Federated Hermes, Inc. (FHI) Q2 2012 Earnings Report, Transcript and Summary

Ray Hanley - Analyst John Christopher Donahue - Chief Executive Officer, President and Director Thomas Robert Donahue - Chief Financial Officer, Vice president, Treasurer, President of FII Holdings Inc and President of Federated Investors Management Company Deborah A. Cunningham - Chief Investment Officer of Taxable Money Markets, Senior Vice President and Senior Portfolio Manager

Kenneth B. Worthington - JP Morgan Chase & Co, Research Division James Howley Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division William R. Katz - Citigroup Inc, Research Division Cynthia Mayer - BofA Merrill Lynch, Research Division Matthew Kelley - Morgan Stanley, Research Division Bulent S. Ozcan - RBC Capital Markets, LLC, Research Division Greggory Warren - Morningstar Inc., Research Division Marc S. Irizarry - Goldman Sachs Group Inc., Research Division Roger A. Freeman - Barclays Capital, Research Division Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division Edwin G. Groshans - Height Analytics, LLC

Greetings, and welcome to the Federated Investors Management Company Second Quarter 2012 Analyst Call and Webcast. [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 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 form, they have drawn extensive negative reaction and commentary from money fund investors, issuers, businesses, state and local municipal finance authorities, various members of Congress, U.S. 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…

Thank you, Chris. Taking a look at, first, at the money fund fee waivers. The impact to pre-tax 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 increase 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 asset 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 fees 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. Debbie?

Yes, yes. Can you hear me okay? From a rate perspective, we've seen continued steadiness, let's say, in U.S. rates. Repo has remained for the most part right around the mid-teens. 1 to 6 months 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. So the curve has steepened [indiscernible] with shortest rates cut slightly tighter and longest rates slightly wider. Treasury builds around 8 basis points at 3 months, and 13 basis points at 6 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 U.S. is slowing to some degree and has been a little bit less robust from a growth perspective than certainly what we saw the end of 2011 that any tightening from the FOMC won't occur until a bit later in 2013. We still are not in agreement with the 2014 prediction, the end of 2014 prediction from Chairman Bernanke and if you look at the information that has come out of the FOMC minutes with regards to who thinks rates will what raise, to what level out at that, what time? It certainly doesn't seem like there is unanimity anonymity in any form of across the various members of the FOMC either, but we do think that economic growth slow down there we've experienced thus far in 2012 will impact that and take any kind of initial rate rises later in the 2013 time frame. 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. U.S. earnings, for the most part, have come through a very positive pace and 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 regards to rating agencies in their continued barrage of downgrades and negative outlooks and credit wash negatives for the various financial institutions that are a part of the U.S. money markets. In fact, that also has had very little, if any, impact on the fund and certainly on the money markets in general. A positive impact has been an actual overall pickup in the amount of commercial paper available so a little bit more supply in that area and I'll close with the Operation Twist continuing to be a mild-positive with [indiscernible] supply in the Treasury sector for our government-only fund.

Okay, Debbie, thank you, and we'd like to open up the call for questions now.

[Operator Instructions] Our first question is from Ken Worthington with JPMorgan. Kenneth B. Worthington - JP Morgan Chase & Co, Research Division: 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? Like how does that flow through to your businesses? And then I guess, equally as important, like what are your views? Is this something that you view as probable, neutral, unlikely?

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 into consideration. So 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 Q above that. Having said that, we're certainly sort of watching might happen in the U.S. money markets play out currently in the euro-denominated money markets, now, granted that is a much smaller sector. And it's playing out mostly in the context of the euro government funds whereby, so the ECB lowered their rate to 0, their deposit rate to 0. And as such, banks are funding themselves right around the 0 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 would, although, I don't think the market's actually buying negative rates from the banks in the euro marketplace at this point. And that does have to do with their operational costs that are associated even with having those outstanding deposits. And certainly, when you look at, then the spread for sovereign financing, short-term sovereign financing, the European sovereigns that are funding themselves in euros are posting also negative rates. So presumably that same sort of situation would occur if, in fact, the IOER went to 0, 0 here in the U.S. What I think that will happen and again what I think will continue to be…

The way we look at this is that we do not have the luxury of trying to decide or game which side will win the election because the regulatory plans are pretty harmful to money market funds as I've said many times. So therefore, we really can't try to game the thing, "Oh, who's going to win? Who's going to lose?" And then, "Therefore, this. Therefore, that." And besides you're getting a lot of speculations. So we are going to focus hard on repeating the sounding joy of the good public policy associated with money funds. Now 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 and 56 million people have the money funds. And I don't think they're going to be happy with holdbacks and even if they're only a $50,000-investor. And therefore, that's going to be an odd kind of a 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 until today over what they would have gotten in a bank, and 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, but I can't control that and I don't know how all the regulators view that kind of a position. But that's a one comment I'd make on the politics of it. Kenneth B. Worthington - JP Morgan Chase & Co, Research Division: Maybe let me rephrase it. If Romney, the Romney administration wins, is it -- does money market fund reform kind of wither and die and 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?

Well there could be tactical changes 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 4 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 out of existence. So 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 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.

Our next question comes from the line of Michael Kim with 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 businesses quarter, as well as kind of the outlook or the pipeline going forward? And then any color on the SMA business, particularly as it relates to strategic value and MDT, I think 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. So 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 a 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 asset allocation decisions moving money around. But that's what was happening beneath the reported numbers on the fixed income side. And just generally, 4 SMAs that continues to be dominated by the strategic value dividend strategy. Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division: Okay great. And then just circling back to kind of acquisitions. I know you guys have been pretty active on the roll upfront for money market funds, as well as couple of the equity and fixed income deals you've done. So just wondering how prominent you continue to see that be for a source of growth going forward? And then how would you characterize the opportunity set as maybe look at some of these international embedded asset manager properties that are reported being shopped? So just kind of trying to get a level of interest there?

We'll handle each one separately. In terms of the roll-up opportunities in the U.S. for money fund assets and other assets as well, they are what we call "lumpy sales." And it's really hard to project them and it's really hard to build any kind of steady state thing where we say we expect this many to happen. They just come in -- 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. And so it's pretty hard to predict the timeline on these things, and a similar kind of 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 fund purveyors, there are maybe about 95 on the list. Maybe the lowest bottom 5 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. Now on the international side, we look at every deal that we can get our hands on, 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. So this is not a deal where, "Oh, you strike an arrangement, spread some pixie dust around the marketplace, declare a victory and move on." We got to live with these things, make them grow and make them work. And that's what takes the time. And a lot of the big deals embedded in other companies require a lot of and analysis and a lot of analysis on these issues of culture. So we continue to look for good cultural fits and develop footprints internationally. And I know that 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.

Our next question comes from the line of Bill Katz with Citigroup.

I missed the first 2 minutes of your prepared remarks. You may have covered this in doing so, but I joined just as you were talking at the tail end of your discussion around the regulatory form and it seemed that you still sort of sighting some onerous changes, if you will. So the question is we heard from Schwab that they suggested that redemption restrictions might be illegal in certain states and doesn't seem like the regulators are sort of contemplated that aspect. And 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 of flowing rates. So just given that all as a very long winded preamble to the question is, at the margin, are you more or less comfortable with sort of the regulatory drift that you're hearing most recently?

Oh, comfort is certainly not the attitude that I would have on it because the regulatory offers -- our position is pretty well dug in. So I agree with the points that you've made and we also, along before Schwab got into this file, the 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, in a state law structure and in an investment company structure. And they are all very troublesome and have not been outlined as to how you solve those challenges. So we just continue to fight on. It's really hard for us to try and make predictions about how SEC commissioners will vote and we remain confident that the proper public policy and good public policies will win out, which means that money market funds will continue. And 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. So 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 and answered an earlier question, it seems like it is our career to continue to fight for the survival of money funds.

Okay. When you -- just couple of 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 sort of the net accretion might be at the full run rate basis to earnings?

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

Okay. And just the last question on the billion dollar transfer from the mutual fund to the separate and managed account, is there any other sort of backlog to be thinking about that this could be more than sort of a one-off trend and maybe you could quantify the impacts?

No, it serves economic impact. Again, it's a client account. So I mean, 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 the particular needs of the client, they switched from a separate account to a fund. And so, no, these are one-offs that are particular to individual circumstances.

Our next question comes from the line of Cynthia Mayer with Bank of America Merrill Lynch.

Couple of questions. It looked like you were able to pass a little bit more of the fee waiver along in distribution this quarter. And again is that just a function of the asset mix?

Yes. That rate that you're referring to, is a portion of the waivers that are effectively born by the distributors through lower distribution expensed the Federated has ranged from a number in the low 70%, 71% to about as high as maybe 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. And so it's not something we're actively managing. It's really a question of where the assets fall.

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

Implicit in the waiver flat is not taking more or less a snapshot of the business and then just doing the math to run numbers out. So, 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.

Well, and Cynthia the one thing we do in there is talk to Debbie and her team about their expectation on rates. So that's not flat, although, it actually ends up being flat, but that's their view.

Okay. And then 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? I mean, are there some that you -- 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. And it's hard to gauge as to which ones are worst, 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. And so are they going to say they're under $50,000 and therefore, they're not subordinated? Or 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 holdback doesn't exist. And so you have to revamp all the systems. Are they going to revamp all the systems, and once again, with all the omnibus accounts, how is it going to work? You have the same kind of challenges. And if you take regular institutional clients like corporations, take a corporation that is 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. And 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. So it's just another form of doing what the Fed said they were going to do back in July of 2010, which is regulate the money funds out of existence.

Okay. And then just on the Ultrashort and short-term bonds flows as they're 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 it's sort of the same pattern as last year?

Well, 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. So we're not like the big retail shop, where you can see the flows and the exchanges going back and forth. And I'll let Ray handle how it compares to last year.

Generally, Cynthia, the flows have picked up in Ultrashort. The gross sales in terms of -- on a monthly average basis we're 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. So I think it is a reasonable conclusion that given the yield situation for money funds for investors who feel comfortable going out of it on the curve, they can pick up decent incremental yield in the Ultrashort 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 of quarters.

Okay. And just maybe just a last question. This comp rate, is this a good run rate?

Yes. It's a good run rate, but every quarter -- how's performance and what are sales, and it could change.

Our next question comes from the line of Matt Kelley with Morgan Stanley.

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

Well, 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 what 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 Ultrashort products, you look at products inside Ultrashort and outside 2a-7, and you begin to look at things that perhaps haven't even been discussed yet, which is what I said in my remarks. So 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, and none of them restore the tax-free nature of the tax-free funds for municipalities. And so you don't end up with as a strong diversification as much efficiency or as good a home for money funds. And on the issuer side, you basically make the whole issuer side a lot more complicated, and 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 are to regulate how much they do in short-term financing and where they do it, how many funds, what percent of their book, et cetera, rather than shoot the money funds so that they can't do it. So that's about as much I can give you on the client base. I think that there are only real -- for a lot of them, their only option is going to be to put money into the bigger banks and the reason I say that is because when they did the unlimited interest, I mean, the unlimited deposit for 0 interest, 75% of the money went into the top 10 banks. And that's about as good a reference point is I would have as to where the money would a lot of the money would go what enabled to fit in to some of these other buckets that I'm talking about.

Okay, that's helpful. And then just one follow-up for 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 base on potential outcomes on the reform?

For number of years, we took out over $400 million loan and maintained our $200 million revolver. Now, we've paid that loan down on the last couple of years, but we still have base. And when took down the loan, we kept a lot of the money here, use it for seed and investment in other products and so paid a bunch of it down. And remember I mentioned our net debt there is only around $15 million of the end of the quarter and then we have that $200 million revolver. So 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.

Our next question comes from the line of Bulent Ozcan with RBC Capital Markets.

Had a quick question. We talked 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 with industry have at that point to fight any regulatory push?

Well, 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. So in the hypothetical you're talking about, the SEC votes 2 to 3 and the regs don't get put out by the SEC, they flop it over into FSOC, now what happens? And FSOC has approved a 3 prong test of Phase 1, Phase 2, Phase 3, 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 FSOC -- of Dodd-Frank, it's written in terms of 10 criteria to be met or examined, and then that was codified into 6 features by the regulators. And so 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. So 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, 2 funds or whether it's all funds or the whole industry, and that's another level of difficulty. So there are 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. And then quick question on the M&A. I'm sure you're looking at different options, evaluating various deals. What do you see in terms of pricing in the market? Are you comfortable? The question is, what are sellers asking and what are bidders bidding?

Well, I'm not -- investment bankers know better that answer. I can give you answer to how we look at it that 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'd 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, then, so fine. But maybe Tom would give you more color on the pricing than I have.

Well, 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 purchased like that, that we want the team to continue and so there's continuing interest in them. And so since we're going to continue and have continuing interest, why aren't they being paid over time for what we acquire? And many times our discussion with them is you can probably make more, over time, if we are able to grow it together, then you could just on some upfront payment. And so then you get a different look at it that way and it satisfies a lot of our cultural thought-process that they fit in with us, especially if there's still working with us.

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

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

Our next question comes from the line of Greggory Warren with MorningStar.

Basically, I wanted to step away from money market reform for a 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 AOM and you've gotten pretty close here, you're about $82 million right now. Do you think that, that target needs to be higher in an environment where potentially reform is out there and you had to potentially keep buffers on the books in order to continue running the money market side of the business? Is there something you can generate internally? Or is this something you need to go for acquisitions on?

Well, first of all, yes. The targets -- once we got the $90 million, which we've announced in the press release, because all we do is we add, for the purpose of getting the $90 million, the liquidation account, which you probably aren't including in your $82 million. So we're cool with that. But once you get the $90 million, a $100 million is hardly the next goal at all. And so we are internally, for now, okay, what are we going to say? If you look at it and say, we want to double in 5 years, you would get pretty much where we would come out once we do our internal stuff, but we haven't done it yet on that. The goals would be much higher and they really don't have anything to do with all of the stuff on money funds. They had to do with the strength of the mandates, the strength of the distribution and that's what it has to do with. And yes, we think we can do that kind of growth organically. You look at our charts on growth 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 see a lot of flexibility into being able to respond and these are the things that give us confidence that we can grow these things organically. Now you can have a debate about whether say the Trustmark thing is an 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. So 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. And I guess maybe just a follow-up too on that is if in a world where reforms do happen, you got to think a lot of people will be coming out of the business, looking at the cost benefit from running the funds, and we've seen that over the last 5 years already. Would you believe -- you'll continue to be a consolidator in this industry? Do you think that will be in the best interest for you guys? Or do you think it will be something where maybe just building out the equity and fixed income makes more sense?

Now we would continue -- I assume you're asking about the consolidation in the money fund side. We would continue to be positive towards doing the consolidation on the money market fund side, because we believe in the beauty and efficacy of the money fund as a good public policy and as a good business. So that's why I went through the market share percentages with you at the beginning of the call and when you take the market share from 5% to 9%, over a little more than a decade, it shows a commitment to this business. And 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 $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. And that's what gives us a lot of confidence in doing it. And yes, reforms happen. In fact, since 1982, many reforms have happened in terms of money funds and reforms happened in 2010, which did strengthen the funds and enabled them to get through with flying colors the changes in the marketplace that occurred in 2011. So our goal is to simply go with those changes and avoid killing the funds, which some of the regulators seem to want to do.

Our next question comes from the line of Mark Irizzary with Goldman Sachs.

Just when I look through the P&L, looks like that -- maybe some of the other expenses, that you're seeing some operating de-leverage there? Can you just may be to help me understand when you go forward like maybe some of the G&A, if you will, what the outlook is there? And then also as the fee waivers roll off, are you thinking we should sort of reinvest those P&L dollars and growing the nonmoney-fund business? Or how should we think about that?

Well, okay, to go through the P&L, I mean, we don't have -- I mean we're going to continue to invest in technology and we're doing that the best we can. We've kind of maintained on a year-over-year basis the advertising and promotional level. The T&E probably will pick up because of the new salespeople that we put into position and still have a few more to hire. The professional service fee, that moves based on things that I'm not sure we can exactly predict. And then we're 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. Gordy Ceresino, on the international side, is going around looking at deals and what we can do there. So would we invest there? Yes. I don't know if anybody has anything else to...

Our next question comes from the line of Roger Freeman with Barclays Capital.

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

I make no such assumption. As I've said in response to 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.

No, I'm not making the assumption. I just found it -- that might that was as such, but thanks for clarifying. Then the second question is, just as Schwab did business update the other day, essentially as I have kind of read through their comments, my take was: they think you may ultimately get is these rules impacting usually Prime funds, credit exposed funds and that users of the product with have to just decide. If they want money market products, they would go to government, the government back funds. And otherwise, going credit, you can find other products and then I'm just wondering your customer base a bit different in terms of the institutional fees and corporate. And how much would just go to government back funds and essentially too, what could sort of 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 were over the guaranteed limits?

Well, going kind of 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 apartments; like broker-dealers, like individuals; and on the issuer side, smaller municipalities all over the country who right now gain the advantage of having Federated and 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. So that's one pretty definitive harm. Now if you hypothesize something, which we do not, where you eliminate the Prime funds, which are $1.6-or-so trillion out of the whole market, then you've got a deal with what you're going to do with the issuers and where are the people going to go for the money. And 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 a 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. And just because at some points, 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 other corporations CVS, Boeing and the like have said that they are not in favor of these kinds of regulatory changes.

Got it. I know you raise good points on issuers and there's clearly impact on that. Okay.

Our next question comes from the line of Robert Lee to you Keefe, Bruyette, & Woods. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: And I apologize if this was asked and answered earlier. I got on the call a little late, but I just want to follow up on the announced to win of the Massachusetts account, I guess, the $9 billion account. I know, I guess, it's similar to the State of Florida and Texas that you've done for bunch of years. But can you maybe just update us on that marketplace. I know those things come up for bid periodically, but are you seeing -- are there other -- is there any kind of change in the landscape like more of those coming up for potential bid over the last couple of years and kind of when you competed for it, besides the incumbent kind of what's the competitive landscape?

Well the competitive landscape is very strong. We competed for the Massachusetts deal, I think, at least 4 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. And -- but we have a good team of people who are calling on the state organizations 100% of the time. I personally spoke at the National Association of State Treasurers earlier this year in Washington, so 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. And these are the key elements that we've brought to the table in Texas and then Florida and now in Massachusetts and would expect to do elsewhere as well. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: All right, great. And maybe one follow-up question on the equity sub-account business. I know you've had 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[ph] advice platforms? Are you seeing traction in 401K 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, so 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 fine in receptivity across channels and in multiple applications. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: Is there any way of getting a feel for 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, it should be kind of recurring flows from that?

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

Our final question comes from the line of Ed Groshans with Height Analytics.

I guess I think you responded to the money market fund thing quite well. And I guess 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. And I guess 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 have mentioned the Fed and the SEC, but the FSOC is really 9 other regulators that seem to be getting onto this bandwagon. And at the meeting you actually had CFTC Chairman, Gary Gensler, highlight the work that Schapiro was doing in this area. And so I think it's -- what you're saying is 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 seems to be, now you have 9 financial regulators lining up on this issue.

Yes, the underdog role. And looking at a few of them, the CFTC -- it was either earlier this year or, yes, 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. And yes, all those people voted to put the report out. And pretty soon, we will have our response to that report. And I think the principal element 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 1 run in 40 years, that does not make susceptibility. And it's interesting that in '94, when the fund broke a $1, there was no run. There were no problems elsewhere. The reason was that there was plenty of liquidity in the system. And the problem in '08 was that as Bernanke has said, it was the worst situation since the depression and the -- 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. And so when we appeal 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 a $1 because as soon as…

Right. I know you guys have been looking at this in grave detail. I just did -- it does seem that at the end of the day, there is a push to do something. And I think when we look at the financial stability over sight council report, I think it's the first time I saw the word "possibly" attached to "redemption features" whereas prior to that, it has always been that we're going to see redemption features, and now it's possibly redemption features. So it seems like there is some movement on that side. And then the other issue then is whether you're going to -- is the push going to continue for capital or for floating NAV? And I guess I understand that you don't appreciate the funding NAV. But it does seem like maybe that 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. So trying to use those 3 things, all of which are deadly, and say, "Well we're compromise this or that one, no." It just doesn't make any sense. They all attacked the essence of what the money fund is. Daily liquidity at par with the market interest rates. So therefore, anyone of them will be devastating to the funds. And so that's how we look at it. And when you start talking about capital, well, you'll go there. And remember that the regulators as a general rules have said, we don't want these funds to be guaranteed or viewed as guaranteed and this is a problem. And if you start putting capital things on them, you will create what one commissioner calls the illusion of protection. And, this illusion will go exactly the opposite way of what the regulators say they want, and 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.

And that's all we have time for. But sure, I'll be happy to -- if you have other questions, feel free to call in. And, operator, we're then going to wrap up the call.

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