Federated Hermes, Inc. (FHI) Q2 2013 Earnings Report, Transcript and Summary

Greetings, and welcome to the Federated Investors' Third Quarter 2013 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ray Hanley, President of Federated Investors Management Company. Mr. Hanley, you may begin.

Good morning, and welcome to our second quarter results conference call. And today, leading the call will be Chris Donahue, Federated CEO and President; and Tom Donahue, Chief Financial Officer; and we also have Debbie Cunningham joining us for some remarks on the money market condition. 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 will turn it over to Chris.

Thank you, Ray, and good morning. I'll begin today with a brief review of Federated's business performance and Tom will then comment on our financial results. Looking first at cash management. Average money market fund assets were down $13 billion from Q1, and period end money fund assets decreased by $10 billion. The decrease included seasonal effects of tax payments and decreases by certain institutional investors against the backdrop of declining rates and yields over the quarter. Debbie will comment later on, on market conditions and our outlook for rates. Our market share for money funds decreased slightly in Q2 to approximately 9% from 9.2%. For historical purposes, recall that in '08, our share was about 8.5% and back in 2000, it was about 5%. The impact of yield-related fee waivers increased in the second quarter. Repo rates have been at very low level since mid-May, which of course, impacts the waivers. And Tom will comment on this in his remarks. On the regulatory front, the SEC issued its 700-page money market fund reform proposal for public comment last month. We commend the SEC for taking a thorough and thoughtful approach proper to preserving their jurisdiction for money market funds. We're working on a series of comment letters to address various aspects of the proposal. The main points of the proposal have been extensively reported, so I won't go through them. Our initial reaction to the proposal is that parts of this are workable, like gating, and would improve money funds, and other parts are unworkable, like floating the NAV, and unnecessarily detrimental to money funds with negative implications for investors, issuers and the financial market. Our core beliefs remained consistent. We continue to advocate for sound policy that enhances the resiliency of money funds for our clients, who fully understand that money funds like other investments have elements of risk. They are not interested in radical, costly and unnecessary change like floating the NAV. The floating NAV would create market inefficiencies without providing meaningful benefits. In particular, as both the Fed and the SEC has acknowledged, the floating NAV would not eliminate the idea of runs. We know that many institutional money fund users have gone on record to make it known that they cannot or will not use any floating NAV money funds due to a host of legal and/or investment policy restrictions, operational complexity and tax burdens. Tax issues remain unsolved and significant. The cost with that systems to accommodate the floating NAV would be enormous. These and other issues will cause many users to move from the product if subjected to a floating NAV. We believe that some of these money fund users will migrate from institutional funds to government agency money funds creating dislocation in that part of the market. Others will increase deposits in banks, in particular among the largest banks, making them even bigger. So others will look to separate accounts, offshore products and other less regulated and less visible alternatives. This process is unnecessary and will be very disruptive to investors and to the financial system. The cost will be significant and real. And the benefits will be minimal, if any. The impact of the floating NAV were it ultimately to be enacted on the money fund asset levels of our clients is difficult to assess. We are hopeful that a significant portion of our current $97 billion in prime money fund assets would be properly classified as retail under the proposal's definition, recognizing that the implementation of a retail exemption could be operationally difficult and involves added complexity because a large portion of our assets are held in omnibus accounts. In contrast with the floating NAV gating, that is giving the fund's Board of Directors the option of a gate on redemption in extremely rare periods of a dysfunctional market, as experienced by money funds and other participants in '08, promotes the equal treatment of investors and improves financial markets by potentially stopping a run, dead in its track. It has proven to be effective in practice, avoids costly and unnecessary disruption and most importantly, preserves the critical features and benefits of money funds for investors, issuers and the capital markets. Following the meaningful reforms enacted by the SEC in 2010 and voluntary efforts by major industry participants, which continue today, to further increase transparency by publishing daily shadow price NAV, money funds are among the safest and most transparent investment products. And will be further enhanced by adding the gating option. Radical change like floating the NAV will unnecessarily cause the demise of the institutional prime money market funds, a high-quality product that enhances our financial system on many levels. Let's turn to equities. Flows for equity mutual funds and separate accounts were positive for the second quarter, with solid results in a number of products. Combined Q2 net sales of equity funds and separate accounts was $383 million. Gross equity fund sales in the second quarter were a little over $1.9 billion. One of our best quarterly totals ever and net fund flows turned solidly positive. Our equity product line is very strong, with solid performance across a variety of products. We had 13 funds produced net positive sales in the second quarter. Some familiar faces: Strategic Value Dividend, Capital Income, International Strategic Value, Kaufmann Large, Muni Stock Advantage, Clover Small, Managed Vol, International Leaders and others. Inflows, were led by the Strategic Value Dividend Strategy to domestic and international I mentioned. We also saw solid increase in the sales of our Capital Income balance allocation fund. This fund is a very strong investment performance record and has gained sales momentum over the last several quarters. Another highlight is the Kaufmann Large Cap Fund, where sales have also increased substantially over the last couple of quarters. This fund is nearing $700 million in assets, up from $370 million at year end, with very strong performance over the 1, 3 and 5-year timeframes, this fund is positioned for substantial growth. Other fund strategies with net flows, I have already mentioned. As we mentioned in April, our second quarter flows in equity separate accounts were negatively impacted by model changes for 2 of the MDT fundamental quant strategies. And this added up to a couple of hundred million dollars in All Cap Core and Small Cap Core when combined. Our MDT strategies continue however to generate very solid investment results in the second quarter. All 7 managed account strategies outperformed the benchmark for the second quarter and the trailing 1- and 3-year periods, all 7 are ahead of benchmark since inception. We have begun to see heightened RFP interest in the MDT strategies. A comment on early Q3 flows. Actively managed equity flows are solidly positive, a hair under $60 million, led by domestic and international strategic value dividend strategy's Kaufmann Large Capital Income Fund. Equity asset inflows are also positive here in the early -- in the third quarter. In our equity index funds, we had a client redeem $220 million from the mid-cap index fund, which uses an enhanced indexing strategy and they did this due to a change in the investment process they made last year. As a result, our combined equity and SMA flows are slightly negative. Looking at equity performance at the end of the second quarter. We had 12 equity strategies in a variety of styles with top quartile 3-year records and 8 in the top quartile for 1 year. Turning now to fixed income. Federated and the industry experienced the rapid reversal in investor sentiment for bond funds in the second quarter. After generating slightly positive bonds on close in April and May, we saw net redemptions of about $1.7 billion in June. July is much calmer. Our bond fund flows are slightly negative for the first 3 weeks of the quarter. In June, investors moved out of bond funds of nearly all types, including corporates, Govies mortgage-backed, multi sector, Munis and international. High-yield funds remained positive, though at a diminished rate. We also saw enclosed into our Floating Rate funds, which is building some momentum and into other short-duration products as a reaction to higher rates on the longer part of the curve. While the industry as a whole experienced significantly higher bond fund redemptions in June, our results were particularly impacted by a change made by one of our intermediary clients, which led to an $800 million redemption from our Total Return Bond Fund. This fund has been just about or just below its category median on a 1-, 3- and 5-year basis and yet its top quartile on a 10-year basis. This fund has had a retirement-based portfolio manager change in mid-April. Its performance since then has been improving. The fund's pure ranking in the second quarter was in the top half and the fund is in the top quartile for the first 3 weeks of the third quarter. At quarter end, we had 10 Fixed Income strategies with top quartile 3-year records and 12 strategies in the top quartile on a 1-year basis. Our 3-year performance stars include Fed Bonds Fund, our High Yield products, emerging market debt products and Ultrashort Bond Funds, among others. Fixed Income separate accounts were slightly negative. New fundings were offset by a sizable redemption from a client as a result of their company being purchased and by series of smaller redemptions due to reallocations and use of cash. The disruption in the fixed income markets was a factor in some of these redemptions. Turning to overall fund performance and looking at Morningstar-rated funds, 53% of rated equity fund assets are in 4- and 5-star products as of quarter end. And 79% are in 3-, 4- and 5-star products. For Bond Funds, the comparable percentages are 45%, 4- and 5-star and 85%, 3-, 4- and 5-star. As of July 24, managed assets were approximately $364 billion, including $267 billion in money markets, $40 billion in equities, $57 billion in fixed income, which includes the liquidation portfolio. Included in these figures, of course, money market mutual fund assets stand at about $233 billion. And so far, in July, our money market fund assets have ranged between $231 billion and $236 billion, averaging where they stand at $233 billion. Looking at distribution. Equity fund to grow sales grew by 9% in the second quarter, compared to quarter 1, and increased 25%, compared to quarter 2 of 2012. We saw the strongest absolute growth in the broker/dealer channel, where we continue to leverage our investment in additional distribution capacity. We are steadily expanding the number of advisers doing business with us and growing the product set used by these advisers. But we are also considering further modest growth in sales personnel in this channel as the year proceeds. Interestingly, the number of advisers doing business with us is approximately 39,000, up from 36,000 in '11 and 29,000 in '08. In the institutional channel, at quarter end, we had about $600 million in equity and Fixed income account additions expected by year end. Roughly, $325 million in equities and $275 million in Fixed Income. Turning to our offshore business and acquisitions. We continue to develop our Asia Pac operation based in Australia. We're in the process of adding our first sales personnel, with the position planned to be Head of Sales in Hong Kong and another in Singapore. In Europe, we had our first trades booked in Q2 from our expanded distribution efforts with Bury Street. We are making progress in Germany with the LVM family of funds, which had positive flows during the quarter. We continue to actively seek alliances and acquisitions to advance our business in Asia, in Europe, as well as in the United States. Now, I will turn over to Tom to discuss our financials.

Thank you, Chris. Taking a look first at money fund fee waivers. The impact of pretax income in Q2 was $23.7 million, up from $21.7 million in the prior quarter. The increase was due mainly to lower rates for treasury and mortgage-related securities. Based on current assets, and assuming overnight repo rates for treasuries and agency securities run at 3 to 8 basis points over the quarter, the impact of minimum yield waivers to pretax income in Q3 could increase to $28 million. 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 45%, and a 25 basis point increase would reduce the impact by about 70%. It is important to note that the variables impacting waivers can and do change frequently. Revenues in Q2 decreased 2% from the prior quarter, due largely to minimum yield waivers and lower average money fund assets, partially offset by an extra day and by higher average assets for equities. Operating expenses decreased from Q1, due largely to lower distribution expense, due to higher minimum yield waivers. Comp and related was up from Q1, which included a reversal of $3 million of incentive compensation expense that was accrued in 2012, but not paid. Q2 comp and related has been estimated to be $69 million, came in at $67.9 million as incentive comp was less than expected. The Q2 effective tax rate was 37.4%. Most of the increase from Q1 was due to increased state taxes, resulting from a tax law change during the quarter. We estimate the effective going forward rate to be around 38%. Looking at our balance sheet. Cash and investments totaled $303 million at quarter end, of which about $231 million is cash available to us. Our net debt was below $75 million. We announced the 4% increase in our quarterly dividend to $0.25. Based on the performance and financial strength of Federated, it is appropriate to further reward shareholders with the first increase in our quarterly dividend since 2008. Looking forward, cash and investments combined with expected additional cash flows from operations and availability under present debt facilities provide us with significant liquidity to be able to take advantage of acquisitions, acquisition opportunities and related contingent payments, share repurchases, dividends, new product seeds and other investments, capital expenditures and debt repayments. [Audio Gap] That completes my part of the presentation, and I'd like to ask Debbie Cunningham to make a few comments on money market. Debbie?

Thanks, Tom. Just giving you some guidance from an outlook perspective about the third quarter and where we stand from a rate perspective. [Audio Gap] versus the second quarter. Right now, we are currently on a 1-month LIBOR basis right around 19 basis points. For most of the second quarter, we were at 20, so down slightly [Audio Gap] basis point similar for 3-months LIBOR currently right around 27 basis points. From the second quarter, it was right around 28. 6- and 12-months LIBOR are up a little bit more, 3 basis points lower from a 6-month LIBOR perspective and 4 basis points lower from a 12-month LIBOR standpoint. Ultimately, giving us a flatter yield curve currently than what we have been dealing with in the first half of the year. Also, detrimental so far in the third quarter as it is the second has been the overnight rate, seasonal rates, basically single digits, and most single digits have been prevalent in the third quarter so far as opposed to what were higher single digits to lower double digits for a portion of the second quarter. Our expectation would be, however, that this improved for a couple different reasons in the third quarter as we enter into the mid-August timeframe. Number one would be from a supply and demand perspective, we expect that the Treasury will need some additional financing and we'll do so in the form of cash management, though, which will essentially bring a little more supply into the marketplace, and as such, improve rates in that process. Secondly, with regard to quantitative leasing, the $85 billion that is currently being purchased on a monthly basis by the New York Fed out of the marketplace in both Treasury and agency, and agency mortgage-backed securities, we do believe will be announced to be cut back or tapered in the context of the market terminology beginning at the September FOMC meeting. We think that will be done sequentially, probably somewhere in the neighborhood of $15 billion to $20 billion cutbacks from us. But, again, that additional supply in back in the marketplace as opposed to being held on the support of the New York Fed, that should really improve their process for a very short-term and overnight rate. We also think that, although Bernanke has been very stressful in telling us that the tapering of quantitative easing is still in an easing process, it's just less than the formal easing. We do think that the market will interpret that to some degree, and as a beginning of an ongoing process, which ultimately should have an impact that can even out the deal curve again, into the second half or the end of 2013, beginning of 2014.

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

[Operator Instructions] Our first question today is coming from Bill Katz from Citigroup.

[indiscernible] A ton of question for you. You mentioned that fee rate were in the single digit-basis-point here, would be about $28 million. How sensitive is it to Debbie's forecast to the extent that rates would move up into August, how quickly could that reset? And then before that question is, prepositive short [indiscernible] rates are actually higher from here and the $28 million were to go away, hard to do believe right now, but could you we envision that, that would drop to the bottom line? Or is there some back-up investments that are needed against that?

Okay, the first part, Will, we have -- we're basically using Debbie's forecast for this quarter. So while we're saying 3 days, the first part of the quarter and the end part of the quarter, that's what we're averaging. So $28 million is our forecast. The second part, do we expect that to fall to the bottom line if it goes away? Is that what your question was?

Yes.

If rates go up, do we expect that fall to the bottom line? So, of course, we have the distribution expenses that when our revenues go up, our distribution expenses will go up. And other than that, we'd have slight changes to our -- depending on how much it went away, would have slight changes to incentive comp as overall, if the company does better, we face a little bit higher incentive comp. But, fundamentally, the major portion of it would go to the bottom line.

And Bill, on the other thing you mentioned, there is no backed-up investments spend?

Okay, and the second question is, Chris, as you've gone through this SEC document, it's a bit luminous. Any sense on the timeline when we might start to get any further public comments or any extension just given now the IRS will sort of comment with their own proposals on that rule as well?

On the timeline, Bill, overall, as it's currently listed that the comment period will go until about September 17. That, of course, could be extended. There have already been I think 60 or 70 comments filed. We expect there will be thousands of comments filed. And as I mentioned, we are working on various topics to file comments. The SEC on the timeline will have to go through those comments and spend a bunch of time on that. And we would expect therefore it would be very, very difficult for them to conclude anything before the turn of the calendar to 2014. So I don't expect the SEC to make intervening comments regardless of what the IRS has done on the Wash-Sale rules. And although the Wash-Sale rule thing is nice, if they -- as I mentioned in my comments, if they persist with their notion of the variable NAV, that hasn't solved the problem because the problem has to do with the compiling of capital gains and losses of miniscule amounts on every money market fund trade and the information we have from before was that, that would be requiring a statutory move on the IRS, which has to do with congress tax law and things like that, which would be highly problematic. And I don't have a timeline for that.

The only thing I would add to that was in the context of the proposals as they stand today, alternative one should it be enacted, which would be the floating NAV for institutional funds, which we don't take lightly but if it were to be enacted that would be at least a 2-year timeframe from an implementation perspective. Alternative 2, which will be the gating and seed idea, which is one that we are supportive of, that would be 1-year transition time period and then the other ideas that they have put forward on a proposal basis, to strengthen some of the other types of diversification, fresh taxing and the merger requirements would be somewhere in the neighborhood of about 9 months.

And so just last one for me, inside the money markets today. You mentioned that the vast majority of your institutional prime might [indiscernible] to this retail designation. How comfortable are you with that notion now that you've been to the document relative to maybe some of the nuances of the categorizations?

Okay, let's tear into the numbers a little bit, Bill, and you'll see how we get to where we come out. So we're right now, we're at $97 billion in Prime, $12 billion of that is from offshore products, okay? So that's not subject to the SEC, so that's over on the side. Another $5 billion is our leftover historical direct retail, along with our internal use of Prime funds, where one fund is used in another fund. So that's not an issue. Then we have $25 billion of the $97 billion that comes from broker/dealer sweep accounts, where usually the underlying customers tend to be retail as defined. And retail, as defined currently in the proposal is, they don't want to receive -- redeem more than $1 million a day. And so we think that, that would probably be okay. Then we have $8 billion that comes from our institutional cash market, which tends to be large corporate customers who could not meet $1 million day-type redemption. Okay. So then we have 2 other categories. We have $32 billion in Trust and Wealth Management, which is our bank trust business is basically. And another $15 billion in our capital markets. So this $47 billion, all these clients, more or less, have come in through omnibus accounts and they are very difficult to characterize. We do know from incidental comments with some clients who are on their own going to comment in this success, and some of them is, the $1 million isn't going to work for them and others say that, most of the time it works but sometimes, it doesn't. And so they might be thinking about different numbers. So it's very difficult for us to characterize that $47 billion because we don't see behind the curtain as to what their redemption profile is.

The next question is coming from Michael Kim from Sandler O'Neill. Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division: First question. Just in terms of the institutional channel. Curious if you're seeing any signs of maybe some shifts in allocation trends or pickup in rebalancing? And then related to that, can you just give us an update on the pipeline and where you stand maybe versus last quarter?

Sure, Michael. On the institutional side, we have certainly seen a step-up in the equity activity. And so from an RFP standpoint, we had more than twice as many in the second quarter than we did in the first quarter. And it would be running at about a 50% higher rate based on Q2 than what we saw a year ago. So we're certainly seeing heightened interest in equities in a variety of strategies. The Clover, we mentioned the Clover small cap. We did mention our $600 million yet to be funded, which is about $325 million of equity, and a big piece of that is in the Clover Small cap value area. That continues to show up in a lot of RFPs. The Strategic Value Dividend Strategy is probably the next one I've mentioned. And then some interest in our tail risk and managed volatility type of strategies. And we mentioned MDT. We're getting several RFP requests, and the performance there has been outstanding. So we have seen a shift to equities in the institutional channel both from an RFP standpoint and from a pipeline standpoint. Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division: Okay, that's helpful. And then maybe can you give us an update on what you're seeing in the M&A markets in terms of opportunities, competition, pricing trends, what have you, particularly in light of sort of the recent step-up in market volatility?

Uptick in market volatility never really seems to be a big factor with us, Michael. The people who we're trying to do transactions with have to fit in with us culturally. And on the sites where we're getting centers of excellence, we're interested in the people staying here and having a long-term view. So they aren't usually going by, drawn or controlled by something happening in the marketplace and there's more volatility here or there. On the roll-ups, that does work only when it's time to get out of the business and if you do see some uptick in volatility there. But on the -- I'd say we have more activity going on as we focused on the Asia Pac and in Europe, and we've got lots of meetings and it's taking us significant amount of time to develop relationships over there, spending time. And actually with our team in Australia, people down there with Craig Bingham and his contacts, we're developing and starting to have some pretty decent discussions. And the same thing in Europe, we've met people for 2 to 3 years now and are -- and can see our way to having pretty decent discussions. And that's what I have to say about that. Michael S. Kim - Sandler O'Neill + Partners, L.P., Research Division: Okay. Maybe just one more for you, Tom. In terms of the adjustment and the bonus accrual in the second quarter, can you quantify that? And then any color in terms of how you're thinking about your comp line as you look out to the back half of the year?

Yes, we thought we were going to have 69, and we basically had 68. So if you -- the way the bonuses work, we have to accrue what we think it's going to be for the full year. So that if we were about $1 million off, that means that we had, since it's half year, it means we had $2 million less for the whole year than we thought we were going to have. And in terms of our run rate into the future, it's -- for the next quarter, we would expect it to be in the $68 million range.

Our next question is coming from Robert Lee from KBW. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: I apologize I got on a little late, so maybe you did touch on this. But can you maybe just -- I think, Chris, you have mentioned -- well, you did mention this. You talked about the outflows from the, I guess, lower return [ph] products and you're changing management. Should we be expecting that with the change due to retirement, that there -- are you aware that there could be some other flows related -- outflows related to that? Or you're not concerned about that at this point?

Well, at this point, we're not aware of any other big lumps like that coming out. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: Okay. And maybe looking at -- and this goes for both the fixed income and the equity business on the funds side. I mean, you guys have always kind of run with higher redemption rates, particularly both for those product lines, at least positive for the industry. And I understand that's somewhat driven by distribution and probably a decent portion of short duration products. But as you look out, is there anything -- is there anything, as you think about just kind of running the business that you think could cause that to demonstrate via -- I'm thinking about this over time. The kind of moderate, maybe shifting the distribution patterns or anything related to the shifting product mix? Does it require you kind of produce a lot of growth sales every quarter just to kind of stay in place?

Well, there is a lot of Red Queen involved in the mutual fund industry, in general, and in this product, in particular, as you have noted. By Red Queen, I mean, you have to run twice as fast just to stay in one place. And what we've seen even with the turnover that occurred in June from what was going on in April and May, there's still a lot of interest in these types of products as standard issues inside our client base. So, even though it was on top of the pipe, on the chart so to speak, you're getting increased volatility. The core demand for the product remains strong. And Don Allen Bergeder [ph] and his team have done an excellent job in these kinds of circumstances. And the watch word that this fund has had with its clients has been consistency over time. And that's why I mentioned the 10-year record because that's what this fund is all about. So with that, I don't think we're going to see the kinds of fundamental changes that you're talking about. Ray?

Rob, to your point on the fixed income side, I think you would look at the shorter duration products, which are a significant part of our product set. And so we would have higher than industry redemptions there. However, on the equity side, I think our redemption rate this quarter, if you annualize, it would be something in the 24% range, I think. And I think that's probably a bit more consistent with the industry. Robert Lee - Keefe, Bruyette, & Woods, Inc., Research Division: Okay, great. And just one last question. I'm just curious. As you look to broaden -- expand in the Asia Pac, can you maybe update us on just what do you kind of think of as your kind of lead strategy that hope you kind of get in maybe just a bit on the running and probably gain some new traction quicker, if there's a couple of specific ones and maybe even some new ones you have there designed specifically for that market?

It has to be answered in 2 parts, Rob. One is, as Tom mentioned, that we're having some discussions and interesting things and have done some [indiscernible], that there -- that one of the things we have in mind is doing acquisition of some investment managers that already have product out there. So that would be one thing. And I'm not going to characterize it because then that gets you too close to who we might be talking to. Then, internally, what we have looked at is our high-yield, our Total Return Bond Fund, our emerging market debt as kind of the triumvirate of lead type products. And there are couple of others that we think would work as well.

Yes, I would throw in to that the dividend strategy, the Strategic Value Dividend, as one that we've had some indications of interest in as we've done our due diligence in those areas.

Our next question is coming from Cynthia Mayer from Bank of America Merrill Lynch.

So maybe just circling back to the math that you were doing on the money market funds, which might qualify for retail and which might not. It sounds like you think you have $8 billion that's definitely institutional, $47 billion, which is hard to characterize. So of that, call it $55 billion, have you surveyed the clients? Do you have a sense of what proportion of those would leave if the NAV floats? What proportion would leave if there are gates? And also is there -- of the money that might leave, is there any offset in expenses?

We have not done that as of yet. And it is very difficult to do. There are others outside firms that are working on doing those kinds of things exactly as part of the comment process. Incidentally, when you're talking to people, you find out that they go through the list of things that we mentioned -- that I mentioned in my remarks. They'll look at govie funds. They will look at bank deposits, primarily the 2 big retail [ph] banks. And some will be willing to look at other types of things, separate accounts, individual separate accounts, if they are really big, team separate accounts on private-type offerings. And maybe even some of them can squish money offshore. So I really can't give you a chapter and verse like I would like to on where that money could possibly end up because we haven't asked them exactly where they think they would go.

And Cynthia, on the expenses, the simple thing is that the revenue would go away, like you're talking about, and the distribution expense would go away. So a lot of the big dollar expenses are answered. And then, we would have to go through and say, if we get that money in the other places, like Chris mentioned, possibility and see what effect it would have on our margin and how we wanted to manage it for growth and for investments, just like you would expect we would do.

Okay. First off that's truly institutional. Is there much in distribution expense?

[ph] It would be lower, Cynthia, than the retail. If you look at in normal yield environments, where we don't have the extremely low rates like we have now, the distribution expense is effectively about half of the money market revenue, but that varies across the channel.

Okay. And so if a lot of money goes into government money market funds, could that potentially push the yields negative? And can you just remind us of what your policy is when yields get negative or close to negative?

I'll let Debbie discuss how much movement of money in the governments could go into -- cause them to go negative, which I don't think would happen. But nonetheless, Debbie will handle that, and then I'll to talk to you after that about the second part of your question.

Cynthia, We haven't really feel about negative yields as much of a threat at this point even if there were a substantial movement of client assets out of prime assets from an industry perspective and into the govie side. Having said that, we're getting a little bit of positive momentum in the context of supply that we expect to be better from a performance perspective for the rest of the year. And if we continue to chug along from an economic standpoint, the improvements for that should continue to be pretty good. We do think, however, that it is dislocating, if you will, in the context of too much filling in for the government space and driving yields closer towards that zero number. Negative yield is something that although can be handled by the Treasury at this point, it's not something that they feel is in the normal and sort of ordinary operating procedure. And we would expect that even on certain instances where specialty bills or treasury security might trade negative for a short period of time in the secondary, the expectation would be that Treasury would work very hard to make sure that in an auction, there would be no such thing as yields, which ultimately would be sort of the precedence that will be set from a market perspective.

And then in answer to the second part, Cynthia, in terms of what our attitude about negative yields in the funds would be. If it is short-term type thing, then it would be handled in an analysis related to waivers. But if it is a long-term negative yield, on the money fund, then we soon discover the Federated Investors, Inc. is not a charity. And that if the marketplace says that this kind of product is no longer viable, then that's the result that the marketplace has cried for. But we don't think that's what's going to happen. So on the short term, it would just fall into our regular waiver type analysis, and we'd see what that meant to us.

Great. And just on expenses, it looks like apart from distribution, which was lower due the waivers, and systems, there were a bunch of other small item -- expense items, they all rose. If you combine them, it was like those expenses were up 2.4% versus the previous quarter -- comp travel, advertising and others. So is that seasonal? Or are there some expenses there which have to do with responding to regulatory stuff? Is that a new good run rate?

You've captured -- with the way you phrased it is, basically stuff happens. We have increased the advertising a little bit. And we do -- are going to expect some more expenses with the money market dealings. And we're picking up a little bit in office and occupancy as we opened up our Australian office and things move up. I don't know if I have a forecast on exactly the next quarter for the other expenses like you're looking for. Maybe we could talk to you after the call.

I would say, Cynthia, that the travel season, we've seen that kind of step-up from Q1 to Q2. And so trending that over a longer-term would be the way to model that. But we can certainly go through that.

Our next question is coming from Eric Berg from RBC Capital Markets.

Chris, acknowledging that the municipal market is one of many, many businesses in which you compete, I nonetheless like to get your views on sort of what's happening right now? And by that, I mean the following: Detroit, broke: Chicago, [indiscernible] ; Illinois, in very bad shape; and many other examples. A 2-part question: first, what do you consider to be the threshold, the most important issues, that need to be resolved in the Detroit matter? And what would you consider to be for the municipal market, in general, given all these difficulties, to be sort of the best case and worst case outcome? Just how could this story end, either favorably or unfavorably?

Let's first cleanse the table by saying that in none of these circumstances do we have any money market assets, so that nobody gets the idea that because we're discussing this that somehow this has gotten into any of the money market funds because -- and this gets into the answer to your question, the first thing is that these things are very slow trains coming down the track that every analyst who does his homework sees. And that was especially true with New York. It was true in Harrisburg in our home, State of Pennsylvania. It was true in Birmingham. It is true in Illinois and the other instances that you mentioned. It was also true in New York back in the day during those times. So that is one thing that supports having a financial advisor and going to the advice routine when you're dealing with your municipal securities, that it isn't just a buy and throw it into a bucket and then everything works out. And so the way that we look at it is that this is an endorsement of the importance of doing real credit work and real analysis on the whole thing. Now, what are the most important issues? The most important issues are to stop the bleeding and get things reorganized. And I don't know all of the facts about Detroit, but I do know that they're spending and making promises a lot more than they can handle. And one of the issues is the underlying efficacy of what a pension promise really is. This will get way beyond the scope of an earnings call on Federated. But at some point, when these pension promises get made, they're really made to save money today in order to burden the future. And this kind of thought -- thinking doesn't always work out. And how can it end? Well, it ends in unfortunate ways for those whose pensions get cut because of the bankruptcy, which is indeed most unfortunate. And -- but because you see these trains coming down the track in a municipal area, careful investment managers can work it out. And all it does is tell you that yes, this is a marketplace, there's risk in this area, and you have to be attentive to it. So I don't look at it in any draconian terms because the marketplace is well informed on the numbers and on the trains that maybe coming down the track. And by the way, I'm not a muni manager.

-- the other thing that I would add to that -- this is Debbie -- is that in the sense of the possibility or the discussion about whether GO-type financing would be included in the bankruptcy filing. This obviously wasn't the case. I think that the discussion of that was not of a scare for the muni market to really go back and rethink in terms of what Chris was saying, from a currency diligence and analysis perspective, sort of why rated issuers, even if GOs were put into subjectivity with regards to their contractual nature and the ability for tax collection for repayment when the subjectives are problematic. But when you're talking about single-A issuers, they would be, and people would think a little bit to be more diligent on what I call the sort of the lower of the investment group products that would be out there from a municipality standpoint. Certainly, that can't be helped here from a treasury refinancing standpoint, so we as well as others in muni marketplace will continue to work with the industry to making sure that in fact those prices -- the GO prices and the taxation behind those types of bond shares perspective are not compromised.

That was really what my ultimate question was. That was implicit in my question. There wasn't enough -- I'll finish up really quickly. But if it turns out that the very nature of general obligation bonds changes so that other courts rule that municipalities are not required to raise taxes in order to meet those obligations, why wouldn't this affect all of the municipal issuers? Why would this be particularly harmful for the single-A marketplace?

Well, I think it would affect all municipal issuers, but if would affect the higher -- highest rated ones last. So, certainly, you're going to see a slide right down muni finance themselves, not as cheap with U.S. government but certainly not as expensive as corporations. And I think that, that would narrow in the refinance much more like of the corporation that doesn't have the kind of security bond behind it and than they do today.

Our next question is coming from Greggory Warren from Morningstar.

I just have a thought about the money market industry going forward. It's easier to make a case for consolidation when there are proposals put on the table for capital buffers, which will have made it a much more expensive business to run. Based on where the proposals are now and based on kind of what the feedback you're hearing out in the industry, do you think that there's going to be a larger level of consolidation going forward? And then, I guess, the question is, are you guys interested in being a major participant in that? Or is your acquisition-related activity more going to be focused on the fixed income and equity side?

We will answer the second question first. We would be open to discussing with others who choose to get out of the money fund business at any time. So we will be open to doing that. And we have been doing that for many years, okay. On the idea of consolidation, remember that I guess it was about in '07, there were over 200 people doing money market funds. Today if you look at the list, they list about 80 people doing money funds. And I think the bottom 10 or 15 of those have 10 million or 20 million in it. So you barely have 60 people, 60 firms doing money market funds. And if you look at the names of the firms, you can very quickly decide well how many of those will actually be consolidation candidates and how money wouldn't. And I think there are consolidation candidates there. But there has already been a consolidation going on here, or look at the other way an oligopolization of this business. And that is encouraged each time you put on more rules, regulations and challenges. And so that will just continue.

Yes, that was sort of the thinking I was going out there, because you've seen a lot of consolidation just because of the impact of fee waivers and interest rates over the last 5 years. But I was just curious if that was something that you guys will continue to focus on going forward? I mean, I know it's a big piece of your business, but looking at equity and then fixed income, your higher-fee rates and the better contributors of top line going forward?

Owner operators like revenues and business even if it may not be the best. It would be best if we could just do acquisitions and equity that will help the ratios, the PEs and all of that. But, if we think we can make a good trade on money funds, we're happy to do it.

Our next question is coming from Roger Freeman from Barclays.

I just have one question. I wanted to ask about another area of great development. I'm curious on your thoughts on the Fed's Basel III rule proposals for the banking industry, with this focus on leverage now and as currently proposed doesn't provide offsets for low risk of pretty tight assets and could reduce repo activity further. And I'm just wondering if not about what impact that have on your business. Maybe on one hand, yields could be higher, but on the other hand, it can just reduce the total size of repo back funds?

I'll let Debbie address that directly, and then I have a comment that's slightly related to that when Deb concludes.

Certainly, when you look at the impacts of banking industry reform, and Basel III in particular, there are implications most clearly felt from a repo market standpoint, at least as far as money markets are concerned. We've been going through some gut wrenching changes already over the course of the last 5 years. In the sense of the repo marketplace, it seems cut back by 2/3. From a size perspective, on where it was in the financial crisis that must have been in '08 that, that type of collaterals that are being financed from the institutions that are doing that finance are much higher and more kind of where the levels today than they ever were historically. So I think despite the fact that the regulation will make it a little bit more costly from a business perspective, the institutions that are currently in that business that remain, that have been able to weather the storms over the last 5 years, will continue to do that as it happens, of financing in that particular way. It may become a little less lucrative. So currently, if you look at the structure of many types of the government money market fund, whether it would be treasury or treasury and agency, a predominant portion of the assets within that product are generally repo, repo back, so indirect ownership bring the repo marketplace on their Treasury and several agency securities. Perhaps that contract will change to some degree if, in fact, the financing side of the equation for repo becomes a little bit more expensive and trends more towards the direct ownership of those particular types of securities. Again, but it's sort of [indiscernible] and undertaken as that implementation quandary for a lot of these things is further down the road from a timing perspective, and the potential, likely sort of additional change is still pretty high.

The comment I'd make, it relates to the liquidity coverage ratio, which is arguably related to the question you've got. But when the Fed's representative testified in front of the Senate about 10 days ago or so, he made the comment that while they were going to get to that and it would probably be by year end. And this is the way that the Fed has the ability to regulate how the banks utilize money market funds on a short-term basis. What they're now calling, of course, the short-term wholesale funding market. And so we would applaud their efforts to continue to do the regulation they think appropriate on the liquidity coverage ratio for the banks because we think it's a much more efficacious way to regulate bank use of money funds than by trying to clobber the money funds on the other side so that it's not unavailable alternative, especially on the prime side.

Our final question today is coming from Ken Worthington from JPMorgan. Kenneth B. Worthington - JP Morgan Chase & Co, Research Division: A couple of questions, maybe first for Debbie. Debbie, what is the risk to your near-term rate forecast? If ever that you're going to be wrong, what would be the likely cause? And if -- I hope you can frame this. If rates were to stay as low as they were today and not rebound in August, what does that do to fee waivers? Does it increase them a little bit? Does it increase them a lot? I know that it's very sensitive around rates when they get especially low, but just framing the magnitude would be helpful there on the waivers.

Hey, Ken. It's Ray. I'll take the second part of that, and then Debbie can comment on her forecast. If you look at where we're trending now in July, we would be roughly heading towards a 9.5 million month of July. So if we had 3 months of July, it would be at $28.5 million. But as we've said, we expect to see some improvements around the middle of the quarter.

Ken, I think from a risk perspective, it would be toward the lower end and not the opposite of that, that we're looking for at this point of up to 2 basis points of improvement. Having said that, it's a few basis points that we're looking for in this quarter. So I do think it's purely impactful in the context of the overall product. Why do I think it's more potential for downside risk, and that just has to do with a couple of things. Number one, the price side of the equation. Certainly, we were surprise with the strength in the supply or the strength in the receipts the Treasury was able to take in during the second quarter. And the tax implication for that is it would give us -- it's no surprise, again, in the third quarter that has some negative implications from a financing needs standpoint. Also, at the end of the second quarter, Fannie Mae paid out on a dividend basis back to the Treasury $60 billion because the housing money market is now improving. They're able to start repaying some of their debt. Freddie is going to be doing something similar at the end of the third quarter, although much smaller in magnitude, only $15 billion. So again, that has -- we're taking that into account, like it potentially has a little bit more impact on the supply side of the equation. And then I think the other targets that we are continuing to be wary about is the economic growth in the marketplace. Certainly, we've seem to have more positive step forward than negative step backward at this point. Nonetheless, I don't think that we are completely convinced that we are on firm footing for ultimately good growth going forward. So I think that would be sort of again the impetus to -- the board has been a little bit more on the negative side than what we originally would like. Kenneth B. Worthington - JP Morgan Chase & Co, Research Division: Moving on to Kaufmann, how much institutional or quasi-institutional money is run by Kaufmann these days? And as we think about Lawrence and Hans, how much of the assets are really at risk if they depart or retire? And are there any contingency plans in place? Or is there a plan in place to kind of the transition to management of these products, just based on them being well into retirement age?

As regards to the institutional participation, it is negligible. As regards to Hans and Larry, they remain as strong at the ship of state and are working hard. I might add as a footnote for that, one of our founding partners, Dick Fisher, is in here. He had his 90th birthday in May, and he's in here working every day, traveling, talking to broker dealers and things like that. So these guys are turned on and tuned in to their portfolios and got some good things going. next point would be that they have a gang of analysts/sub-portfolio managers that are outstanding and have been together for a long time. When we bought the enterprise years ago, one of our fellows went up there, by the name of Aash Shah, and he remains a part of that team. And the individuals in that team run sections of those portfolios, which would continue. So the succession plan is that you have Mr. Lerner in there, who's been with them for many, many years, and you have a strong portfolio management team that has segmented that portfolio for a long time. And I have not heard from any of them nor do I expect it to be true that either Hans or Larry have any idea of retirement. They, like Dick Fisher, love it and have to have it, and we're happy to have them.

That does conclude our question-and-answer session. I'll turn the floor back over to management for any further or closing comments.

Well, we'll conclude the call, and we thank you for your time today.

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