Federated Hermes, Inc. — Q3 2023 Form 10-Q
Reporting period: Three and nine months ended September 30, 2023. Financial statements are unaudited. Federated Hermes provides investment management, administration, distribution, stewardship and related services; it reported $715.2 billion of managed assets at quarter-end.
Financial performance
| Metric | Q3 2023 | Q3 2022 | Nine months 2023 | Nine months 2022 |
|---|---|---|---|---|
| Revenue | $402.7 million | $381.1 million | $1,218.1 million | $1,071.9 million |
| Operating income | $101.4 million | $96.8 million | $285.0 million | $273.0 million |
| Operating margin | 25.2% | 25.4% | 23.4% | 25.5% |
| Net income attributable to Federated Hermes | $75.0 million | $69.5 million | $216.8 million | $183.0 million |
| Diluted earnings per share | $0.86 | $0.78 | $2.44 | $2.02 |
- Q3 revenue rose 5.6% year over year, while operating income increased 4.8% and net income increased 8.0%. Nine-month revenue rose 13.6%, operating income 4.4% and net income 18.5%.
- Revenue growth reflected higher money-market revenue and carried interest. Nine-month comparisons also benefited from the absence of $85.3 million of voluntary yield-related fee waivers recorded in 2022. The 2023 revenue increase was partly offset by lower long-term asset revenue.
- Expenses increased: nine-month distribution expense rose $56.4 million, compensation and related expense rose $47.2 million, and professional-service fees rose $11.2 million. The distribution increase primarily reflected the elimination of fee waivers; compensation also increased with carried-interest vehicle consolidation and higher staffing and compensation costs.
- Nine-month nonoperating results improved substantially year over year, mainly because investment securities recorded gains rather than the significant losses recognized in 2022, and investment income rose with yields.
Assets, cash flow and capital
- Period-end managed assets were $715.2 billion, up 15% from a year earlier. Money-market assets rose 19% to $525.1 billion; long-term assets increased 4% to $190.1 billion. Nine-month average managed assets increased 10%, with average money-market assets up 17% while average long-term assets declined 3%.
- Equity assets experienced net redemptions of $2.3 billion in the first nine months; fixed-income assets had $2.0 billion of net sales, and alternative/private-market assets had $0.2 billion of net sales.
- Nine-month operating cash flow was $182.2 million, versus $191.5 million in 2022. Investing activities provided $8.6 million and financing activities used $151.6 million. Cash and cash equivalents were $377.0 million at September 30.
- Management reported liquid assets, net of noncontrolling interests, of $599.3 million, compared with $559.5 million at December 31, 2022.
- Long-term debt was $347.8 million, net of issuance costs. There were no revolver borrowings; $350 million was available under the revolving facility, plus a $200 million optional accordion. The company reported covenant compliance, a 37-to-1 interest coverage ratio against a 4-to-1 minimum, and a 0.78-to-1 leverage ratio against a 3-to-1 maximum.
- Nine-month cash uses included $112.0 million of treasury-stock purchases and $74.0 million of common dividends. The company repurchased approximately 3.4 million shares for $117.0 million during the period. A new authorization for up to 5.0 million shares was approved after quarter-end.
Outlook, risks and unusual items
- The filing provides no specific earnings or revenue guidance. Management said it expects to have sufficient liquidity for short-term and reasonably foreseeable long-term needs, considering cash, operating cash flow and borrowing capacity.
- Management cited asset values, flows and mix, market conditions, interest rates, fee waivers, investor preferences and extensive regulatory change as factors that can affect revenue, expenses and results. Money-market products generated 46% of nine-month revenue, up from 37% a year earlier. One government money-market fund accounted for 14% of revenue in both the quarter and nine-month period; one intermediary accounted for approximately 11%.
- SEC money-market reforms became effective October 2, 2023, with key compliance dates extending into 2024. The filing also discusses proposed and adopted U.S. and international rules affecting money-market and open-end funds, private funds, ESG disclosures and other investment-management activities. Management said implementation and compliance costs, product changes and investor responses could adversely affect the business; the impact of future developments remains uncertain.
- An administrative error involving registration of shares in a closed-end tender fund resulted in an estimated $18.9 million cost. A $17.9 million shareholder settlement was paid in Q2, and the company recorded a $16.4 million insurance receivable. The insurance claim is in litigation with two carriers, and the eventual recovery could differ materially from the recorded amount.
- Following an infrastructure-fund restructuring, the company recorded $9.8 million of expense in Q2 and a further $2.9 million in Q3 for acquired carried-interest rights and related matters. Negotiations for additional consideration continue; the final amount could differ significantly.
- The FHL public-fund management intangible had estimated fair value less than 10% above carrying value at September 30. Management noted that lower projected cash flows or a higher discount rate could lead to future impairment.
- Management stated that no material changes had occurred to the risk factors in its 2022 Form 10-K, and that disclosure controls were effective at quarter-end.
Important facts for investors to verify
- Whether elevated money-market assets, rates and fee-waiver conditions persist, and how changes affect revenue and distribution costs.
- Asset flows and average AUM trends in equity, fixed-income and other long-term products, alongside reliance on money-market revenue and key relationships.
- Actual insurance recoveries and final costs associated with the share-registration error and infrastructure-fund restructuring.
- Progress of regulatory implementation, compliance costs and any effects on fund products, flows or operating margins.
- Whether the FHL intangible’s valuation assumptions remain supportable and whether impairment indicators emerge.
- Capital allocation, including subsequent share repurchases, dividends and use of available borrowing capacity.