a chain or an avalanche on this kind of business. They are periodic.

But we have a good team of people who are calling on these state organizations 100% of the time. I personally spoke at the National Association of State Treasurers earlier this in Washington. It is a considered effort on our part to expand our business model, which we think works very well with our investment management and then with our customer service at the local level to both service the existing accounts and help them expand the footprint of their state pool. These are the key elements that we brought to the table in Texas and then Florida and now in Massachusetts and would expect to do elsewhere as well.

All right. Great. Maybe one follow-up question on the equity account business, you've had some success there, I know with strategic value dividend. But can you talk a little bit about how much of that or the potential to add that or other strategies to sub-advised platforms? Are you seeing traction in 401(k) plans and variable annuity products and the like with any of that?

The strategic value dividend, Rob, is working in a number of channels and we're expanding distribution in all of the areas that you're mentioning. We've had, I mentioned before, RFP level for the strategy. We've had a number of platform wins. It really is proving to be something that we think is more than something that's going to come and go with the emphasis on the dividend income and the growth of dividends. We're really finding receptivity across channels and in multiple applications.

Is there any way of getting a feel for it within your separate account fixed income and equity business? How much of the assets are currently placed on platforms where, for lack of a better way of putting it, there should be kind of recurring flows from that?

That would be typical of most of the platforms when they're dropped into asset allocation programs. It would probably be the reverse of that, it would be exceptional for that not to be a growth opportunity. Then of course, there's a flip side to that, too. We've seen when clients make changes to their asset allocation decisions, both the inflows and outflows, of course, can be lumpy.

Okay. Thanks, guys. Thanks for taking my questions.

Ed Groshans, Height Analytics.

I think you've responded to the money market funds thing quite well. The only thing I would add is the Financial Stability Oversight Council did come out with their annual report on July 18 and they specifically recommend that the SEC adopt reforms to address runs on money market funds. From your view, you feel that the rule changes done on August 2010 to 2a-7 are sufficient, yet it seems like you don't just have, you mentioned the Fed and the SEC, but the FSOC is really nine other regulators that seem to be getting onto this bandwagon. At the meeting, you actually had CFTC Chairman Gary Gensler highlight the work that Schapiro was doing in this area. What you're saying to the regulators, I think you've got a much bigger push on your end, given that it's not just the SEC or the Fed, but it seems to be now that you have nine financial regulators lining up on this issue.

Yes. The underdog role. Looking at a few of them, the CFTC, I think it was earlier this year, expanded the available use of money market funds to their participants and went through a whole process and then came up with expanded use of money funds. The OCC has just recently decided that what should happen with the short-term management and banks is that they should be coordinated much closer with the existing rules on 2a-7. Yes, all those people voted to put the report out and pretty soon, we will have our response to that report. I think the principal elements that we will respond to that report is that the fundamental assumption that somehow money market funds are susceptible to runs is simply untrue. When you've had one run in 40 years, that does not make susceptibility. It's interesting that in '94 when a fund broke $1, there was no run, there were no problems elsewhere.

The reason was that there was plenty of liquidity in the system. The problem in '08 was that, as Bernanke has said, it was the worst situation since the Depression and all the markets had been frozen up and that was what the real problem was, in addition to some changes in how the government was looking at companies like Lehman on the one hand, and Bear Stearns and AIG on the other hand, that you did not have consistent government response. When we peel through the amendments that have been made to 2010 on the subject of runs, we note that, number one, you can't have a run in the existing fund that may make $1, because as soon as they break $1, they go into liquidation. Liquidation means they exercise the living will, which means there's a pause on redemptions and everything comes out according to its redemption thing. There is no run in the first fund.

Then the next question, will there be runs on the other funds? Now you have a lot of things that ameliorate that. For example, everybody knows what's in the other funds because we file them publicly and with the SEC. The SEC knows what's in those funds and we file them even quicker. They have the right to do emergency powers and say, we want to hit a pause mode on this fund if they want. The independent directors of a given fund have the obligation to treat all shareholders fairly anyway.

Because of the transparency, because of the increase in cash positions that have been made, because of the increase in regulatory ability and confidence on these subjects, we think they have ameliorated, more than sufficiently, the chances of creating money market fund runs. But what we have not done is that we have not made the funds perfect, because they are investments and what we beg is that they not make perfect the enemy of the good.

Right. I thank you for your response on that and I know you guys have been looking at this in great detail. It does seem that, at the end of the day, there is a push to do something. I think when we look at the Financial Stability Oversight Council report, I think it's the first time I saw the word "possibly" attached to redemption features, whereas prior to that it had always been that we're going to see redemption features and now it's possibly redemption features. It seems like there is some movement on that side and then the other issue then is, is the push going to continue for capital or for floating NAV? I understand that you don't appreciate the floating NAV, but it does seem like maybe the compromise comes on the capital end of things and I would like to hear your thoughts on that.

Compromising among ways of killing yourself does not make a lot of sense to us. Trying to use those three things, all of which are deadly, and say we'll compromise on this one and that one, it just doesn't make any sense. They all attack the essence of what a money fund is -- daily liquidity of par of the market interest rate. Therefore, any one of them will be devastating to the funds. That's how we look at it.

When you start talking about capital, you go there, remember, that the regulators, as a general rule, have said, we don't want these funds to be guaranteed or viewed as guaranteed and this is a problem. If you start putting capital things on them, you will create what one commissioner calls the illusion of protection. This illusion will go exactly the opposite way of what the regulators say they want. Yet the capital will impact the efficacy of the funds, either from the advisor's point of view or from the yield on the fund point of view or both.

That's all we have time for, but I'd be happy to -- if you have other questions, feel free to call in. Operator, we're going to wrap up this call.

Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation. Have a wonderful day.