Federated Hermes hosted its quarterly earnings call (see the Seeking Alpha transcript here) on Friday, and fee waivers and virtually zero rates were the big topic of discussion. Federated's release explains, "Money market assets were $419.1 billion at March 31, 2021, down $32.2 billion or 7% from $451.3 billion at March 31, 2020 and down $1.2 billion or less than 1% from $420.3 billion at Dec. 31, 2020. Money market fund assets were $297.2 billion at March 31, 2021, down $38.9 billion or 12% from $336.1 billion at March 31, 2020 and down $4.7 billion or 2% from $301.9 billion at Dec. 31, 2020."
It explains, "Revenue decreased $18.0 million or 5% percent primarily due to an increase in voluntary fee waivers related to certain money market funds in order for those funds to maintain positive or zero net yields (voluntary yield-related fee waivers). For further information, see "Impact of voluntary yield-related fee waivers" below. This decrease was partially offset by an increase in revenue due to higher average equity and fixed-income assets and an increase in revenue from alternative/private markets assets primarily related to revenue of a previously nonconsolidated entity being recorded in operating revenue beginning March 2020. During Q1 2021, Federated Hermes derived 75% of its revenue from long-term assets (49% from equity, 16% from fixed-income and 10% from alternative/private markets and multi-asset), 24% from money market assets, and 1% from sources other than managed assets."
President & CEO J. Christopher Donahue says on the call, "Moving to money markets, assets were down about $1 billion in Q1 from year-end. Our money market fund market share including sub advised funds at quarter-end, was about 7.4%, down slightly from the year-end market share of 7.8%. While we've seen longer-term interest rates increased recently, short-term interest rates remain at historic lows, with yields on money market securities dropping to the low single-digits over the last couple of months. As a result, minimum yield waivers were greater than anticipated in the first quarter, and certain money market separate accounts have begun to be impacted in a similar way. Minimum yield waivers are expected to increase again in the second quarter before declining over the rest of the year, as we noted in our press release. As usual, we experienced waivers for competitive purposes as well."
He continues, "Against the challenging interest rate and yield environment, money market funds continue to show their resilience and value to investors, issuers, and the overall financial system. The most recent ICI statistics show $4.5 trillion in money fund assets, up from $4.3 trillion since year-end and $3.6 trillion at the end of 2019. We believe that the lower interest rate challenge will pass despite the Fed's current stance. It's hard not to conclude that the pandemic recovery and the massive stimulus being unleashed will not lead to interest rate increases."
Donahue tells us, "We also believe that as we enter another round of the 40-plus years of money market fund regulatory discussions, the truth is that the March 2020 market disruptions in the midst of the global pandemic were in no way caused by money market funds. The essential role money market funds play in our capital markets will be recognized by regulators. We expect the regulatory process to follow the data. Any regulatory changes should be based on facts, not false narratives, and should preserve issuers and investors ability to utilize money market funds."
CFO Thomas Donahue says, "Total revenue for the quarter was down from the prior quarter due to the increased negative impact of minimum yield waivers of $27 million, fewer days costing $9.3 million, lower money market assets costing $6.4 million, and lower performance fees.... As noted in the press release, negative impact from operating income from minimum yield waivers on money market mutual funds and certain separate accounts may range from $35 million to $45 million during the second quarter. This range is based on gross yields on government money market portfolios of 3 to 10 basis points. The historically low yields are being driven by technical factors at the front-end of the yield curve. In March, we began taking on more of the impact of the low rates through waivers as we were not able to further reduce distribution expenses on certain funds and separate accounts. This was largely responsible for the higher than forecasted Q1 waivers and the higher forecast range for Q2."
He adds, "We believe that minimum yield waivers are likely to peak in Q2 and we expect short-term rates to increase in Q3 and Q4. The amount of minimum yield waivers and the impact on operating income will vary based on a number of factors, including among others interest rates, the capacity of distributors to absorb waivers, asset levels, and flows. Any changes in these factors can impact the amount of minimum yield waivers, including in a material way."
During the Q&A, Money Market CIO Deborah Cunningham explains, "Some of the more specific factors about our outlook have to do with currently where overnight rates are trading, which is in the one basis point, maybe one to two basis range.... [T]hroughout most of 2020 ... overnight rates have been somewhere in the neighborhood of five to eight basis points. Our expectation would be because of various processes that the Fed has already gone through by increasing their RRP counterparty limits.... We do believe that we will see some technical adjustments to that reverse repo rate ... up to a level [of] five basis points. Commensurate with that would be likely an IOER of 5 basis points. What this does not only raises the floor from an overnight perspective by that amount of basis points, but it also raises the money market yield curve by upwards of probably three to five basis points depending upon what part of the curve you're looking at. So that plays directly through as we invest in those markets on a daily basis to the yields of the fund and thus the waivers."
She also says, "So ... the technical adjustments that we hope are coming in the second quarter from the Fed with regard to the RRP and IOER rates should be extremely helpful. Then ... debt ceiling issues start to impact in the beginning of the third quarter. Once that [is] past us, we believe that the money market yield curves which on the Prime side, like the BSBY curve, which I'll note I'm using that instead of LIBOR now, the Bloomberg Short Term Bank Yield Index, a new gauge that we think is helpful on the Prime side. That curve is already backed up maybe one to three basis points since the beginning of the year really starting in the fourth quarter of last year. But the [T-bill] curve, where the majority of our assets lie from a Government fund standpoint, has actually declined and gotten less steep by anywhere from one to three basis points."
Cunningham comments, "So we think we start in the third quarter to have the bill curve start to normalize a little bit more. Also at that point, it's our expectation that because of the economic recovery, we should be seeing an improvement in where we see our current standard inflation measures. And the Fed will need to begin to address those -- that issue, the target rate. And we think that they start that process by beginning to announce cutbacks in their bond buying late in the second half of 2021, which then sets the stage for further economic recovery, further inflationary issues in 2022 at which point we think the Fed will react by increasing by 25 basis points. So the point ... is that even without the Fed adjusting the target Fed funds rate, we think that there is a huge benefit with some of the technical adjustments that they can and will likely do that will improve the products from a gross yield stand point, which obviously helps waivers. But ... true target adjustments don't come until sometime in 2022 later in the year, more than likely."
In response to another question, she responds, "The large majority of our $430 billion in assets under management in the liquidity space is in the Government product area, roughly two thirds of it. As such, those portfolios generally have about 40% to 60% of their composition of their assets in overnight securities. So, 50% of five basis points gives you two and a half basis points on two thirds of the assets. The other asset classes, the Prime products, and the Tax Free products and then the remaining portion of the Government products would be more impacted by what the curve does as opposed to what overnights do, and we think that impact is more along the lines of maybe a basis point or two."
When asked, if "the money market fund business was a profitable business," Tom Donahue replies, "It is not generating losses, it is still a profitable good thing to be doing." On consolidation, Chris Donahue comments, "Yes, there will be more of those come along.... Each step in this process from prior to the big recession of 2008-2009 as I mentioned before, there were over 200 people doing money market funds. Now, if you look at the list it's 50 or so. And a lot of those are just in it, because they totally control the money in and out. And as time evolves and as these things occur, people decide they're going to throw in the towel. And then we work out a deal not unlike we worked our with PNC that works out for everybody. And as I always like to say we are a warm and loving home for any money market fund assets."
Finally, when asked about sharing fee waivers, Chris Donahue adds, "Generally as rates go down in this period, and in the last period, we have shared pro rata with our distribution partners. [But] as rates ... get down to where there's no more sharing -- i.e. the distribution partner is receiving zero -- there's no more sharing that they can do and we take the brunt of the hit.... And that's what you saw -- late in the first quarter.... The distribution savings couldn't go ... any lower and it hit all to us."
