Federated Hermes released its Q3'22 earnings and hosted its quarterly earnings call late last week, which discussed the end of money fund fee waivers, increases in retail money fund assets, pending money fund regulations and more. The press release, entitled, "Federated Hermes, Inc. reports third quarter 2022 earnings," says, "Money market assets were $441.3 billion at Sept. 30, 2022, up $27.6 billion or 7% from $413.7 billion at Sept. 30, 2021 and up $1.6 billion or less than 1% from $439.7 billion at June 30, 2022. Money market fund assets were $309.9 billion at Sept. 30, 2022, up $17.6 billion or 6% from $292.3 billion at Sept. 30, 2021 and up $11.9 billion or 4% from $298.0 billion at June 30, 2022."
It continues, "Revenue increased $54.6 million or 17% primarily due to a decrease 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).... This increase was partially offset by a decrease in revenue due to lower average long-term assets. During Q3 2022, Federated Hermes derived 54% of its revenue from long-term assets (33% from equity, 13% from fixed income and 8% from alternative/private markets and multi-asset), 45% from money market assets, and 1% from sources other than managed assets. Operating expenses increased $56.2 million or 25% due to increased distribution expenses resulting primarily from lower voluntary yield-related fee waivers, partially offset by a decrease due to lower average managed fund assets."
Federated explains, "There were no material voluntary yield-related fee waivers during the quarter ended Sept. 30, 2022. During the nine months ended Sept. 30, 2022, voluntary yield-related fee waivers totaled $85.3 million. These fee waivers were partially offset by related reductions in distribution expenses of $66.5 million, such that the net negative pre-tax impact to Federated Hermes was $18.8 million for the nine months ended Sept. 30, 2022. During the three and nine months ended Sept. 30, 2021, voluntary yield-related fee waivers totaled $109.2 million and $310.2 million, respectively. These fee waivers were partially offset by related reductions in distribution expenses of $72.3 million and $204.9 million, respectively, such that the net negative pre-tax impact to Federated Hermes was $36.9 million and $105.3 million for the three and nine months ended Sept. 30, 2021, respectively."
The release adds, "Due to increases in the yields of securities held by money market portfolios, the net negative pre-tax impact of the voluntary yield-related fee waivers has been eliminated. The amount of voluntary yield-related fee waivers can vary based on a number of factors, including, among others, interest rates, yields, asset levels, asset flows and the ability of distributors to share in waivers. Any change in these factors can impact the amount and level of voluntary yield-related fee waivers, including in a material way."
During the earnings call, CEO Chris Donahue comments, "While Q3 presented challenging market conditions across asset classes, our business mix enabled Federated Hermes to achieve positive net sales in equities, fixed income, private markets and long-term assets overall. We also produced increases in revenue, operating and net income compared to the prior quarter as growth in money market revenue offset lower revenues from market-based decreases in long-term assets."
Discussing money markets, he says, "Assets increased in the third quarter compared to the second quarter. Money market fund assets increased about $12 billion, benefiting from higher yields and continued elevated liquidity levels in the financial system. Money funds also benefited from higher yields relative to deposit alternatives. We continue to believe that higher short-term rates will benefit money market funds over time, particularly as compared to deposit rates. Money market separate accounts were down by $10 billion mainly from seasonal factors related to timing of tax payments. Our money market mutual fund market share including sub-advised funds was about 7.4% at the end of the third quarter, up from about 7.3% at the end of the second quarter."
CFO Tom Donahue tells us, "On the financials, total revenue for Q3 increased $15 million or 4% from the prior quarter, due mainly to lower money market fund minimum yield related waivers of $9.5 million, higher average money market assets, increasing revenues by $6.6 million, lower money market competitive waivers, an additional day in the quarter and higher carried interest and performance fees. These were all partially offset by lower average long-term assets which reduced revenue by $12.8 million.... Q3 operating expense increased $10.7 million or 4% compared to Q2, driven by $9 million of higher distribution expense from lower money market fund minimum yield-related waivers."
During the Q&A, Federated was asked about "anemic money fund flows." Donahue answers, "Next week, the Fed's going to do 75. What are they going to do in December? What we've always said on several of these calls is that over time, this helps the money fund business. We often go back to the story of '16 to '18 when the Fed was increasing rates where our assets then increased about 15% and the industry about 11%. Then in the next period, once you're dealing with higher rates. Our assets went up another 22% and the industry increased about 14%. So those 2 levels, we think, we'll obtain. When? I don't know. I'm going to let Debbie comment on other dynamics and let her take a guess about fourth quarter avalanches.
CIO Debbie Cunningham says, "Looking at historic cycles, there's generally about a 6-month lag to when policy changes start to occur.... The Fed began moving in March, so we're at about ... that 6-month lag. Our expectation would be that we start to see a little bit more of a pickup going forward. Number two, we were moving off of zero [rates].... That's not the norm. So I think cycles coming off of zero react a little bit differently. Thirdly, if you look at where there has been a huge amount of growth since March within the industry, and this was referenced several different times in media articles over the course of last week, it's been in retail prime."
Asked about money funds' fee mix, President Ray Hanley answers, "Just from a fee standpoint, the retail-oriented funds will tend to have both higher revenue and higher related distribution expenses. But if you consider it on a net revenue basis, it would be fairly comparable to institutional. So we should not see a meaningful change there in our blended, if you will, fee rate.... On the sweep front, it's hard to identify what a lot of our clients do with us on an omnibus basis, so we don't always have visibility into the end use. I would peg it at somewhere in the neighborhood of 10% to 15% of our money fund AUM [sweeps]. But again, it's difficult to get a precise figure at that."
Cunningham comments, "The other thing I'd add ... is that the sweep clients changed completely into the government products after the last set of reforms because of the institutional prime floating NAV.... So it's essentially a government product phenomenon now. As far as institutional growth goes ... the expectation is that when you are nearing a peak or getting to a point where you think there's a terminal rate in sight from a Fed funds target standpoint, that's when institutions really begin to move in earnest."
She adds, "Quite honestly, a steady to declining rate environment is really what produces inflows into institutional money market funds on an outsized basis, as long as you're not declining into a zero rate environment again. So I think we're far away from ... either one of those things happening.... [But] I think institutional growth is beginning to happen. It will continue to happen but it will increase in earnest more than likely in 2023 versus '22."
Finally, when asked about regulatory changes and swing pricing, Donahue says, "It would be about $8 billion [in Prime Inst MMFs].... Various things occurred at the SEC ... that put the actual implementation of the rule off at least a quarter. Now we don't know when they're going to come up with it. We thought it would be already. But because of some glitches in their systems on the comment situation, they had to extend.... Another thing which we mentioned ... is the GAO is doing a little study on money funds to see what impact has been had and that was requested by certain Congress representatives in Congress. I don't know what that's going to report but that's supposedly coming out here in the fourth quarter and perhaps that will help inform."
He continues, "We are, needless to say, using this additional comment period to point out ... that really swing pricing on money funds is a great disease to impose on the money funds and there's no basis data or history for doing that.... Now of course, the SEC announced they're going to do put out something on swing pricing on bond funds. That has been done in Europe. I don't know what they're going to propose or what the deal will be on that. That's another whole round. But it just makes no sense on the money funds at all. We've also been talking to them about what happens when ... you get to negative rates."
Finally, Donahue adds, "We've had very recent discussions with them on reverse distribution mechanism ... to enable funds to deal with it long term. If you do get negative rates which nobody foresees and it's hard for us to figure out why you would injure current funds that are functioning well by that concept when you have plenty of time to study it. So we don't know when the regs are coming out. We know it's been delayed. And we know there's been a lot of commentary much like ours [from] the industry and many others against doing what they're proposing. But we'll see."
