Federated Hermes Inc (FHI) 2015 Q1 法說會逐字稿

Welcome to the Federated Investors first-quarter 2015 analyst call and webcast.

(Operator Instructions)

As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Mr. Ray Hanley, President of Federated Investors Management Company. Thank you, Mr. Hanley, you may now begin.

Good morning and welcome. As mentioned, we have some brief remarks and then we'll open it up for your questions. Leading today's call will be Chris Donahue, Federated's CEO and President; and Tom Donahue, Chief Financial Officer. And joining us for the Q&A is Debbie Cunningham, our Chief Investment Officer for Money Markets.

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.

With that, I'll turn it over to Chris.

Thanks, Ray. Good morning, all. I will briefly review Federated's business performance and then Tom will comment on our financial results. I will begin by reviewing another strong quarter for our equity business.

Total equity managed assets grew by 5% from the prior quarter and were up 18% from the first quarter of 2014. We had our best quarter yet for gross equity sales, with sales of $4.5 billion, and our third-best quarter for net equity sales of $1.6 billion. These figures, of course, include a combination of both the mutual funds and the separate account sales and net sales figures.

Looking specifically at Federated's equity fund organic growth rate, we see it was 11% for the first quarter, annualized. And, again, this was among the best in the industry. Based on Strategic Insight's data, our first-quarter equity net flows, of just under $900 million, ranked in the top 3% of the industry. Equity sales results were solid in a number of different strategies and believe we are well positioned for continued growth.

Our equity success comes from years of focus and investment, leading to a diversified mix of high-quality teams and strategies delivered through effective and growing intermediary-based distribution. Performance continues to be solid. Using Morningstar data for ranked funds as of year end, seven Federated funds, or 27%, were in the top decile for trailing three years. We had 11 funds, which is 42%, in the top quartile. And over three-fourths of our funds in the top half for the trailing three years. Looking at the one-year rankings, eight funds, or 31%, were in the top quartile, and 62% were above median.

Performance highlights include the Kaufmann Large Cap Fund in the top 4% or better for the trailing one, three, and five years. The Kaufmann team and the Kaufmann Large Cap Fund were featured prominently in this past weekend's Barron's. MDT's Stock Fund, a large-cap value strategy, and MDT All Cap Core Fund were both in the top 2% for the trailing three years. The International Leaders Fund, a foreign large-cap blend strategy, is in the top 5% or better for the trailing 3, 5, and 10 years. And our Global Allocation Fund was top quintile for the trailing one, three and five years.

These results highlight the breadth and strength of our equity product line. We continue to have distribution success across a variety of equity strategies. In fact, two-thirds of our active equity strategies had net positive sales for the first quarter, led by Kaufmann Large Cap, the domestic and international Strategic Value Dividend Funds, Capital Income, Muni Stock Advantage, International Leaders, and Clover Small Value Funds. Equity separate account net sales were again driven by the domestic and international strategic value strategies. Equity fund net sales remain solidly positive here early in the second quarter, with positive net flows in many of the same strategies that occurred in the first quarter.

Now turning to fixed income. Our net fund sales were led by Total Return Bond Fund and the Institutional High Yield Bond Fund. Our High Yield Trust Fund earned the Lipper Award for its category for leading performance over five years ending December 31 of 2014. The fund ranked in the top 1% for trailing 3, 5, and 10 years. We continue to see institutional interest and RFP activity for high-yield, short-duration, and total-return bond strategies.

At the end of the quarter, we had five fixed-income strategies with top quartile three-year records including high yield, short intermediate muni, ultrashort, and mortgage institutional. Tax-related seasonality, mainly in the ultrashort products, resulted in negative early Q2 fixed-income fund flows.

Now let's look at money markets. Assets decreased about $10 billion, reflecting seasonality, though average assets were higher than the prior quarter. We expect to see further seasonal money fund asset decreases in the second quarter, largely due to tax-related uses of cash. Recall, however, that money markets separate accounts tend to benefit from tax seasonality. Money market fund share at quarter end was slightly over 8%.

We continue to make progress in reshaping our money market fund product line in response to the 2014 rules. The fund's board will consider a variety of related proposals next month, and we expect to be able to fill in additional details on product changes in the coming months. We expect to have products in place to meet the needs of all of our money fund clients. These will likely include prime and muni money market funds modified to meet the new requirements, government money funds, separate accounts, and offshore money funds.

We are also working to develop privately placed funds in an attempt to mirror existing Federated money market funds to serve the needs of groups of qualified institutional investors unable or unwilling to use money funds modified by the new rules. The new rules are subject to a lengthy implementation period. The floating NAV requirement for institutional prime and muni fund takes effect in October of 2016.

Last week, we announced a deal with Reich & Tang Asset Management to transition approximately $7 billion in money fund assets to Federated money funds. We're working with Reich & Tang, financial intermediaries, and fund shareholders to transition these assets, which we expect will begin in June.

Taking a look, now, at our most recent asset totals, as of April 22, managed assets were approximately $349 billion, including $240 billion in money markets, $55 billion in equities, and $54 billion in fixed income. Money market fund assets were $204 billion, and April average money fund assets were running at about $206 billion.

Looking at distribution, our sales force continued its momentum in the first quarter, leading to the record equity sales that I mentioned earlier. Equity fund gross sales have increased each quarter in 2014 and Q1 of 2015. Compared to Q1 of last year, gross equity fund sales grew by 22%, led by 37% growth in our wealth management and trust channel, 28% growth from the broker dealer channel. Fixed-income fund gross sales increased 6% compared to the first quarter of 2014, with solid gains in both of these channels.

The SMA business continues to be solid and expanding. Total SMA assets ended the quarter at $16.5 billion, with most of this in equities. Assets here are up about 27%, compared to Q1 of last year, and have more than doubled over the past three years. Federated ranked eighth in the Cerulli Associates rankings of the largest SMA managers at year end.

In the institutional channel, we added two equity mandates in Q1 for MDT mid-cap growth, totaling about $225 million, of which about $100 million funded in the first quarter. We also won separate account mandates for Kaufmann Large Cap and the International Leaders strategies. We expect about $250 million in equity institutional account funding in the second quarter.

We recently announced the addition of the West Virginia local government investment pool and expect about $1.2 billion to fund in the third quarter. RFP activity remains solid and diversified, with interest in Kaufmann, Clover, MDT, strategic value, and international strategies for equities, high yield and short duration for fixed income. Our equity RFP activity has more than doubled when compared to the first quarter of 2014.

On the international side, we are planning for product enhancements for Canada to accelerate the growth we have seen in retail and institutional markets. We expect to launch a Canadian domiciled strategic value dividend product this year. We continue to seek alliances and acquisitions to advance our business in Europe and the Asia-Pac region, as well, of course, as in the United States.

Tom?

Thank you, Chris. Revenue was up $3 million from the prior quarter, due mainly to lower money fund yield waivers, which added nearly $6 million in higher equity assets, which added $4 million. These increases were partially offset by the impact of two fewer days in Q1, which negatively impacted sequential quarterly revenues by more than $7 million. Revenue increased from Q1 2014 by $9 million, due largely to growth in equity assets. Equities contributed 46% of Q1 revenues, again, the highest percentage among the various asset classes. Combined equity and fixed-income revenues were just under 70% of the total.

Before commenting on expenses, I'd like to note that we moved certain sales commission-related expenses previously included in the other line item into distribution expense. The amount reclassified for Q1 2015 was $4 million; for Q1 2014, it was $2.6 million; and for Q4 2014, it was $3.8 million.

The operating expenses were up from the prior quarter, due mainly to higher comp and professional service expense. Comp increased due to seasonally higher payroll tax and benefit costs as well as stock comp expense. Professional service fees were up due to an increase in legal expenses. Sequential quarter distribution expense was impacted by fewer days in the quarter, which reduced these expenses by $2.5 million, offset by the impact of lower money fund yield waivers.

As we pointed out last quarter, the reduced number of days impacted our operating income by about $5 million, which impacted the operating margin by 1.2%. Comp increased from Q1 of last year due to higher incentive comp expense and wage increases. The impact of money fund yield waivers of $27 million was down from the prior quarter and year over year. Based on current assets, and assuming overnight repo rates for treasury- and mortgage-backed securities run at roughly 9 to 12 basis points over the quarter and T bills stay in the 2- to 10-basis-point range, the impact of these waivers to pretax income for Q2 would be around $24 million.

Looking forward, we estimate that gaining 10 basis points in gross yields from beginning Q2 levels would likely reduce the impact of yield waivers by about 40% and a 25-basis-point increase would reduce the impact by about 65%. We continue to expect to recover about 75% of money fund yield waiver-related pretax income when yields increase to the point of eliminating these waivers. This estimate is based on our assessment of competitive market conditions, including the expectation that we will incur higher distribution expense as a percentage of money fund -- money market revenues when rates and yields increase.

Multiple factors impact waiver levels and we expect these factors and their impact to vary. These factors include changes in fund assets; available yields per investments; actions by regulators; changes in the expense levels of the funds; changes in the mix of customer assets; changes in product structure; changes in distribution-fee arrangements with third parties; Federated's willingness to continue the fee waivers; and changes in the extent to which the impact of the waivers is shared by third parties.

Q1 effective tax rate was about 38%, as expected, and that continues to be our expectation going forward. Looking at the balance sheet, cash and investments total $280 million at quarter end.

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

Thank you.

(Operator Instructions)

Our first question is coming from the line of Michael Kim with Sandler O'Neill.

Good morning. First, as it relates to reshaping your money market funds to align with the upcoming regulatory changes, wondering what the long-term impact on yields could be as some of your institutional prime money market funds convert to 60-day funds, and whether you think that could have any impact on market shares across the industry?

Let's divide that into two questions. One, what the impact on yield might be as people move from prime to govi in some cases or move into the 60-day range, and then as relates to market share. I will handle the second part, and we'll let Debbie comment on the first part.

On the market share, what I expect to happen over the longer term is that in a post October 2016 environment, Federated will see increases in assets, in the money market fund area, because the dust will settle, all of the education will have occurred on the efficacy of the new product offerings and the things that exist in the marketplace now to encourage more cash use will continue. For example, banking regulations that causes certain customers to not be favored as deposit customers, the increase still in amount of money being printed by the government as part of normal operations, the regular use of cash by customers, the fact that corporations -- there used to be pretty near half of the corporations used money funds.

Today that number is closer to 20% and I think they will come back in. So overall, I think we will begin to see increases in assets, which I think will turn back to increases in market share for our offerings.

Now, I'll let Debbie comment on the potential rate impacts of some of these changes.

Good morning, Michael. Thanks, Chris.

From a historic perspective, if you looked at the gross yield differences between a traditional prime fund, and by traditional I mean one that can use all of the allowances under 2a-7, so out to 397 days on a final maturity basis and 60 days on a WAM basis. Historically, that's produced about a 12-basis point yield differential between prime and government funds. Our expectation is that a 60-day type product will fit right into the middle of that particular spread, so if it remains at 12 basis points, somewhere in the 6 basis point neighborhood.

Our real thought, though, in the context of how this all works out is that there will likely be some swell of assets that initially takes the easy path, and that easy path would be going into a government fund from a prime fund and effectively abandoning their allowances to go into the prime market. And so what does that do? That, generally speaking, would cause supply and demand differences in the marketplace that would probably cause that 12-basis point spread on a historic basis to go a little bit wider.

How much wider? 20 basis points, 30 basis points, 40 basis points, you pick the number. But at some point there will be a time then that for those investors that did choose the easy path and went into the government institutional marketplace yet have the allowances to go back into prime at that point, there will be a point at which they then look at whatever that spread differential is and think it's fairly attractive.

What we think will be the case is that there will be reverse swells that go back in the other direction, probably over a longer period of time but with less volume in each one of them. Again, throughout this entire period and continuing as we have these products up and running post the 2016 time period, prime versus government versus 60-day is going to show that 60-day prime probably right smack dab in the middle of where that prime govi gross yield differential is.

Great. That's very helpful.

Then, it just seems like the pending regulatory changes are increasingly forcing smaller players to exit the money market fund business. So just wondering how big of a roll-up opportunity you think that can be? Then related to that, does that shift your capital management approach at all as you think about the mix between these types of opportunities versus share repurchases and dividends?

Since as a general rule for our money market funds we don't use capital upfront to pay for the transactions, there would be no impact on capital. As regards to roll-up activity, as I've said on these calls before, before the 2008 timeframe, there were over 200 firms offering money funds. Today, if you look at the list, there are 80 and the bottom 25 or so don't have enough of assets to really make a third-party game of it.

Increasingly you see one-at-a-time type things like Touchstone or like Reich & Tang or others that we have done come along. So it's not exactly a catalyst. If you look at the whole picture of it, you'd say, gee whiz, 2008 caused people to leave the money funds. The 2010 amendments caused others to leave. The 2014 amendments will cause still others to leave. The actual implementation date in 2016 will cause others. And so, it is more or less a steady march, but it is without a sudden catalyst.

Got it. Then maybe just one last one for Tom. Any color in terms of how we should be thinking about comp and expense growth more broadly, just as we look out to the rest of the year, particularly in light of some of the seasonality in the first quarter?

Of course, the first quarter was up and we'd probably give a range of comp and related for next quarter of between $74 million and $75 million. We keep looking at increased sales, which is one of my old success items. We're happy when that expense goes up because it means we're getting more assets.

Okay. Great. Thanks for taking my questions.

Thank you. Our next question is coming from the line of Surinder Thind with Jefferies.

Good morning. I was hoping you could just walk me through some of the underlying trends that you're seeing in the institutional business? And maybe investor appetite for, let's say, equities versus fixed income and how that dynamic is changing?

What we're seeing in terms of RFP activity, which I mentioned in the remarks, is a pretty good increase when the number of RFPs that we're successfully responding to, that doesn't mean we win, but that we feel we have a real good chance, have doubled. What this is simply the result is that a lot of good mandates -- it isn't any one mandate that's driving the truck.

We're seeing it in a number of mandates, whether it is international leaders, increased interest in MDT, which is Sequent, obviously a strategic value dividend, the Kaufmann Enterprise, Clover Small Cap. It isn't necessarily the story of a complete re-risking in the marketplace, although it continues to move ahead.

All these various market moves have encouraged people and we are seeing some aspects of an increasing, a willingness to take on more types of risks. But it is not a big accelerant and it doesn't push the needle all the way to the other side, but we do see it moving. What mostly is being rewarded is long-term basic blocking and tackling and producing the kinds of records and in the numbers of mandates that I talked about in the call. That is the real trend.

Surinder, it's Ray. I would just add, it is multiple strategy as we went through. There is, though, a notable increase in the international component, both the international dividend strategy that we have and the EFA large foreign blend strategy. We're seeing a pretty good step up on both of those fronts.

That's helpful. Then maybe just touching base, I think you mentioned that there's going to be a number of new announcements regarding your new product set for the money market reform. Are we going to -- when should we -- is that more about just products starting to being launched starting around 3Q and stuff, or when should we expect to see that you'll have all of your products in place?

What we've said is at the fund board meetings, which is mid May, so that's coming up in a couple of weeks here, we will go to the Board with the proposals as to which funds will end up in which category. We have already announced the types of buckets and the types of funds that we will have, and so we're sticking with that.

Now, we're putting the finishing touches on getting clearance from the boards that this particular fund will be a retail fund. This particular fund will be an institutional fund. This fund will be a 60-day fund, et cetera. I won't commit to a time right now, but it will be sometime after that Board meeting when we will say which funds are going to be going in which direction. It may be that there are more than one announcements that come out.

In addition, we have a large proxy that we're working on for our one fund that has several portfolios in it equal to $175 billion or so of our money fund assets, so that is a big effort to get that proxy statement done. That will be occurring. We will also have seven or so fund mergers, and we'll probably spawn 20 or 22 new classes. There will be a lot of those kinds of changes, and they may take enough time that we go through and have more than one announcement about what's going on. The proxy statement, of course, itself will be a large and substantial public announcement.

Okay, that's helpful. That's it for me, guys. Thank you.

Our next question is from the line of Ken Worthington with JPMorgan.

Good morning.

A little twist on Michael's earlier question. Observing the shift from prime to govi, and this is for Debbie, how much do you expect the shift will impact short-term rates, and how big a gap starts to emerge between fed funds and very short-term rates? Does that dynamic actually start to pop out that spread between the two?

Well, first of all, I do think it will be occurring at a point in time when the fed is in play from an increasing rate environment, so that's always a helpful time and a helpful undertaking. It's not as if we're thinking that government yields will go yet further lower while prime yields shoot out. We in fact think that all types of yields will be increasing at that point in time, but with perhaps the prime side increasing a little bit more.

We do think that the supply on the government side is beneficial for keeping those rates in a positive trajectory. Certainly, what we have been looking at in the context of the treasury supply is pretty positive. There's a huge amount of coupon debt that's rolling into one-year maturities in 2015 and 2016, so that's a big positive for supply in addition to the treasury itself expecting increases in the bill supply and in the treasury floater supply. So those will all be helpful in keeping governments going in the right direction.

From a spread differential perspective between prime and government, like I said before, it's definitely going to increase. I can't think -- unless assets don't move, unless there's enough client education and comfortability with the product mix as it changes in 2016 leading up to and post the October implementation time period, then we're going to see spreads increase in some way, shape or form.

From 12 to 20 to 40, I don't know exactly where it stops, but at some point there's a tradeoff that customers who chose to go into the government option and don't need to will want to rethink and re-look at their other options in the marketplace because the differential is now large enough. Historically that's been somewhere in the 20 to 25 basis point range, but could be different and certainly in the context that we've been at zero for so long, who knows what holds going forward.

It's not that we think that there will be government yields going in one direction while prime goes in the other. We do think that they'll both be lifting but with a spread differential that probably favors prime going up a little bit higher.

Can the fed use reverse repos to maybe better narrow any spread that emerges between -- I was thinking more like treasuries in fed funds as opposed to CP in fed funds, but really on the government side and the dynamics that could play out there? Is there potential there, or do you not buy that?

No, absolutely, we think that's the other big positive on the supply side of the equation. As I said treasury issuance and rolling in of coupon debt is a positive, but the reverse repo available from the New York fed is also a huge one. Currently it's capped a $300 billion in total on overnight. They've offered somewhere in the $100 billion to $300 billion range at various points in time on term.

They have a $4 trillion supply on their balance sheet, so there is very -- we expect that there will be upward movement and that that will indeed help satisfy and keep any dislocations out of the marketplace. When we think of a rising rate environment, traditionally, we think of the fed funds rate going up and everything adjusting by 25 basis points.

In this case, what we think we're going to see when the fed does begin to raise rates is something that keeps reverse repo at the bottom of that range. So let's say they go to a 25 to 50 basis point range, probably puts reverse repo from the fed at 5 basis points, term reverse repo and fed funds at about 10 basis points, interest on excess reserves at the top of the list at 50 basis points, and all of that, I think, is being coordinated by those various tools from the fed, the largest of which seems to be at this point the reverse repo facility.

Okay, great. Thank you.

Then for Chris, assuming I did the math correct, on the management fee rate, if I back out the negative impact of fee waivers and I account for days, it looks like the management fee rate went down. Given mix toward equities, I would have expected it to go up. Again, assuming I did this correct, what's going on behind the scenes to drive that decline?

Ken, it's Ray. On the blended fee rates for -- and taking the money funds out of it then, on equities it looks like the decrease was something like 0.5 of a basis point, and that would just be mix, talking about things like the SMA growth and the separate accounts. Here, I'm just talking about the fund portion -- within the funds we would have had a slight decrease. On an overall basis -- I'm looking for the number here -- yes, not really much change. It's really just the mix of products. It's not anything more complicated than that.

Okay, but on the mix -- well, at least I'm looking at the asset classes. The equity bucket increased more than the fixed income and money market bucket on an average basis. So I would think that mix would have helped, not hurt unless there was a massive shift within each bucket. You had mentioned before about not capturing all of the fee waiver recovery. I was thinking maybe there was something there that had already started to shift within money market fund rates.

No.

Any merit there?

No, nothing there because that's really predicated on rates increasing more than they did in Q1. We're -- looking at the equity blended rate. It was 0.3 of a basis point so it's just not much of a move, and that was downward 0.3. Even though equity was higher, it came in a little bit.

Okay. I'll work with you offline on it. Thank you very much.

Our next question comes from the line of Patrick Davitt with Autonomous Research.

Good morning. Thanks. Since announcing last quarter the large renegotiation on the distribution side, have you seen any other large clients approach you about negotiating similar deals and/or are you concerned about that now that it's more publicly out there?

No and no.

Fair enough. Thank you.

Our next question is from the line of Robert Lee with Keefe, Bruyette & woods.

Thank you. Good morning. First off, Tom, if you could just clarify -- I'm trying to understand it -- there was some distribution related, was it comp that moved from other expenses to distribution?

Commissions. Commissions that we had in other.

Okay.

We just thought it was better understandable in distribution line.

Okay. How did those commissions differ from -- you mentioned comp guidance for second quarter, I guess it was $74 million, $75 million partially due to better sale. I'm just trying to understand why there's some commissions that go through distribution and some that go through comp when they both seem to be sales related?

It doesn't have anything to do with comp, Rob. It's commissions that we pay to the intermediaries, nothing to do with compensations.

Oh, okay. All right. I was mixing the two. Okay.

I guess another question just hypothetically -- it's always tough to deal with hypotheticals, but when the fee waivers start to move away, obviously you start to recapture -- not recapture but profitability starts to improve. Should we be thinking that when that starts to occur that because overall firm profitability is going to expand, that we'll also see some offset, partial offset against that in comp, just as maybe comp pools to the extent they may be based on pretax operating income or something will expand? Well maybe not in lock step, but we could see compensation expenses rise as well?

Rob, the investment management pools aren't really related to that. The sales incentive pools aren't really related to that. The rest of the Company does have a, how's the Company is doing? So, if the Company is doing better, i.e. there are less waivers and we are earning more, I would expect that that would get reflected in the incentive comp for the rest of the squad.

Okay.

We'll reflect that every quarter because we have to put an estimate in every quarter of what we think our compensation levels are going to be. If they raise rates, we'll look at what we think comp will be, and you'll see it right away.

Okay, thanks. One last question maybe for Chris. You talked about some of the RFP activity in the separate account business. Unless I missed the comment, it seemed like you were pretty focused on the equities business, which is doing well and you've had some success fixed income. It seemed there was less commentary, at least this quarter, around that business. Can you maybe update us, unless I missed it, how the pipelines or in the fixed income separate account business, what you're seeing there?

Rob, we did announce the West Virginia win, which is a $1.2 billion. It will be funding here in the third quarter. On the high yield side, we have had some good success internationally and are commencing a road show over there with a new client on high yields, so that's a pretty good thing. There are activities in the fixed income side and I did comment on some of them in the remarks.

Rob, we're still see elevated activity on the total returned side, RFM activity, as well as fund flows and some institutional activity there that ends up coming in on the fund side of the product line, things like consultants recommending us to their clients where we're still working through what we expect to continue to see some elevated flows as we've seen over the last several quarters.

Okay, thanks, and I lied. I do have one last question.

The SEC recently released its responses to frequently asked questions as it relates to the money fund reform. Just curious if there was anything in their responses that you thought was a surprise, or making you go back and rethink or rejigger some of your plans for reshaping the product line?

Well, one of the reasons Debbie's on the phone here is because she's in Washington with ICI and SEC people in order to go over this. As you know, this came out a couple days ago, so there's still some work to be done.

At this point, I don't see anything in changing what we have determined we are going to do in terms of the kinds of funds that we're going to offer. In other words, we're still going to offer 60-day funds. As I've mentioned, we're going to work on private funds, and we're going to look at separate accounts and we're going to have Mary Joe White funds. That's what I call institutional prime funds that have a floating net asset value that are greater than 60 days. So we're going to score on all those streets.

When you say, well, what were some of the surprises? Well, since we were involved in asking a lot of those questions, although the SEC put some of their own questions in, there really weren't a lot of surprises. It didn't surprise us that they defined government securities to include the fed repo program and trade receivables that you have when you're selling governments. Further, they continued an SEC policy of not including the $250,000 of FDIC insured CDs as a government security. Okay, so there were no surprises there.

On the definition of natural person and how it works in a retail fund, I don't know whether it was surprising or not that if you're dead, you're still a natural person. But nonetheless that's the position. They did get into some sticky situations in terms of further commenting on beneficial owner and what that meant. And that has to be sorted out.

We were very happy that they enable you to involuntarily redeem shareholders who don't belong in a given fund because traditionally the mutual funds don't have that right, so that was very good. We can't understand why they wouldn't let you just put them into a government fund. If you're taking them out of a prime fund, it's a lot easier for a lot of our customers to just take it and exchange in to a government fund. But they say you basically have to send them a check, so that wasn't all that hot.

It was interesting to note that on the 60-day funds, they've gotten into the communication and marketing of it. Here, you are not permitted to say that you seek to maintain a $1 net asset value on your 60-day fund. Regardless of whatever intent you have or however Debbie is managing the fund, you're not allowed to say that and further, you must say that the NAV will fluctuate.

So, you have these two things to deal with. This will require increased education. That's why I said in answer to an earlier question that once people see how these products work, the education is complete, the dust settles, then people can logically see how these things are all being interpreted.

So those were some of them. There were a lot of other ones, too. You asked about the bigger ones or the ones that may have been a little different than what may have been expected. That would be my list.

Debbie, you're allowed to add any if you wish.

No, you hit on the highest priority ones, Chris.

There were some disclosure on what is considered financial support and would be required to be reported on the website and telegraphed out to clients and what is not, not being operational errors, not being fund mergers that are topped off in order to make the NAVs of those merging products the same. That was all as expected. Some clarification around the stress testing and some of the inconsistencies about different parts of the implementation periods, all of which had been, I think, pretty much expected.

Great. Thanks for taking my questions. Appreciate it.

Our next question is from the line of Bill Katz at Citigroup.

Staying on the money markets, I want to come out a little bit differently. Can you give us an updated sense of what percentage of the assets likely could be in motion as we work through the implementation process and you have a little bit more visibility to the type of products that are out there? Then, what do you think would be the normalized yield adjusting for fee waivers, so putting fee waivers aside or adding them back? Just given what would likely be a shift of the product mix.

Then, a little bit more broad and maybe a little more uncertain, we had the Department of Labor coming out with their fiduciary's reform discussion a week or so ago. Can you talk about what kind of risk there might be to the money market business broadly, where distribution costs are somewhat on the high side relative to the management fee?

Let's deal with -- I think there are at least three questions baked in that. I'll deal with the last one first, which is what about the DOL definition of fiduciary and how will that impact the money market funds specifically? The DOL definition of fiduciary, we don't think will affect the money market fund as we see it. Right, you can get into the question inside both the lawsuits that are going on in this area and inside what is the best interest of shareholders as compared to suitability, but I think that you'll be able to see, at least we have been able to see, that not much will change in terms of intermediary payments and activity here.

I think what will happen in this industry, and this is something that we have been in favor of for some considerable amount of time, is that intermediaries who are receiving various payments for various services on money funds, whether it is for a retirement account or not, ought to be thinking about how they justify and allocate their own expenses in terms of receiving those amounts in any event. And I think that this effort will accelerate that as a response from various people in the marketplace because it is very expensive for the intermediaries to handle the accounts, especially on the cash management side. At this point, even though it's early on in the sequence and even though the dust hasn't settled on its implementation, that's how I would look at that.

In terms of amount of money in motion, from an industry standpoint on the money fund side, we've heard estimates from a $100 billion to $500 billion of money moving from prime to govi an initial basis. And I can't really put my finger on either side of that or come up with a good estimate myself. In terms of our own clients, I will comment on it and then I'll let Debbie comment on it and let her handle the rate part of your question.

What we have been having discussions with some of our larger clients is in increasing balances because of the Basel III impact of non-operational deposits being unfavored by the banks. And so that factor has been very large.

In terms of clients, they are waiting to see how the dust settles, so I am not able to say what exactly our client base will do. Believe me, we talked to them quite often, but they look at cash management as something that's simple and that's done, and they'll decide when they have to. So I don't have a precise answer on what amount of our clients will go in which direction.

Debbie?

I think in the hundreds of conversations with individual clients that I've had, and obviously continuous discussion and dialogue around it with our salespeople, I would say that from a retail prime perspective that there will be something on the order of maybe 10% of those assets from a federated standpoint shifting into something other than where they are now in that prime retail category. It mostly has to do with broker dealer sweep and the context of the fees and gates potentially being an impetus for them to move into a product that doesn't have fees and gates.

The vast majority of our intermediaries that offer that service won't have an issue with it, but we found a few that likely could. So that's the low end of estimation of assets switching and money in motion.

On the higher end, we're probably up in the a third of the assets that would be in what would be our true institutional clients. Most of them retaining the capability to stay in an institutional prime fund, both with regard to the floating NAV as well as with regard to the gates and fees, but perhaps wanting to take a little bit of a hiatus and see what happens as that money is in motion, as the impact in the broader short-term markets is assessed utilizing the fed reverse repo program, looking at what happens from a supply perspective. Does it increase enough in the govi side? Is it stagnate or decreasing on the prime side? How does that all hold out?

I think we have a variation depending upon the types of clients and I think that's probably ranging somewhere in the 10% to up to 30%, 35%, 40% range with the initial money in motion change. Then, with ultimately some portion of that going back into their original type of product at some point when spreads start to widen out. What that takes from a spread perspective is hard to say.

I do think that we'll go into it -- our official outlook at this point is that we're into the September time period for the fed to lift off and initiate their increasing rate program. If that in fact is the case, that's still a year in advance of when the money in motion has to be at its peak to meet the demands of the implementation time period of October 14, 2016 to the 2a-7 reforms.

I think you're probably looking at something initially, with the fed lifting off, going back to the historic norm. 12 to 15 basis points maybe in differential between prime and govi, but then I think slowly as we work toward 2016, that spread will start to increase until it gets to a point where it's too high and money starts to go back the other way, probably not until 2017. I don't know what that too high number is. it's just really hard to say.

If you looked at it in historic periods, when there's been a panic in the marketplace because there's been a credit event, so the 2008 time period and even 2007 when money markets were impacted by the SIV problems in the market place and ABCP, you had investors that voluntarily chose to leave very high spread products from a prime perspective and go into the safety of governments. And that's because they were afraid of what was transpiring from more of an industry and a credit problem that was happening this those 2007 and 2008 marketplaces.

We're not anticipating that being the case in 2016. We're just anticipating this to be the operational difficulties of these new fund requirements by the SEC that I think are probably a lot easier to overcome than the concerns that have been the 2007 and 2008 type of concerns in the credit markets.

Thanks for that.

My question on the yield, I'm sorry, I may have misstated it. I'm really more interested in what do you think happens to the revenue, the management fee rate for Federated's pro forma money market business once all the other products and money in motion settle out? Less about the market spread, I understand that concept. I'm just understanding how it works the pricing for your business model?

Well, Bill, that's kind of hard to predict that far into the future. We've looked at -- as we thought about the private accounts, we thought about those being priced comparable to the money market funds. I don't know that we see coming out of reform and the product changes coming out of reform as being an impetus to pricing changes.

Just one other one for me, just so I don't monopolize all the time. You mentioned in your remarks, Chris, that Q2 fixed income is slightly negative due to some seasonal pressure from the ultrashort. What gives you confidence that this is just a seasonal dynamic? Because I would think that if rate expectations is going to start to go up that might be a relatively sizable negative for the bucket itself?

Bill, it's Ray. I would just point out that we saw just about the exact same thing last year, and particularly with the Muni Ultrashort Fund, which of course has a lot of clients who use it as an extension of their cash management beyond money funds, and those are wealthier folks who are paying taxes and pay it out of that municipal fund. So the dynamic is the same as we've seen, in particular last year as tax payments went up. That product in particular was affected.

More broadly on rising rates, Chris, do you want to comment on that?

Well, most of the products on the broad fixed income side are well aware of what the fed is thinking about and going through, but yet there are still people quite interested in high-yield total return bond fund, et cetera. As Ray was saying, the ultrashort funds are a seasonal long cash type investment by the certain individuals and it is the flip side of what happens on the money market separate accounts where they gain on the other side of that. Those would be my comments.

Okay. Thank you.

Our next question is from the line of Craig Siegenthaler from Credit Suisse Group.

Thanks. In you prepared remarks I heard you reiterate the 10 basis point, 40% fee waiver guidance, but I didn't hear the 25 basis point, 65% guidance from last call. Has your view here at all changed?

It was the same guidance, Craig. There were no change there.

Got it. This may be new or may not be. I heard your comments on the swell in government money market AUM and the spread between T bills and reverse repos and fed funds. Wouldn't that actually impact your guidance as the spread could widen with short-term rates increasing?

We put in the numbers and if the -- we put in 9 to 12 basis points on mortgage backs and 2 to 10 basis points on the T bills, which were 3 to 6 months. If those go up, it will be better.

I think what you want to think about here is that the bulk of the waiver recovery happens pretty quickly, and so what Debbie is talking about longer-term trends out into 2016 and 2017 and spreads widening and then coming back, our expectation will be that we will have been past, certainly, the first 10 basis points, 25 basis points or more by then, so the vast majority of the waivers will not be a factor at that point.

If I look at the margin on the fee waiver, it's about 31% today, but if I look at the improvement over last year, the incremental margin on the improvement in revenue was much lower at 23%. Do you know why this was? Was it maybe mix shift or was there some maybe early fee concessions there with the intermediaries? I'm just wondering what drove that?

We've said that the recovery is not linear and each product has a different profile. That would be a difficult analysis to go through here, but that would be something I would be happy to talk to you about offline.

Got it. And just one quick last question. How were flows tracking quarter to day? Could you actually give us a number or a rough feel? Maybe I missed that earlier in the call.

Yes, we did. We are very, very happy with equity flows at this point in the second quarter. I'm trying to see -- what I said was they were solidly positive in the second quarter, and it's over $100 million through April 17. And it's basically the same -- mostly the same strategies that were leading the pack in Q1. Then, on the fixed income side to repeat, they were negative, primarily driven by that ultrashort discussion we just had.

Got it. And combined, do we know if it's positive or negative?

Combined the fixed income is more negative than the equity, again with the -- we're looking at numbers through April 17, so we're at the peak of the tax impact.

Great. Thanks, guys, for taking my questions.

Our next question is from the line of Michael Carrier with Bank of America Merrill Lynch.

Thanks, guys. Just two quick ones.

First, when you guys give the what you can recoup in the waivers, like the 75%, I think we are all doing the math on are the new products going to have similar fees and what will shift from prime to, say, government and obviously a lot of that is in motion and we'll find out over the next year or so. But in terms of the conversations with clients on fees on the current pricing, has most of that taken place? So you're pretty good with that 75% ex some big shift happening in the types of assets or other competitive pressures?

We're pretty comfortable with that. We've run through it on two calls now, so we've had two big chances to decant it and that's where we are.

Okay. All right, that's good. On the equity side of the business, I think you mentioned in terms of where your flows or in the organic growth relative to the industry, things are really strong. You have done a lot on the distribution side over the past couple of years in terms of expanding that. Do you see more that can be done? When you look at the different channels and how you're stacking up to some of the competition given the demand that you're seeing in the products, is there more in the pipeline? Or do you feel like a lot of those investments on the distribution side are in place and we're seeing the benefits now?

I think that as some of those salespeople that were added mature, you're going to see more growth coming out of them as they move up to the accomplishments which we had planned. What we've seen, just recently quarter to quarter, is basically an increase in a thousand of financial advisors, FAs, doing business with us so that you're beginning to see that.

I think there are also expansions available not just in who we do business with but going from one product to two products to three products. It's not unlike same-store sales. You can see plenty of room for growth there, as well.

Now, we have taken the sales force up to where it's now about 211 people, and we don't have any a current time to add dramatically to that. We recently added, as I've mentioned on previous calls, an individual for Latin America. We did add the people in -- two individuals in Canada, and we've seen very good growth in Canada where the assets are now about $1.5 billion and at, say, in the end of 2013 they were a little over $1 billion and in 2012 they were at about $600 million. So we're looking for some pretty good growth there, which is why we're putting that new fund together.

That's what I view. We don't have any big plans on a whole lot of new salespeople to add at this point.

Okay. Thanks a lot.

Our next question is from the line of Jonathan Casteleyn with Hedgeye Risk Management.

I just wanted to zoom out for a second, and just assuming that your fee waivers burn off and obviously you adjust your comp higher over time, what do you think normalized operating margins are for the business, say, 12 months plus out?

Adjust the comp up. Remember, it's not going to be a sales incentive comp change. It's not going to be investment management, so it's not really a big adjustment that we're talking about. In terms of the margin, the way that I'd look at that is what's the -- do the margin on the little chart that we give in the press release and so it will help the margin.

I was thinking, what are your operating margin targets for a fully loaded Federated? Can you get to 30%, 35%? I'm just curious as to longer term what do you think the margin opportunity is?

The industry is certainly higher than 30%. Why shouldn't we have an industry-like margin? We've been -- it's been difficult with the waiver situation to maintain that, but we certainly ought to have a higher margin. The growth in the equity ought to carry the day there when things return to normal on interest rates.

Okay. Then some of the money center banks have been talking about non-core deposits being de-emphasized. They're taking off regulatory charges over time. JPMorgan put out a $100 billion number as far as a non-core deposit deemphasis, and they have about 10% market share. That would gross up to about $1 trillion opportunity. Is that pool of money an opportunity for money funds, as you see it? If so, how are you preparing for it?

Yes, it is. In fact, I have made the comment at various times that I felt the reason that the fed wanted to deal with money funds first before they dealt with their LCR rules was because they knew that the money funds would be a very worthy home for some of this money. And so, yes, it is. As I mentioned earlier in some of the responses to questions, some of the meetings we've had with some of the larger clients have been on exactly this issue, so now it becomes a question as to when that money is moved out. That's based on each individual client and each individual bank as they look at the timing and their relationship with each of those client and the extent to which they want to deal with them. That's all based on their time.

I can't comment on how you got to the trillion dollars. I think it's big in terms of an opportunity, but don't forget that those banks are going to be doing everything they can to somehow keep that money in the family in some way, meaning their own family, that doesn't negatively impact their capital, their ratios or how they run their business. So they're going to want to try to keep it, and they already have it.

But, on the other hand, that's why they're talking to us because we're a warm and loving home. I can't put a number on what we'll get, but there is a substantial opportunity. That's why I said, at one point, that I believe in the post-2016 environment, you will see up assets in money funds at Federated.

Understood. Thanks. Lastly for Debbie, everyone seems to be a fed head in analyzing dots, et cetera. I'm just curious because you deal in the short-term rate environment every day as to what you think participants are baking in as far as timing from the fed, i.e. when do you think the first move will come as expressed by market participants that you deal with every day?

We're in the fall camp, the September/October timeframe from an FOMC meeting standpoint. That's pretty much in agreement with what we have seen in the marketplace generally, with fed fund futures, treasury futures, that sort of thing. If you look, though, over the last quarter and really year to date over 2015, we've already gained 8 basis points in steepness essentially from overnights out to a year. What that means is, we're seeing higher yields already in anticipation. And 8 basis points is not a move, but it's a third of the move. Yes, it is from the 12 months part of the curve, but the six-month part was up 5 basis points and the shorter up, up a little bit less.

I sometimes gauge these things and what the market is expecting by what's happening from our trading room personnel, and essentially they're smiling at this point, because every additional dollar that they get to invest, every additional maturity that they have that needs to be reinvested, they're putting it to work in a marketplace take gives them a positive benefit over what just was maturing off in the portfolio. So they're adding value.

They're increasing yields as they do their daily business of keeping these funds 100% invested. Even though the fed is delayed, and our initial thought six months ago would have been that in June was when we would have seen the first lift-off, we're still at least seeing the expectation of it positively accrued to the yields of the funds at this point.

Great. Thanks for your time. Appreciate it.

Thank you. At this time I will turn the floor back to Mr. Ray Hanley for closing comments.

That concludes our call. We thank you for joining us today.

Thank you. You may disconnect your lines at this time, and we thank you for your participation today.