Federated Hermes, Inc. — Q3 2021 Form 10-Q
Reporting period: Three and nine months ended September 30, 2021. Unless stated otherwise, financial figures below are in millions of U.S. dollars. Federated Hermes provides investment management, administrative, distribution, stewardship and related services. It reported $634.1 billion of managed assets at quarter-end.
Financial performance and position
| Metric | Q3 2021 | Q3 2020 | Nine months 2021 | Nine months 2020 |
|---|---|---|---|---|
| Revenue | $326.6 | $364.5 | $978.8 | $1,084.4 |
| Operating income | $98.4 | $113.4 | $277.7 | $303.4 |
| Operating margin | 30.1% | 31.1% | 28.4% | 28.0% |
| Net income attributable to Federated Hermes | $71.4 | $85.8 | $201.7 | $231.2 |
| Diluted EPS | $0.73 | $0.85 | $2.04 | $2.29 |
| Cash dividends per share | $0.27 | $0.27 | $0.81 | $0.81 |
For the first nine months, operating cash flow was $101.0 million, versus $243.5 million in 2020. Investing activities provided $13.0 million; financing activities used $213.4 million. Cash and cash equivalents were $201.7 million at September 30, compared with $301.8 million at December 31, 2020. Management reported liquid assets, net of noncontrolling interests, of $411.8 million, down from $432.5 million at year-end.
Long-term debt was $102.2 million, compared with $75.0 million at December 31, 2020. The company had $247.8 million available under its $350 million revolving facility and an additional $200 million accordion option. The facility matures July 30, 2026; the company reported compliance with its covenants.
Material changes versus comparable periods
- Q3 revenue fell 10.4% year over year and nine-month revenue fell 9.7%. Net income attributable to the company declined 16.9% for Q3 and 12.7% for the nine-month period.
- Money market voluntary yield-related fee waivers were a major drag: $109.2 million in Q3 and $310.2 million year to date, partly offset by lower distribution expenses. The resulting net pretax impact was $36.9 million for Q3 and $105.3 million year to date, versus $3.8 million and $5.9 million, respectively, in 2020.
- Higher equity and fixed-income assets partly offset weaker money market revenue. Period-end managed assets rose 3% year over year; long-term assets rose 21%, while money market assets declined 4%. Nine-month average equity and fixed-income assets increased 24% and 25%, respectively, while average money market assets fell 5%.
- Q3 operating expenses declined $22.9 million, largely because of lower distribution expense associated with fee waivers. Nine-month operating expenses declined $79.9 million, while compensation expense increased and technology-related systems costs rose.
- On August 31, the company acquired BT Pension Scheme’s remaining 29.5% noncontrolling interest in Hermes Fund Managers Limited for £116.5 million ($160.2 million), funded with cash and credit-facility borrowings. The transaction reduced redeemable noncontrolling interests and increased debt.
Outlook, commentary and risks
- Assuming asset levels and mix remain constant and based on recent and projected market conditions, management estimated Q4 2021 voluntary yield-related fee waivers could have an approximately $39 million net pretax negative impact. Actual results depend on short-term rates, fund assets and yields, expenses, customer and intermediary arrangements, and regulatory actions.
- Management said it expects sufficient liquidity to meet present and reasonably foreseeable cash needs. The board declared a $0.27-per-share dividend payable November 15, 2021 to holders of record November 8.
- Management identified low interest rates and potential money market fund reforms as significant business risks, alongside market-driven changes in assets, product mix and investor flows; regulatory and compliance costs; Brexit and foreign exchange exposure; and the continuing effects of COVID-19. It noted uncertainty about the impact of proposed U.S. and international regulation.
- Approximately $11 million of previously recognized carried interest was subject to clawback; management estimated no clawback based on current asset valuations, but future declines could trigger repayment. The estimated fair value of certain indefinite-lived HFML-related intangible assets exceeded carrying value by less than 5%, making future impairment sensitive to assumptions about growth, margins and discount rates.
- The company recorded a $1.3 million Q3 expense on a foreign-currency forward related to the HFML acquisition. A hypothetical 20% currency fluctuation could affect financial condition and results by approximately $10 million. Management did not believe a material loss from ordinary-course legal claims or indemnifications was reasonably possible; it reported no material changes to the prior annual report’s risk factors.
Important facts for investors to verify
- How money market fee waivers and related distribution-expense offsets evolve as short-term interest rates and fund yields change.
- Whether asset flows, market performance and product mix sustain the growth in equity and fixed-income assets and offset weakness in money market assets.
- Post-acquisition cash, debt, interest expense and performance of the HFML business following the purchase of the remaining 29.5% interest.
- Whether projected Q4 fee-waiver costs, contingent carried-interest clawbacks or potential impairment of HFML-related intangible assets change materially.
- Developments in money market fund regulation, other compliance requirements and foreign exchange exposure, including the company’s LIBOR transition and Brexit-related risks.