Federated Hermes, Inc. — 2019 Form 10-K
Reporting period: Fiscal year ended December 31, 2019. The filing is an annual report, not a standalone fourth-quarter filing. The company changed its name from Federated Investors, Inc. to Federated Hermes, Inc. effective January 31, 2020; its NYSE ticker changed from FII to FHI.
Business context
Federated is an investment manager operating as one segment. It earns most revenue from advisory, administrative and other services tied to assets under management (AUM). Its offerings include money market, equity, fixed-income, alternative/private markets and multi-asset products, plus stewardship services through Hermes. Year-end AUM was $575.9 billion, including $395.5 billion in money market assets.
Financial and operating performance
| Metric | 2019 | 2018 | Change |
|---|---|---|---|
| Total revenue | $1,326.9 million | $1,135.7 million | +17% |
| Operating income | $347.9 million | $330.3 million | +5% |
| Net income attributable to Federated Hermes | $272.3 million | $220.3 million | +$52.0 million |
| Diluted EPS | $2.69 | $2.18 | +$0.51 |
| Operating margin | 26.2% | 29.1% | Lower |
| Cash provided by operating activities | $334.9 million | $206.3 million | +$128.6 million |
Revenue growth reflected higher money market assets and a full year of Hermes results versus six months in 2018. Operating expenses rose $173.6 million, including higher compensation and distribution costs. Nonoperating results improved by $51.5 million, largely because 2018 included a $29.0 million loss on Hermes-related foreign-exchange derivatives. The effective tax rate was 24.1%, versus 24.9%.
Average AUM rose 23% to $509.2 billion; year-end AUM increased 25% to $575.9 billion. Year-end money market AUM rose 31%, equity AUM 23%, and fixed-income AUM 9%; alternative/private markets declined 1%. Long-term products had net redemptions of $3.3 billion in 2019, while market gains and other investment returns added $22.1 billion. The filing attributes broad asset appreciation to strong equity markets and falling bond yields.
Fourth-quarter 2019 revenue was $358.0 million, operating income $102.8 million, net income attributable to the company $82.1 million, and EPS $0.81. In fourth-quarter 2018, the corresponding figures were $307.2 million, $88.0 million, $61.5 million and $0.61.
Cash, debt and liquidity
Year-end cash and cash equivalents were $249.2 million. Management reported liquid assets, net of noncontrolling interests, of $359.1 million, up from $222.1 million a year earlier. Investing activities used $94.7 million; financing activities used $152.7 million. The company paid $109.1 million in dividends, or $1.08 per share, during 2019.
Debt was $100 million, down from $135 million, under a revolving credit facility expiring June 2022. The company had $275 million of borrowing capacity available and was in compliance with its covenants. Its leverage ratio was 0.2 to 1 against a maximum of 3 to 1. Management said existing liquidity, operating cash flow and borrowing capacity should cover present and reasonably foreseeable needs.
Material changes, outlook and risks
- Acquisitions: Hermes contributed for the full year in 2019, compared with six months in 2018. Federated also paid $58.0 million for certain PNC Capital Advisors business assets in November 2019, recorded as indefinite-lived fund-management rights.
- Fees and asset mix: Money market assets generated 40% of 2019 revenue, as did equity assets. Total fund fee waivers were $427.3 million, including $311.6 million relating to money market funds. The company reported no voluntary yield-related waivers in 2019; management estimated these would remain near zero under assumed asset levels and mix, while acknowledging actual waivers could vary.
- Costs and margins: Distribution expense increased $53.1 million, primarily with higher average money market fund assets. Management noted competitive pressure on distribution costs and continuing spending needs for compliance, technology and regulation.
- Regulatory and market exposure: Risks include changes to money-market rules, fiduciary standards, liquidity and derivatives regulation, Brexit and European requirements, and the planned LIBOR transition. Lower short-term rates, shifts in investor preferences, market declines, redemptions, poor investment performance and fee competition could reduce AUM and revenue. The filing discusses the coronavirus outbreak as a potential source of market and business disruption; it does not quantify its financial effect.
- Concentration and contingent interests: Three strategies/funds each contributed 9%–11% of revenue; one intermediary accounted for about 11%. Hermes has a redeemable noncontrolling interest of $192.2 million, subject to put/call options at future dates and fair-value estimates.
- Unusual items and contingencies: No material loss from ordinary-course legal claims or indemnifications was considered reasonably possible at year-end. No material off-balance-sheet arrangements were reported. Goodwill and intangible assets totaled $1.22 billion; no impairment was recorded in 2019. The auditor issued unqualified opinions on the financial statements and internal controls, while identifying intangible-asset valuation, the PNC asset acquisition and Hermes noncontrolling-interest valuation as critical audit matters.
No specific earnings or AUM guidance for 2020 is provided. The board declared a $0.27-per-share dividend in January 2020, paid February 14, 2020.
Important facts for investors to verify
- Whether the increase in AUM and revenue persists, and whether long-term net redemptions reverse; separate market appreciation and acquisition-related growth from organic flows.
- How money market yields, asset mix and competitive fee waivers affect net revenue and profitability.
- Whether compensation, distribution, regulatory and technology costs continue to outpace revenue growth and pressure margins.
- Hermes performance, the valuation and timing of its put/call options, and the assumptions supporting goodwill and intangible assets.
- Debt repayment and refinancing plans ahead of the 2022 credit-facility maturity, alongside the company’s dividend and repurchase commitments.
- Developments in regulation, Brexit, LIBOR transition and market conditions, including any subsequent effects of the coronavirus outbreak.