EX-13.01 2 fii-1301fy2012.htm SELECTED PORTIONS OF 2012 ANNUAL REPORT TO SHAREHOLDERS FII - 13.01 FY 2012

EXHIBIT 13.01
 
  
Financial Review
  
 
 
 
 
 
  
Selected Consolidated Financial Data
  
 
 
 
 
  
Management’s Discussion and Analysis
  
 
 
 
 
  
Management’s Assessment of Internal Control Over Financial Reporting
  
 
 
 
 
  
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm, on Consolidated Financial Statements
  
 
 
 
 
  
Report of Ernst & Young LLP, Independent Registered Public Accounting Firm, on Effectiveness of Internal Control Over Financial Reporting
  
 
 
 
 
  
Consolidated Balance Sheets
  
 
 
 
 
  
Consolidated Statements of Income
  
 
 
 
 
 
Consolidated Statements of Comprehensive Income
 
 
 
 
 
  
Consolidated Statements of Changes in Equity
  
 
 
 
 
  
Consolidated Statements of Cash Flows
  
 
 
 
 
  
Notes to the Consolidated Financial Statements
  
FORWARD-LOOKING STATEMENTS
Certain statements in this Annual Report on Form 10-K and the 2012 Annual Report to Shareholders, including those related to asset flows and business mix; obligations to make additional contingent payments pursuant to acquisition agreements; obligations to make additional payments pursuant to employment arrangements; legal proceedings; future cash needs and management’s expectations regarding borrowing; future principal uses of cash; performance indicators; impact of accounting policies and new accounting pronouncements; concentration risk; indemnification obligations; the impact of increased regulation including potential rule proposals by the Securities and Exchange Commission affecting money market funds or action taken by the Financial Stability Oversight Council; the prospect of increased distribution-related expenses; management’s expectations regarding fee waivers, the impact of interest rates on such waivers, and the impact of such waivers on revenues and net income; the ability to raise additional capital; possible impairment charges; tax liability and the realization of deferred tax assets; capital losses; the impact of the interest rate swap; plans for international growth and the various items set forth under the section entitled Risk Factors constitute forward-looking statements, which involve known and unknown risks, uncertainties, and other factors that may cause the actual results, levels of activity, performance or achievements of Federated or industry results, to be materially different from any future results, levels of activity, performance or achievements expressed or implied by such forward-looking statements. Among other risks and uncertainties, market conditions may change significantly resulting in changes to Federated’s asset flows and business mix, which may cause a decline in revenues and net income, result in impairments and increase the amount of fee waivers incurred by Federated. The obligation to make contingent payments is based on certain growth and fund performance targets and will be affected by the achievement of such targets, and the obligation to make additional payments pursuant to employment arrangements is based on satisfaction of certain conditions set forth in those arrangements. Future cash needs and future uses of cash will be impacted by a variety of factors, including the number and size of any acquisitions, Federated’s success in distributing its products, as well as potential changes in assets under management and/or changes in the terms of distribution and shareholder services contracts with intermediaries who offer Federated’s products to customers. Federated’s risks and uncertainties also include liquidity and credit risks in Federated’s money market funds and revenue risk, which will be affected by yield levels in money market fund products, changes in fair values of assets under management and the ability of Federated to collect fees in connection with the management of such products. Many of these factors may be more likely to occur as a result of the increased scrutiny of the mutual fund industry by federal and state regulators, and the recent and ongoing disruption in global financial markets. As a result, no assurance can be given as to future results, levels of activity, performance or achievements, and neither Federated nor any other person assumes responsibility for the accuracy and completeness of such statements in the future. For more information on these items, see the section entitled Risk Factors herein under Management’s Discussion and Analysis of Financial Condition and Results of Operations.

 
2012 Annual Report
7

SELECTED CONSOLIDATED FINANCIAL DATA
(in thousands, except per share data and managed assets)

The selected consolidated financial data below should be read in conjunction with Federated Investors, Inc. and its subsidiaries’ (Federated) Consolidated Financial Statements and Notes. The selected consolidated financial data (except managed assets) of Federated for the five years ended December 31, 2012 have been derived from the audited Consolidated Financial Statements of Federated. See Management’s Discussion and Analysis of Financial Condition and Results of Operations and the Consolidated Financial Statements and Notes which follow.
Years Ended December 31,
 
2012

 
2011

 
2010

 
2009

 
2008

Statement of Income Data1, 2
 
 
 
 
 
 
 
 
 
 
Total revenue
 
$
945,706

 
$
895,114

 
$
951,943

 
$
1,175,950

 
$
1,223,680

Operating income
 
312,593

 
257,455

 
309,791

 
329,227

 
361,175

Income from continuing operations including
   noncontrolling interests in subsidiaries
 
197,628

 
155,083

 
189,163

 
208,540

 
228,625

Amounts attributable to Federated Investors, Inc.
 
 
 
 
 
 
 
 
 
 
Income from continuing operations
 
188,088

 
150,906

 
179,114

 
197,292

 
221,509

Income from discontinued operations
 
0

 
0

 
0

 
0

 
2,808

Net income
 
188,088

 
150,906

 
179,114

 
197,292

 
224,317

Share Data attributable to Federated Investors, Inc.
 
 
 
 
 
 
 
 
 
 
Earnings per share – Basic1, 2
 
 
 
 
 
 
 
 
 
 
Income from continuing operations
 
$
1.79

 
$
1.45

 
$
1.73

 
$
1.93

 
$
2.17

Income from discontinued operations
 
0.00

 
0.00

 
0.00

 
0.00

 
0.03

Net income
 
1.79

 
1.45

 
1.73

 
1.93

 
2.20

Earnings per share – Diluted1, 2
 
 
 
 
 
 
 
 
 
 
Income from continuing operations
 
$
1.79

 
$
1.45

 
$
1.73

 
$
1.92

 
$
2.15

Income from discontinued operations
 
0.00

 
0.00

 
0.00

 
0.00

 
0.03

Net income
 
1.79

 
1.45

 
1.73

 
1.92

 
2.18

Cash dividends per share3
 
$
2.47

 
$
0.96

 
$
2.22

 
$
0.96

 
$
3.69

Weighted-average shares outstanding – basic
 
100,313

 
100,609

 
99,925

 
99,923

 
99,605

Weighted-average shares outstanding – diluted
 
100,313

 
100,632

 
99,993

 
100,056

 
100,395

Balance Sheet Data at Period End
 
 
 
 
 
 
 
 
 
 
Intangible assets, net and Goodwill1, 4
 
$
727,857

 
$
720,926

 
$
720,825

 
$
662,996

 
$
657,321

Total assets1, 4
 
1,090,061

 
1,150,856

 
1,153,504

 
912,433

 
846,610

Long-term debt5
 
276,250

 
318,750

 
361,250

 
105,000

 
126,000

Federated Investors shareholders’ equity3
 
495,432

 
541,959

 
491,799

 
528,207

 
423,374

Impact of Minimum Yield Waivers6
 
 
 
 
 
 
 
 
 
 
Revenue
 
$
(290,966
)
 
$
(320,671
)
 
$
(241,576
)
 
$
(120,587
)
 
$
(3,743
)
Less: Reduction in Distribution expense
 
218,479

 
232,336

 
186,573

 
86,357

 
2,067

Operating income
 
(72,487
)
 
(88,335
)
 
(55,003
)
 
(34,230
)
 
(1,676
)
Less: Reduction in Noncontrolling interest
 
1,243

 
6,473

 
1,023

 
0

 
0

Pre-tax impact
 
(71,244
)
 
(81,862
)
 
(53,980
)
 
(34,230
)
 
(1,676
)
Managed Assets (in millions)
 
 
 
 
 
 
 
 
 
 
As of period end
 
$
379,771

 
$
369,697

 
$
358,241

 
$
389,316

 
$
407,310

Average for the period
 
365,149

 
354,387

 
347,074

 
405,595

 
342,521

1
In 2010 and 2009, Federated recorded pretax impairments totaling $10.2 million and $21.7 million, respectively, primarily related to certain intangible and fixed assets. See Note (6) to the Consolidated Financial Statements for information on the 2010 impairment.
2
In 2012 and 2010, results included pretax insurance recoveries totaling $20.2 million and $25.0 million, respectively, for claims submitted over the past several years related to various legal proceedings.
3
Federated paid a special dividend to shareholders of $1.51 per share or $156.9 million in 2012, $1.26 per share or $129.8 million in 2010 (see Note (14)(a) to the Consolidated Financial Statements) and $2.76 per share or $281.2 million in 2008.
4
In connection with business acquisitions, Federated recorded Intangible assets, net and Goodwill in 2010 of $44.7 million and $24.1 million. See Note (20)(a) and Note (3), respectively, to the Consolidated Financial Statements.
5
In 2010, Federated amended and restated its term-loan facility which increased borrowings and extended the term of the loan. See Note (11) to the Consolidated Financial Statements for additional information.
6
See Note (4) to the Consolidated Financial Statements for additional information regarding the impact of minimum yield waivers.

8
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS
of Financial Condition and Results of Operations

Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with the Selected Consolidated Financial Data and the Consolidated Financial Statements appearing elsewhere in this report.
General
Federated Investors, Inc. (together with its subsidiaries, Federated) is one of the largest investment managers in the United States with $379.8 billion in managed assets as of December 31, 2012. The majority of Federated’s revenue is derived from advising Federated mutual funds and Separate Accounts (which include separately managed accounts, institutional accounts, sub-advised funds and other managed products) in both domestic and international markets. Federated also derives revenue from providing administrative and other mutual fund-related services, including distribution, shareholder servicing, and retirement plan recordkeeping services.
Federated’s investment products are primarily distributed in four markets. These markets and the relative percentage of managed assets at December 31, 2012 attributable to such markets are as follows: wealth management and trust (48%), broker/dealer (31%), institutional (12%) and international (6%).
Investment advisory fees, administrative service fees and certain fees for other services, such as distribution and shareholder service fees, are contract-based fees that are generally calculated as a percentage of the net assets of the investment portfolios that are managed by Federated. Federated’s revenue is primarily dependent upon factors that affect the value of managed assets including market conditions and the ability to attract and retain assets. Nearly all assets under management (AUM or managed assets) in Federated’s investment products can be redeemed at any time with no advance notice requirement. Fee rates for Federated's services generally vary by asset and service type and may vary based on changes in asset levels. Generally, management-fee rates charged for advisory services provided to equity products are higher than management-fee rates charged on money market and fixed-income products. Likewise, mutual funds typically have a higher management-fee rate than Separate Accounts. Similarly, traditional separate accounts typically have a higher management-fee rate than liquidation portfolios. Accordingly, revenue is also dependent upon the relative composition of average AUM across both asset and product types. Federated may waive certain fees for competitive reasons such as to maintain positive or zero net yields, to meet regulatory requirements or to meet contractual requirements. Since Federated’s products are largely distributed and serviced through financial intermediaries, Federated pays a portion of fees earned from sponsored products to the financial intermediaries that sell these products. These payments are generally calculated as a percentage of net assets attributable to the financial intermediary selling the product and comprise the vast majority of Distribution expense on the Consolidated Statements of Income. Certain components of distribution expense can vary depending upon the asset type, distribution channel and/or the size of the customer relationship. Federated generally pays out a larger portion of revenue earned from managed assets in money market funds than revenue earned from managed assets in equity or fixed-income funds.
Federated’s most significant operating expense, aside from distribution expense previously described, is compensation and related expense. Compensation and related costs include base salary and wages, incentive compensation and other employee expenses including payroll taxes and benefits. Incentive compensation, which includes stock-based compensation, can vary dependent on various factors including, but not limited to, overall results of operations for Federated, investment management performance and sales performance.
The discussion and analysis of Federated’s financial condition and results of operations are based on Federated’s Consolidated Financial Statements. Federated operates in a single operating segment, the investment management business. Management evaluates Federated’s performance at the consolidated level. Management analyzes all expected revenue and expenses and considers market demands in determining an overall fee structure for services provided and in evaluating the addition of new business. Federated’s growth and profitability are dependent upon its ability to attract and retain AUM and upon the profitability of those assets, which is impacted, in part, by management’s decisions regarding fee waivers in order for certain money market funds to maintain positive or zero net yields. Fees for fund-related services are ultimately subject to the approval of the independent directors or trustees of the mutual funds. Management believes the most meaningful indicators of Federated’s performance are AUM, total revenue and net income, both in total and per diluted share.


 
2012 Annual Report
9

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Business Developments
Money Market Fund Matters
For the year ended December 31, 2012, approximately 47% of Federated’s total revenue was attributable to money market assets as compared to 46% and 50% for 2011 and 2010, respectively. A significant change in Federated’s money market business or a significant reduction in money market assets due to regulatory changes, changes in the financial markets including significant and rapid increases in interest rates over a short period of time causing certain investors to prefer direct investments in interest-bearing securities, significant deterioration in investor confidence, further persistent declines in or additional prolonged periods of historically low short-term interest rates and resulting fee waivers or other circumstances, could have a material adverse effect on Federated’s results of operations.
(a) Current Regulatory Environment
In January 2010, the Securities and Exchange Commission (SEC) adopted extensive amendments to Rule 2a-7 of the Investment Company Act of 1940 (Rule 2a-7) aimed at enhancing the resiliency of money market funds. These amendments included a series of enhancements including rules that require all money market funds to meet specific portfolio liquidity standards and rules that significantly enhance the public disclosure and regulatory reporting obligations of these funds. In 2010 and 2011, Federated dedicated internal resources to comply with these amendments including efforts to enhance its information systems and improve related reporting capabilities. These efforts were internally sourced and not material to Federated's financial position, results of operations or cash flows for those years. In Federated's view, the amendments of 2010 meaningfully and sufficiently strengthen money market funds. Recent experience demonstrated that the amendments of 2010 were effective in meeting heightened requests for redemptions occurring in connection with the U.S. credit rating downgrade in 2011 and the ongoing European debt crisis.
The SEC undertook a project to develop a proposal for additional reforms related to money market funds. In August 2012, then SEC Chairman Mary Schapiro issued a public statement announcing that she did not have sufficient votes from the other SEC commissioners to pursue certain proposed reforms relating to money market funds. In her statement, Ms. Schapiro stated that the SEC had been considering two alternative reform proposals, one which would have required a floating net asset value (NAV), and the other which would have imposed capital requirements coupled with some form of redemption restriction. In her statement, she invited other policymakers to take up the issue of reform. On September 27, 2012, then Treasury Secretary Timothy Geithner sent a letter to the members of the Financial Stability Oversight Council (FSOC) announcing his intent to pursue money market fund reform. His letter urged FSOC to use its authority under Section 120 of the Dodd-Frank Act to recommend that the SEC proceed with money market reform. Mr. Geithner outlined three potential options for reform in his letter and stated that he had asked his staff to begin drafting a formal recommendation for FSOC to consider at its November 2012 meeting.
In November 2012, FSOC issued Proposed Recommendations Regarding Mutual Fund Reform citing its authority under Section 120 of the Dodd-Frank Act (Proposed Recommendations). The Proposed Recommendations are in draft form and are subject to a public comment period which ended on February 15, 2013. The Proposed Recommendations include three main alternatives: a floating NAV for money market funds; an NAV capital buffer and minimum balance at risk (or 30-day hold back of up to 3% on certain redemptions); and an NAV capital buffer combined with other measures. In response to the Proposed Recommendations, Federated has filed five comment letters on the Proposed Recommendations pointing out, among other things, that: (1) FSOC exceeded its authority in how it used the Section 120 process; (2) FSOC has not provided justification for further reform efforts; (3) a floating NAV would not prevent “runs” on money market funds; (4) an NAV capital buffer of the kind proposed is impractical and not economically attainable in the current interest rate environment; and (5) the minimum-balance-at-risk concept would impair the utility of money market funds to investors and would be prohibitively costly for both fund groups and intermediaries to implement.
On November 30, 2012, the SEC Staff issued a study entitled Response to Questions Posed by Commissioners Aguilar, Parades and Gallagher. This study responded to questions posed by the Commissioners in response to potential reform measures being advanced by then SEC Chairman Mary Shapiro. The study addressed certain misconceptions about the role of money market funds in the financial crisis of 2008 and confirmed the effectiveness of the 2010 amendments to Rule 2a-7. Federated also filed a comment letter on the study commending the SEC Staff for its work while raising questions on some aspects of the study and recommending further analysis.

10
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Finally, it has been reported that the SEC Staff is working on its own rule proposal and that proposal could include a floating NAV for certain money market funds, in particular prime funds. It could also include a floating NAV proposal for all money market funds as well as other reform measures.
Federated believes the changes currently under consideration, if enacted, would significantly reduce the utility and attractiveness of money market funds for investors who, in Federated's view, value money market funds in their current form as an efficient and effective cash management investment product offering daily liquidity at par.
If ultimately enacted, some or all of these changes would be detrimental to Federated's money market fund business and could materially and adversely affect Federated's operations. The very proposal of such amendments could have an adverse impact on Federated's money market fund business and operations and could also negatively impact the short-term credit markets. Management is carefully monitoring developments in this area and plans to actively participate both individually and with industry groups in the public comment process that would accompany any rule change proposal. Federated is unable to assess the degree of any potential impact such additional reforms may have on its business and operations until such proposals are issued. Even when issued, the final version of any rule amendment could vary significantly from the form in which it is proposed.
(b) Historically Low Short-Term Interest Rates
Throughout 2011 and 2012, the Federal Reserve left the near-zero federal funds rate unchanged and short-term interest rates continued at all-time low levels. Since the fourth quarter 2008, Federated has voluntarily waived fees in order for certain money market funds to maintain positive or zero net yields. These fee waivers were partially offset by related reductions in distribution expense and net income attributable to noncontrolling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the waivers.

These voluntary fee waivers are calculated as a percent of AUM in certain money market funds and thus will vary dependent upon the asset levels in such funds. In addition, the level of waivers are dependent on several other factors including, but not limited to, available yields on instruments held by the money market funds, changes in expenses of the money market funds and changes in the mix of money market assets. In any given period, a combination of these factors drives the amount of fee waivers necessary in order for certain funds to maintain positive or zero net yields. As an isolated variable, an increase in yields on instruments held by the money market funds will cause fee waivers to decrease. Conversely, as an isolated variable, an increase in expenses of the money market fund would cause fee waivers to increase.

With regard to asset mix, changes in the relative amount of money market fund assets in prime and government money market funds as well as the distribution among certain share classes that vary in pricing structure will impact the level of fee waivers. Generally, prime money market funds waive less than government money market funds as a result of higher gross yields on the underlying investments. As such, as an isolated variable, an increase in the relative proportion of average managed assets invested in prime money market funds as compared to total average money market fund assets should typically result in lower waivers to maintain positive or zero net yields. Conversely, the opposite would also be true.
The impact of such fee waivers on various components of Federated's Consolidated Statements of Income was as follows for the years ended December 31:
 
 
 
 
 
 
 
 
2012

 
2011

in millions
 
2012

 
2011

 
2010

 
vs. 2011

 
vs. 2010

Investment advisory fees
 
$
(177.2
)
 
$
(201.6
)
 
$
(134.3
)
 
12
 %
 
(50
)%
Other service fees
 
(113.8
)
 
(119.1
)
 
(107.3
)
 
4
 %
 
(11
)%
   Total Revenue
 
(291.0
)
 
(320.7
)
 
(241.6
)
 
9
 %
 
(33
)%
Less: Reduction in Distribution expense
 
218.5

 
232.3

 
186.6

 
(6
)%
 
24
 %
   Operating income
 
(72.5
)
 
(88.4
)
 
(55.0
)
 
18
 %
 
(61
)%
Less: Reduction in Noncontrolling interest
 
1.3

 
6.5

 
1.0

 
(80
)%
 
550
 %
Pre-tax impact
 
$
(71.2
)
 
$
(81.9
)
 
$
(54.0
)
 
13
 %
 
(52
)%
The negative pre-tax impact of fee waivers to maintain positive or zero net yields decreased in 2012 as compared to 2011 primarily as a result of improved yields on instruments held by the money market funds. During 2011, further declines in

 
2012 Annual Report
11

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

interest rates for certain money market investments drove an increase in these fee waivers as compared to 2010. (See Note (22) to the Consolidated Financial Statements for information regarding the quarterly pre-tax impact of these fee waivers.)

Based on recent commentary from the Federal Reserve Bank in its January 30, 2013 press release, “the current highly accommodative stance of monetary policy will remain appropriate for a considerable time…,” Federated is unable to predict when the Federal Reserve will increase its target for the federal funds rate. As such, fee waivers to maintain positive or zero net yields and the related reduction in distribution expense and net income attributable to noncontrolling interests could continue for the foreseeable future. Assuming asset levels and mix remain constant and based on recent market conditions including the lower short-term interest rate environment in the first quarter of 2013 as compared to the fourth quarter of 2012, fee waivers for the first quarter 2013 may result in a negative pre-tax impact on income of approximately $21 million. While the level of fee waivers are impacted by various factors, increases in short-term interest rates that result in higher yields on securities purchased in money market fund portfolios would reduce the negative pre-tax impact of these waivers. Management estimates that an increase of 10 basis points in gross yields on securities purchased in money market fund portfolios will likely reduce the negative pre-tax impact of these waivers by approximately forty percent from the current levels and an increase of 25 basis points would reduce the impact by approximately seventy percent from the current levels. The actual amount of future fee waivers could vary significantly from management’s estimates as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, available yields on instruments held by the money market funds, actions by the Federal Reserve, the U.S. Department of the Treasury, the SEC, FSOC and other governmental entities, changes in expenses of the money market funds, changes in the mix of money market customer assets, Federated’s willingness to continue the fee waivers and changes in the extent to which the impact of the waivers is shared by third parties. 
Global Expansion
Federated continues to explore opportunities to further expand its global footprint. In the second quarter 2012, Federated completed the acquisition of London-based Prime Rate Capital Management LLP, a cash management firm with $4.3 billion in money market AUM as of the date of acquisition. In the third quarter 2012, Federated expanded its European distribution capabilities through an agreement with Bury Street Capital, a European distribution firm based in London. Federated also expanded into the Asia-Pacific region by opening an office in Australia. The expansion into the Asia-Pacific region will result in increased operating costs that could approximate $5 million over the next twelve months. The actual increase in operating costs could vary significantly from management’s estimates as further business development plans are finalized and implemented.
Prior Year Business Combinations and Acquisitions
In the third quarter 2010, Federated acquired the money market management business of SunTrust Banks, Inc. (SunTrust Acquisition). Pursuant to the acquisition agreement, $14.1 billion of money market assets transitioned to Federated in a series of closings during the third and fourth quarters of 2010. The SunTrust Acquisition included upfront cash payments that totaled $6.6 million. The transaction also includes annual contingent purchase price payments payable in the fourth quarters of each of the five years following the acquisition date. See Note (3) and Note (20)(a) to the Consolidated Financial Statements for additional information on this acquisition and the related contingent payments.
Insurance Proceeds

In 2012 and 2010, Federated obtained the final approvals from various insurance carriers for claims submitted over the past several years related to various legal proceedings. Accordingly, in 2012 and 2010 Federated recognized $20.2 million and $25.0 million, respectively, in the Consolidated Statements of Income as a reduction to the operating expense lines originally charged, primarily Professional service fees.
Special Cash Dividend
In the fourth quarter 2012, Federated paid $1.51 per share, or $156.9 million, as a special cash dividend to shareholders. This payment was in addition to the aggregate $0.96 per share, or $99.9 million, regular quarterly cash dividends paid throughout the course of 2012. The fourth quarter 2012 special dividend of $1.51 per share negatively impacted diluted earnings per share for the fourth quarter 2012 by $0.04 per share and for the full-year 2012 by $0.02 per share due to the application of the two-class method of calculating earnings per share.
In the first quarter 2010, Federated paid $1.26 per share, or $129.8 million, as a special cash dividend to shareholders. This payment was in addition to the aggregate $0.96 per share, or $98.9 million, regular quarterly cash dividends paid throughout the course of 2010. The first quarter 2010 special dividend of $1.26 per share negatively impacted diluted earnings per share for the

12
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

first quarter 2010 by $0.03 per share and for the full-year 2010 by $0.01 per share due to the application of the two-class method of calculating earnings per share.
All dividends were considered ordinary dividends for tax purposes.
Asset Impairments
In 2012, Federated recorded a $3.0 million charge to write down the value of its equity-method investment and in 2010, recorded a $10.2 million charge to write down the value of certain intangible assets. See Note (6)(b) to the Consolidated Financial Statements for additional information regarding these impairments.


 
2012 Annual Report
13

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Asset Highlights
Managed Assets at Period End
in millions as of December 31,
 
2012

 
2011

 
Percent
Change

By Asset Class
 
 
 
 
 
 
Money market
 
$
284,704

 
$
285,140

 
0
 %
Fixed-income
 
52,711

 
44,814

 
18
 %
Equity
 
35,010

 
30,887

 
13
 %
Liquidation portfolios1
 
7,346

 
8,856

 
(17
)%
Total managed assets
 
$
379,771

 
$
369,697

 
3
 %
By Product Type
 
 
 
 
 
 
Mutual Funds:
 
 
 
 
 
 
Money market
 
$
255,689

 
$
255,857

 
0
 %
Fixed-income
 
42,478

 
37,241

 
14
 %
Equity
 
23,152

 
21,930

 
6
 %
Total mutual fund assets
 
321,319

 
315,028

 
2
 %
Separate Accounts:
 
 
 
 
 
 
Money market
 
$
29,015

 
$
29,283

 
(1
)%
Fixed-income
 
10,233

 
7,573

 
35
 %
Equity
 
11,858

 
8,957

 
32
 %
Total separate account assets
 
51,106

 
45,813

 
12
 %
Liquidation Portfolios1
 
$
7,346

 
$
8,856

 
(17
)%
Total managed assets
 
$
379,771

 
$
369,697

 
3
 %

Average Managed Assets
in millions for the years ended December 31,
 
2012

 
2011

 
2010

 
2012
vs. 2011

 
2011
vs. 2010

By Asset Class
 
 
 
 
 
 
 
 
 
 
Money market
 
$
274,206

 
$
271,501

 
$
268,701

 
1
 %
 
1
 %
Fixed-income
 
48,986

 
42,573

 
37,690

 
15
 %
 
13
 %
Equity
 
33,816

 
30,560

 
29,104

 
11
 %
 
5
 %
Liquidation portfolios1
 
8,141

 
9,753

 
11,579

 
(17
)%
 
(16
)%
Total average managed assets
 
$
365,149

 
$
354,387

 
$
347,074

 
3
 %
 
2
 %
By Product Type
 
 
 
 
 
 
 
 
 
 
Mutual Funds:
 
 
 
 
 
 
 
 
 
 
Money market
 
$
246,731

 
$
242,187

 
$
238,767

 
2
 %
 
1
 %
Fixed-income
 
39,941

 
34,455

 
30,864

 
16
 %
 
12
 %
Equity
 
23,015

 
22,071

 
21,016

 
4
 %
 
5
 %
Total average mutual fund assets
 
309,687

 
298,713

 
290,647

 
4
 %
 
3
 %
Separate Accounts:
 
 
 
 
 
 
 
 
 
 
Money market
 
$
27,475

 
$
29,314

 
$
29,934

 
(6
)%
 
(2
)%
Fixed-income
 
9,045

 
8,118

 
6,826

 
11
 %
 
19
 %
Equity
 
10,801

 
8,489

 
8,088

 
27
 %
 
5
 %
Total average separate account assets
 
47,321

 
45,921

 
44,848

 
3
 %
 
2
 %
Liquidation Portfolios1
 
$
8,141

 
$
9,753

 
$
11,579

 
(17
)%
 
(16
)%
Total average managed assets
 
$
365,149

 
$
354,387

 
$
347,074

 
3
 %
 
2
 %
1
Liquidation portfolios include portfolios of distressed fixed-income securities. Federated has been retained by a third party to manage these assets through an orderly liquidation process that will generally occur over a multi-year period.

14
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Changes in Federated’s average asset mix year-over-year across both asset and product types have a direct impact on Federated’s operating income. As described above, asset mix impacts Federated’s total revenue due to the difference in the fee rates earned on each asset class and product type per invested dollar and certain components of distribution expense can vary depending upon the asset class, distribution channel and/or the size of the customer relationship. The following table presents the relative composition of average managed assets and the percent of total revenue derived from each asset class and product type over the last three years:
 
 
Percent of Total Average Managed Assets
 
Percent of Total Revenue
 
 
2012

 
2011

 
2010

 
2012

 
2011

 
2010

By Asset Class
 
 
 
 
 
 
 
 
 
 
 
 
Money market assets
 
75
%
 
76
%
 
78
%
 
47
%
 
46
%
 
50
%
Fixed-income assets
 
14
%
 
12
%
 
11
%
 
21
%
 
20
%
 
18
%
Equity assets
 
9
%
 
9
%
 
8
%
 
31
%
 
33
%
 
31
%
Liquidation portfolios
 
2
%
 
3
%
 
3
%
 
0
%
 
0
%
 
0
%
Other activities
 
--

 
--

 
--

 
1
%
 
1
%
 
1
%
By Product Type
 
 
 
 
 
 
 
 
 
 
 
 
Mutual Funds:
 
 
 
 
 
 
 
 
 
 
 
 
Money market assets
 
68
%
 
68
%
 
69
%
 
46
%
 
45
%
 
49
%
Fixed-income assets
 
11
%
 
10
%
 
9
%
 
19
%
 
19
%
 
17
%
Equity assets
 
6
%
 
6
%
 
6
%
 
26
%
 
28
%
 
27
%
Separate Accounts:
 
 
 
 
 
 
 
 
 
 
 
 
Money market assets
 
7
%
 
8
%
 
9
%
 
1
%
 
1
%
 
1
%
Fixed-income assets
 
3
%
 
2
%
 
2
%
 
2
%
 
1
%
 
1
%
Equity assets
 
3
%
 
3
%
 
2
%
 
5
%
 
5
%
 
4
%
Liquidation Portfolios
 
2
%
 
3
%
 
3
%
 
0
%
 
0
%
 
0
%
Other activities
 
--

 
--

 
--

 
1
%
 
1
%
 
1
%
Total managed assets represent the balance of AUM at a point in time. By contrast, average managed assets represent the average balance of AUM during a period of time. Because substantially all revenue and certain components of distribution expense are generally calculated daily based on AUM, changes in average managed assets are typically a key indicator of changes in revenue earned and asset-based expenses incurred during the same period.
December 31, 2012 period-end and average managed assets for the year then ended increased 3% over December 31, 2011 period-end and average managed assets for the year then ended primarily as a result of increases in fixed-income and equity assets. Period-end money market assets remained flat for 2012 compared to 2011. Average money market assets increased 1% for 2012 compared to 2011. The financial markets posted a strong performance in 2012 despite the continued pressure of global macroeconomic events, including political uncertainty regarding U.S. election outcomes and fiscal policies on taxes and federal spending as well as the ongoing effects of the global financial crisis. Short-term interest rates remained low as 2012 proved to be another historic year for U.S. Federal Reserve quantitative easing. Federated experienced net sales in both equity and fixed-income asset classes in 2012, once again led by income-oriented investment strategies. Average equity assets increased 11% for 2012 compared to 2011. Period-end equity assets increased 13% for 2012 as compared to 2011 primarily due to market appreciation and, to a lesser extent, positive net sales. Average fixed-income assets increased 15% for 2012 as compared to 2011. Period-end fixed-income assets increased 18% for 2012 as compared to 2011 primarily due to positive net sales and, to a lesser extent, market appreciation. Average assets in liquidation portfolios decreased 17% for 2012 as compared to 2011 due to the anticipated gradual liquidation of the portfolio.
December 31, 2011 period-end managed assets increased 3% over period-end managed assets at December 31, 2010 primarily as a result of increases in money market assets and fixed-income assets. Average managed assets for 2011 increased 2% over average managed assets for 2010. Period-end money market assets increased 3% for 2011 compared to 2010. Average money market assets increased 1% for 2011 compared to 2010. In 2011, the financial markets experienced extreme volatility, driven by the effects of the global financial crisis and uncertainty surrounding U.S. policies regarding deficit reduction and federal debt ceiling limits. Historically low interest rates persisted in 2011. In this environment, investors favored income-seeking strategies. As a result, Federated experienced net sales in both equity and fixed-income asset classes in 2011. Average equity assets increased 5% for 2011 compared to 2010, while period-end equity assets remained flat. Strong net sales in certain equity portfolios investing in domestic and international dividend-paying companies were largely offset by market depreciation and net redemptions in other equity products. In addition, Federated completed two acquisitions in mid-2011 which resulted in an increase in equity assets. Period-end fixed-income assets increased 10% and average fixed-income assets increased 13% for

 
2012 Annual Report
15

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

2011 as compared to 2010. Net sales in the multi-sector and high-yield bond strategies and market appreciation drove the increase. Average assets in liquidation portfolios decreased 16% for 2011 as compared to 2010 due to the anticipated gradual liquidation of the portfolio.

Changes in Fixed-Income and Equity Fund Assets
in millions for the years ended December 31,
 
2012

 
2011

 
Percent
Change

Fixed-Income Funds
 
 
 
 
 
 
Beginning assets
 
$
37,241

 
$
31,933

 
17
 %
Sales
 
20,426

 
17,990

 
14
 %
Redemptions
 
(15,664
)
 
(15,844
)
 
(1
)%
Net sales
 
4,762

 
2,146

 
122
 %
Net exchanges
 
(1,520
)
 
1,873

 
(181
)%
Acquisition-related
 
144

 
132

 
9
 %
Market gains and losses/reinvestments1
 
1,851

 
1,157

 
60
 %
Ending assets
 
$
42,478

 
$
37,241

 
14
 %
Equity Funds
 
 
 
 
 
 
Beginning assets
 
$
21,930

 
$
22,626

 
(3
)%
Sales
 
6,221

 
7,633

 
(18
)%
Redemptions
 
(7,377
)
 
(7,461
)
 
(1
)%
Net (redemptions) sales
 
(1,156
)
 
172

 
(772
)%
Net exchanges
 
(70
)
 
(76
)
 
8
 %
Acquisition-related
 
190

 
463

 
(59
)%
Market gains and losses/reinvestments1
 
2,258

 
(1,255
)
 
280
 %
Ending assets
 
$
23,152

 
$
21,930

 
6
 %
1
Reflects approximate changes in the fair value of the securities held by the funds, and, to a lesser extent, reinvested dividends, distributions, net investment income and the impact of changes in foreign exchange rates.

16
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Changes in Fixed-Income and Equity Separate Account Assets and Liquidation Portfolios
in millions for the years ended December 31,
 
2012

 
2011

 
Percent
Change

Fixed-Income Separate Accounts
 
 
 
 
 
 
Beginning assets
 
$
7,573

 
$
8,772

 
(14
)%
Sales2
 
1,546

 
1,698

 
(9
)%
Redemptions2
 
(1,128
)
 
(1,443
)
 
(22
)%
Net sales2
 
418

 
255

 
64
 %
Net exchanges
 
1,593

 
(1,806
)
 
188
 %
Market gains and losses/reinvestments3
 
649

 
352

 
84
 %
Ending assets
 
$
10,233

 
$
7,573

 
35
 %
Equity Separate Accounts
 
 
 
 
 
 
Beginning assets
 
$
8,957

 
$
8,176

 
10
 %
Sales2
 
4,252

 
2,861

 
49
 %
Redemptions2
 
(2,291
)
 
(2,530
)
 
(9
)%
Net sales2
 
1,961

 
331

 
492
 %
Net exchanges
 
(8
)
 
54

 
(115
)%
Market gains and losses/reinvestments3
 
948

 
396

 
139
 %
Ending assets
 
$
11,858

 
$
8,957

 
32
 %
Liquidation Portfolios
 
 
 
 
 
 
Beginning assets
 
$
8,856

 
$
10,708

 
(17
)%
Sales2
 
0

 
2

 
(100
)%
Redemptions2
 
(1,509
)
 
(1,854
)
 
(19
)%
Net redemptions2
 
(1,509
)
 
(1,852
)
 
(19
)%
Market gains and losses/reinvestments3
 
(1
)
 
0

 
N/A

Ending assets
 
$
7,346

 
$
8,856

 
(17
)%
2
For certain accounts, Sales, Redemptions or Net sales/redemptions are calculated as the remaining difference between beginning and ending assets after the calculation of Market gains and losses/reinvestments.
3
Reflects approximate changes in the fair value of the securities held in the portfolios, and, to a lesser extent, reinvested dividends, distributions, net investment income and the impact of changes in foreign exchange rates.

Results of Operations
Revenue. The following table sets forth components of total revenue for the three years ended December 31:
in millions
 
2012

 
2011

 
2010

 
2012
vs. 2011

 
2011
vs. 2010

Revenue from managed assets
 
$
937.9

 
$
887.1

 
$
944.4

 
6
 %
 
(6
)%
Revenue from sources other than managed assets
 
7.8

 
8.0

 
7.5

 
(3
)%
 
7
 %
Total revenue
 
$
945.7

 
$
895.1

 
$
951.9

 
6
 %
 
(6
)%
Revenue from managed assets increased $50.8 million in 2012 as compared to 2011 primarily due to a decrease of $29.7 million in voluntary fee waivers related to certain money market funds in order for these funds to maintain positive or zero net yields and an increase of $19.2 million due to higher average fixed-income assets.
See Business Developments – Historically Low Short-Term Interest Rates for additional information on voluntary fee waivers related to certain money market funds in order for these funds to maintain positive or zero net yields, including the offsetting decreases in expense and net income attributable to noncontrolling interests, the net pre-tax impact on income and a discussion of management's expectation regarding the pre-tax impact on income from fee waivers for the first quarter of 2013.
Federated’s ratio of revenue from managed assets to average managed assets for 2012 was 0.26% as compared to 0.25% for 2011. The increase in the rate was primarily due to the decrease in voluntary fee waivers to maintain positive or zero net yields for 2012 as compared to 2011.

 
2012 Annual Report
17

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Revenue from managed assets decreased $57.3 million in 2011 as compared to 2010 primarily due to an increase of $79.1 million in voluntary fee waivers related to certain money market funds in order for these funds to maintain positive or zero net yields. The decrease in revenue was partially offset by an increase of $13.4 million due to higher average fixed-income assets, an increase of $9.1 million resulting from higher average money market assets (inclusive of an increase in revenue of approximately $26.6 million from average assets attributable to the SunTrust Acquisition) and an increase of $3.5 million due to higher average equity assets.
Federated’s ratio of revenue from managed assets to average managed assets for 2011 was 0.25% as compared to 0.27% for 2010. The decrease in the rate was primarily due to the significant increase in voluntary fee waivers to maintain positive or zero net yields for 2011 as compared to 2010.
 
Operating Expenses. The following table sets forth significant fluctuations in operating expenses for the three years ended December 31: 
in millions
 
2012

 
2011

 
2010

 
2012
vs. 2011

 
2011
vs. 2010

Compensation and related
 
$
257.6

 
$
245.4

 
$
242.9

 
5
 %
 
1
 %
Distribution
 
253.4

 
235.7

 
259.2

 
8
 %
 
(9
)%
Professional service fees
 
18.9

 
53.7

 
19.0

 
(65
)%
 
183
 %
Intangible asset related
 
2.6

 
7.9

 
22.5

 
(67
)%
 
(65
)%
All other
 
100.6

 
95.0

 
98.6

 
6
 %
 
(4
)%
Total operating expenses
 
$
633.1

 
$
637.7

 
$
642.2

 
(1
)%
 
(1
)%
Total operating expenses for 2012 decreased $4.6 million compared to 2011. Professional service fees decreased $34.8 million primarily due to a $20.2 million decrease related to the recognition of insurance proceeds in 2012 (See Business Developments – Insurance Proceeds for additional information) and a $17.2 million decrease in expenses related to non-recurring legal proceedings in 2011. Distribution expense increased $17.7 million in 2012 as compared to 2011 primarily due to a $13.8 million increase resulting from lower fee waivers associated with maintaining positive or zero net yields in certain money market funds and a $4.7 million increase related to higher average fixed-income assets. Compensation and related expense increased $12.2 million in 2012 as compared to 2011 reflecting a $5.9 million increase in base compensation primarily due to increased headcount and a $5.4 million increase in incentive compensation. Intangible asset related expense decreased $5.3 million primarily due to a $2.2 million decrease due to certain intangible assets becoming fully amortized in 2011 and a $1.7 million decrease related to changes in fair value of acquisition-related future consideration liabilities.
Total operating expenses for 2011 decreased $4.5 million compared to 2010. Professional service fees increased $34.7 million primarily due to the recognition of $25.0 million in insurance proceeds in 2010 related to various previously disclosed legal proceedings, $21.6 million of which was recorded as a reduction to Professional service fees. See Business Developments – Insurance Proceeds for additional information. In addition, there was an $8.5 million increase in Professional service fees related to certain of these legal proceedings. Distribution expense decreased $23.5 million in 2011 as compared to 2010 primarily due to a $45.7 million decrease as a result of higher fee waivers associated with maintaining positive or zero net yields in certain money market funds, partially offset by a $17.5 million increase related to the client mix of average money market assets in 2011 as compared to 2010 and a $4.2 million increase resulting from higher average fixed-income assets in 2011 as compared to 2010. Intangible asset related expense decreased $14.6 million primarily due to the $8.2 million impairment of certain intangible assets in 2010 and a $5.4 million decrease due to certain intangible assets becoming fully amortized in 2010 and the second quarter of 2011. See Note (6)(b) to the Consolidated Financial Statements for additional information on these impairments. Compensation and related expense increased $2.5 million in 2011 as compared to 2010 reflecting a $3.1 million increase in base compensation primarily due to merit increases and a $1.1 million increase in other compensation, including payroll taxes and benefits. These increases were partially offset by a $1.7 million decrease in incentive compensation.
Nonoperating Income (Expenses). Nonoperating expenses, net, decreased $7.0 million in 2012 as compared to 2011. The decrease reflects a $5.5 million increase in Gain on securities, net due primarily to increases in fair values of trading securities held ($3.1 million) and increased realized gains on Investments—affiliates ($1.4 million), a $2.6 million decrease in Debt expense primarily due to decreased average outstanding loan balances ($1.7 million) and a lower average interest rate ($1.2 million) due to Federated refinancing this debt in June 2011 (see Note (11) to the Consolidated Financial Statements for additional information) and a $1.9 million increase in Investment income, net primarily due to a higher average yield on Federated's investment portfolio. This decrease was partially offset by a $3.0 million increase in Other, net primarily due to an

18
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

impairment charge recorded in 2012 to write down the value of Federated's equity-method investment to fair value (see Note (6)(b) to the Consolidated Financial Statements for additional information).
Nonoperating expenses, net, increased $2.4 million in 2011 as compared to 2010. The increase reflects a $2.1 million decrease in Gain on securities, net due primarily to decreases in fair values of trading securities held during 2011 as compared to 2010 and an increase of $2.0 million in Debt expense primarily resulting from loan borrowings outstanding for a full year in 2011 as compared to a partial year in 2010. See Liquidity and Capital Resources – Borrowings for additional information.This was partially offset by a $1.5 million increase in Investment income, net in 2011 as compared to 2010 due primarily to increases in average investment balances and investments in higher yielding products.
Income Taxes. The income tax provision for 2012, 2011, and 2010 was $110.9 million, $91.3 million, and $112.0 million, respectively. The provision for 2012 increased $19.6 million as compared to 2011 primarily due to higher Income before income taxes. The provision for 2011 decreased $20.7 million as compared to 2010 primarily due to lower Income before income taxes. The effective tax rate was 35.9% for 2012, 37.1% for 2011 and 37.2% for 2010. See Note (16) to the Consolidated Financial Statements for additional information on the effective tax rate, as well as other tax disclosures.
For 2012, Federated’s pretax book income was $76.8 million in excess of federal taxable income due primarily to temporary tax differences of $56.4 million associated with certain intangible assets, $9.2 million associated with capital losses recognized in 2012 for tax purposes for which impairment charges had been recognized in a prior year for book purposes and $8.3 million related to the insurance proceeds recognized as income for book purposes in 2012 versus when received in a prior year for tax purposes. See Business Developments – Insurance Proceeds for additional information.
For 2011, Federated’s pretax book income was $50.9 million in excess of federal taxable income due primarily to $53.4 million in temporary tax differences associated with certain intangible assets.
For 2010, Federated’s pretax book income was $69.0 million in excess of federal taxable income due primarily to $33.8 million in temporary tax differences associated with certain intangible assets and $20.8 million in temporary tax differences related to the insurance proceeds recognized as income for book purposes in 2010 versus when received in a prior year for tax purposes. See Business Developments – Insurance Proceeds for additional information.

Net Income attributable to Noncontrolling Interests in Subsidiaries. Net income attributable to noncontrolling interests in subsidiaries increased $5.4 million for 2012 as compared to 2011 primarily due to the impact of lower fee waivers associated with maintaining positive or zero net yields in certain money market funds.

Net income attributable to noncontrolling interests in subsidiaries decreased $5.9 million for 2011 as compared to 2010 primarily due to the impact of higher fee waivers associated with maintaining positive or zero net yields in certain money market funds.
Net Income attributable to Federated Investors, Inc. Net income increased $37.2 million in 2012 as compared to 2011 primarily as a result of the changes in revenues and expenses noted above. Diluted earnings per share for the year ended December 31, 2012 increased $0.34 as compared to the same period of 2011 primarily due to increased net income.
Net income decreased $28.2 million in 2011 as compared to 2010 primarily as a result of the changes in revenues and expenses noted above. Diluted earnings per share for the year ended December 31, 2011 decreased $0.28 as compared to the same period of 2010 primarily due to decreased net income.
Liquidity and Capital Resources
Liquid Assets. At December 31, 2012, liquid assets, consisting of cash and cash equivalents, investments and receivables, totaled $282.7 million as compared to $343.8 million at December 31, 2011. The decrease of $61.1 million primarily reflects a decrease of $58.5 million in Investments—other due primarily to net redemptions of trading securities and a decrease of $23.5 million in Investments—affiliates due primarily to net redemptions of available-for-sale securities in 2012, partially offset by an increase of $18.3 million in Cash and cash equivalents, which is described further in the discussion below.
At December 31, 2012, Federated's liquid assets included investments in certain Federated-sponsored money market and fluctuating-value funds that may have direct and/or indirect exposures to international sovereign debt and currency risks. Federated has been actively monitoring its money market, fixed-income and equity portfolios to manage sovereign debt and currency risks with respect to recent events in certain euro-zone countries. Federated's experienced portfolio managers and analysts work to evaluate credit risk through quantitative and fundamental analysis. Further, for cash invested in certain money

 
2012 Annual Report
19

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

market funds (approximately $53 million), only indirect short-term exposures exist primarily to high-quality international bank names that are subject to Federated's credit analysis process and meet the requirements of Rule 2a-7.
Cash Provided by Operating Activities. Net cash provided by operating activities totaled $316.3 million for 2012 as compared to $113.5 million for 2011. The increase of $202.8 million was primarily due to a $169.1 million increase in net sales of trading securities and an increase in cash received from customers due to the $50.8 million increase in revenue from managed assets previously discussed.
Cash Provided by Investing Activities. In 2012, cash provided by investing activities was $11.4 million and was primarily related to $92.4 million in redemptions of available-for-sale securities, partially offset by $58.3 million in cash paid for purchases of available-for-sale securities and $14.1 million in cash paid in connection with acquisitions. See the section entitled Contractual Obligations and Contingent Liabilities for additional information on payments made in connection with acquisitions.
Cash Used by Financing Activities. In 2012, cash used by financing activities was $309.4 million. During 2012, Federated paid $256.8 million or $2.47 per share in dividends to holders of its common shares, $156.9 million or $1.51 per share of which related to a special cash dividend to shareholders. Federated also repaid $42.5 million during 2012 in connection with its long-term debt obligations (see Note (11) to the Consolidated Financial Statements for additional information).
Borrowings. In the second quarter 2011, Federated entered into an Amended and Restated Credit Agreement with a syndicate of banks (Credit Agreement). The borrowings included a $382.5 million term loan (Term Loan) and $200 million revolving credit facility. Proceeds from the debt facilities have been used for general corporate purposes including cash payments related to acquisitions, dividends, investments and share repurchases. During each of 2012 and 2011, Federated made principal payments of $42.5 million on the Term Loan. As of December 31, 2012, the entire $200 million revolving credit facility was available for borrowings. The interest rate swap (the Swap) that Federated entered into during 2010 to hedge its interest rate risk associated with the term loan remains in effect. The Swap converts the variable interest rate on the Term Loan to a fixed rate of 3.646%. See Note (11) to the Consolidated Financial Statements for additional information.
The Credit Agreement has an interest coverage ratio covenant (consolidated earnings before interest, taxes, depreciation and amortization (EBITDA) to consolidated interest expense) and a leverage ratio covenant (consolidated debt to consolidated EBITDA) as well as other customary terms and conditions. An interest coverage ratio of at least 4 to 1 is required and as of December 31, 2012, the interest coverage ratio was 27.00 to 1. A leverage ratio of no more than 2.5 to 1 is required and as of December 31, 2012, the leverage ratio was 0.91 to 1. Federated was in compliance with its interest coverage and leverage ratios at and during the year ended December 31, 2012. The Credit Agreement and the Swap also have certain stated events of default and cross default provisions which would permit the lenders/counterparties to accelerate the repayment of the debt or the Swap if not cured within the applicable grace periods. The events of default generally include breaches of contract, failure to make required loan payments, insolvency, cessation of business, deterioration in credit rating to below investment grade, notice of lien or assessment and other proceedings, whether voluntary or involuntary, that would require the repayment of amounts borrowed.
Future Cash Needs. In addition to the contractual obligations and contingent liabilities described below, management expects that principal uses of cash will include paying incentive and base compensation, funding distribution expenditures, paying shareholder dividends, repaying debt obligations, funding business acquisitions and global expansion, paying taxes, repurchasing company stock, advancing sales commissions, seeding new products and funding property and equipment acquisitions, including computer-related software and hardware. As a result of the highly regulated nature of the investment management business, management anticipates that expenditures for compliance and investment management personnel, compliance systems and related professional and consulting fees may continue to increase.
On January 24, 2013, the board of directors declared a $0.24 per share dividend to shareholders of record as of February 8, 2013, which was paid on February 15, 2013.
After evaluating Federated’s existing liquid assets, expected continuing cash flow from operations, its remaining borrowing capacity under the revolving credit facility of the Credit Agreement and its ability to obtain additional financing arrangements and issue debt or stock, management believes it will have sufficient liquidity to meet its present and reasonably foreseeable cash needs. Although management currently is not projecting to draw on the availability under the revolving credit facility in 2013, management may choose to borrow additional amounts up to the maximum available under the revolving credit facility which could cause total outstanding borrowings to total as much as $508 million.

20
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Management estimates that of the $14.1 million of deferred tax assets (net of valuation allowances) at December 31, 2012, $6.9 million and $1.7 million will reverse in 2013 and 2014, respectively, as tax deductions are taken in those years for various expenses recorded in 2012 or prior years, such as certain compensation-related expenses. In addition, a $3.9 million deferred tax asset associated with the Swap is expected to reverse no later than its expiration in 2015.
Financial Position
The following discussion summarizes significant changes in assets and liabilities that are not discussed elsewhere in Management’s Discussion and Analysis of Financial Condition and Results of Operations and the status of Federated's goodwill and equity-method investment as of December 31, 2012.
Long-term deferred tax liability, net at December 31, 2012 increased $26.2 million from December 31, 2011 primarily as a result of tax amortization in excess of book amortization of intangible assets.
There were no indicators of goodwill impairment as of December 31, 2012 as Federated's market capitalization exceeded the book value of equity by more than 300%.

Federated holds a 12% non-voting, noncontrolling interest in a privately-held investment management firm that is registered as an investment adviser and a commodity trading adviser. This investment is accounted for using the equity-method of accounting. Federated's investment in and maximum exposure to loss related to its equity-method investment as compared to its proportionate share of the investee's underlying net assets is characterized as goodwill. Federated evaluates the carrying value of its investment for other-than-temporary impairment under the equity-method of accounting. Due to declines in the investee's AUM, their performance relative to indices and the uncertainty regarding each in the future, management estimated the fair value of its investment at June 30, 2012 and September 30, 2012. Based on the evaluation of qualitative and quantitative factors, management concluded that the investment was not other-than-temporarily impaired as of June 30, 2012 and September 30, 2012.

In light of significant declines in the investee's AUM in the fourth quarter of 2012 and lower short-term growth forecasts in AUM, management once again estimated the fair value of its investment at December 31, 2012 and considered whether it was other-than-temporarily impaired. The estimate of fair value was based primarily upon the present value of expected future cash flows using an income-approach valuation methodology with unobservable data inputs (Level 3). Significant unobservable model inputs included: (1) projected AUM across product lines with a 10-year compounded annual growth rate of 15% and a terminal growth rate of 3%; and (2) a 17% discount rate based upon the current estimated market rate of return. Based on management's evaluation of qualitative and quantitative factors, management concluded that the investment was other-than-temporarily impaired as of December 31, 2012. Accordingly, Federated recorded a $3.0 million impairment charge in Nonoperating Income (Expenses)Other, net to write down the equity-method investment to a fair value of $3.8 million. Given uncertainties regarding the success of future sales efforts and possible prolonged periods of over/underperformance compared to indices and the significance of these factors to AUM, management cannot be certain of the outcome of future cash flow analyses.
Off-Balance Sheet Arrangements
As of December 31, 2012 and 2011, Federated did not have any material off-balance sheet arrangements.


 
2012 Annual Report
21

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Contractual Obligations and Contingent Liabilities
Contractual. The following table presents as of December 31, 2012, Federated’s significant minimum noncancelable contractual obligations by payment date. The payment amounts represent amounts contractually due to the recipient and do not include any unamortized discounts or other similar carrying value adjustments. Further discussion of the nature of each obligation is included either in the referenced Note to the Consolidated Financial Statements or in a footnote to the table.
  
 
 
 
Payments due in
 
 
in millions
 
Note
Reference
 
2013

 
2014-2015

 
2016-2017

 
After 2017

 
Total

Long-term debt obligations1
 
(11)
 
$
53.4

 
$
205.3

 
$
86.0

 
$
0

 
$
344.7

Operating lease obligations
 
(15)
 
12.7

 
21.9

 
18.2

 
28.5

 
81.3

Purchase obligations2
 
 
 
20.0

 
8.5

 
1.0

 
0.2

 
29.7

Employment-related commitments3
 
 
 
16.9

 
7.7

 
0

 
0

 
24.6

Acquisition-related commitments4
 
(20)
 
4.5

 
0

 
0

 
0

 
4.5

Total
 
 
 
$
107.5

 
$
243.4

 
$
105.2

 
$
28.7

 
$
484.8

1
Amounts include principal and interest payments. Assuming the debt amortization schedule and the fixed interest rate in effect at December 31, 2012 as a result of the Swap (see Note (11) to the Consolidated Financial Statements), Federated’s minimum contractual interest payments would be approximately $10.9 million, $14.0 million and $1.0 million for 2013, 2014-2015 and 2016, respectively.
2
Federated is a party to various contracts pursuant to which it receives certain services including services for legal, marketing and information technology, access to various fund-related information systems and research databases, trade order transmission and recovery services as well as other services. These contracts contain certain minimum noncancelable payments, cancellation provisions and renewal terms. The contracts expire on various dates through the year 2019. Costs for such services are expensed as incurred.
3
Federated has certain domestic and international employment arrangements pursuant to which Federated is obligated to make minimum compensation payments. These contracts expire on various dates through the year 2014.
4
Amount represents Federated's obligation to make acquisition-related contingent purchase price payments in cases where the related contingencies are resolved as of December 31, 2012. For a full discussion of Federated's commitments regarding acquisition-related purchase price payments, see the discussion that follows herein under Contingent Payments.
Contingent Payments. Pursuant to various acquisition- and employee-related agreements, Federated is required to make certain periodic contingent payments. Details regarding these commitments are as follows:
As part of the SunTrust Acquisition, Federated is required to make annual contingent purchase price payments in the fourth quarters of each of the five years following the acquisition date. The contingent purchase price payments are calculated as a percentage of revenue less distribution expenses directly attributed to certain eligible assets. The first two contingent purchase price payments of $5.0 million and $4.2 million were paid in the fourth quarters of 2011 and 2012, respectively. At December 31, 2012, management estimated remaining contingent payments could total $11 million over the three years that remain; however, the actual amount of the contingent payments will vary based on asset levels and related net revenues and is not limited by any maximum amount. A wide range of outcomes for actual payments is possible due to the extent of reasonably possible flow-rate volatility for the respective AUM. As of December 31, 2012, a liability of $8.2 million representing the estimated fair value of future consideration payments was recorded in Other current liabilities ($3.5 million) and Other long-term liabilities ($4.7 million) (see Note (6)(a) for a discussion regarding the valuation methodology). This liability is remeasured at each reporting date with changes in the fair value recognized in Intangible asset related expense on the Consolidated Statements of Income.
In 2008, Federated completed the acquisition of certain assets of David W. Tice & Associates LLC that relate to the management of the Prudent Bear Fund and the Prudent DollarBear Fund (Prudent Bear Acquisition). As part of the Prudent Bear Acquisition, Federated was required to make contingent purchase price payments based upon certain revenue growth targets over the four-year period following the acquisition date. The contingent purchase price payments were recorded as additional goodwill at the time the contingency was resolved. The first two contingent purchase price payments of $5.1 million and $44.7 million were paid in the first quarters of 2010 and 2011, respectively. The applicable growth targets were not met for the third or fourth anniversary years. As such, no amount was paid related to the third anniversary year and no amount was accrued for the fourth and final anniversary year ended in December 2012.
In 2008, Federated completed the acquisition of certain assets of Clover Capital Management, Inc., a Rochester, New York-based investment manager that specializes in value investing (Clover Capital Acquisition). As part of the Clover Capital Acquisition, Federated is required to make contingent purchase price payments based upon growth in revenues over the five-

22
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

year period following the acquisition date. The contingent purchase price payments, which could total as much as $56 million, will be recorded as additional goodwill at the time the contingency is resolved. The applicable growth targets were not met for the first two anniversary years and as such, no related payments were made. In the first quarter 2012, $5.9 million was paid with regard to the third anniversary year ended in December 2011. As of December 31, 2012, $3.4 million was accrued for the fourth anniversary year ended in December 2012 and was paid in January 2013.
As part of the 2005 acquisition of the cash management business of Alliance Capital Management L.P. (Alliance Acquisition), Federated was required to make contingent purchase price payments over a five-year period following the acquisition date. These payments were primarily calculated as a percentage of revenues less certain distribution expenses directly attributed to the assets acquired. Contingent purchase price payments totaled $95.7 million, including $35.7 million paid in 2010, the final year of the contingent-payment period. Contingent payments were recorded as additional goodwill at the time the related contingency was resolved.
In 2007, Federated completed a transaction with Rochdale Investment Management LLC to acquire certain assets relating to its business of providing investment advisory and investment management services to the Rochdale Atlas Portfolio (Rochdale Acquisition). The Rochdale Acquisition agreement provided for two forms of contingent purchase price payments payable over the five-year period following the acquisition date based on certain revenue earned by Federated from the Federated InterContinental Fund and/or related asset growth and performance. Contingent purchase price payments over the five-year period totaled $8.0 million, which included payments totaling $2.1 million in 2010, $1.1 million in 2011 and $2.8 million in 2012, the final year of payment. Contingent payments were recorded as additional goodwill at the time the related contingency was resolved.
Pursuant to other acquisition agreements, Federated may be required to make additional purchase price payments based on a percentage of revenue less certain direct expenses attributable to eligible AUM. The payments could occur annually through 2017 and, based on current projections, are not expected to be material to the Consolidated Financial Statements.
In addition to the $16.9 million of employee-related commitments to be paid in 2013, Federated may be required to make certain incentive compensation-related payments in connection with various significant employment arrangements. The employment contracts expire on various dates through the year 2014 with payments possible through 2018. As of December 31, 2012, the maximum bonus payable over the remaining terms of the contracts approximates $43 million, none of which would be payable in 2013. In addition, certain employees have incentive compensation opportunities related to the Federated Kaufmann Large Cap Fund (the Fund Bonus). Based on asset levels at December 31, 2012, $0.6 million would be paid in 2013 as a Fund Bonus payment. Management is unable to reasonably estimate a range of possible bonus payments for the Fund Bonus for subsequent years due to the wide range of possible growth-rate scenarios.
Legal Proceedings. Federated has claims asserted and threatened against it in the ordinary course of business. As of December 31, 2012, Federated does not believe that a material loss related to these claims is reasonably possible.
Variable Interest Entities
Federated is involved with various entities in the normal course of business that may be deemed to be variable interest entities (VIEs). Federated determined that it was the primary beneficiary of certain investment-fund VIEs and, as a result, consolidated the assets, liabilities and operations of these VIEs in its Consolidated Financial Statements. See Note (5) to the Consolidated Financial Statements for more information.
Recent Accounting Pronouncements
For a complete list of new accounting standards recently adopted by Federated and new accounting standards issued, but not yet adopted by Federated, see Note (2) to the Consolidated Financial Statements.
Critical Accounting Policies
Federated’s Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). In preparing the financial statements, management is required to make estimates and assumptions that affect the amounts reported in the Consolidated Financial Statements and accompanying notes. Management continually evaluates the accounting policies and estimates it uses to prepare the Consolidated Financial Statements. In general, management’s estimates are based on historical experience, information from third-party professionals and various other assumptions that are believed to be reasonable under the facts and circumstances. Actual results may differ from those estimates made by management and those differences may be material.

 
2012 Annual Report
23

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

Of the significant accounting policies described in Note (1) to the Consolidated Financial Statements, management believes that its policies regarding accounting for intangible assets, acquisition-related future consideration liabilities and income taxes involve a higher degree of judgment and complexity.
Accounting for Intangible Assets. Three aspects of accounting for intangible assets require significant management estimates and judgment: (1) valuation in connection with the initial purchase price allocation; (2) ongoing evaluation for impairment and (3) reconsideration of an asset's useful life. The process of determining the fair value of identifiable intangible assets at the date of acquisition requires significant management estimates and judgment as to expectations for earnings on the related managed assets acquired, redemption rates for such managed assets, growth from sales efforts and the effects of market conditions. Management often utilizes an independent valuation expert to help with this process. If actual changes in the related managed assets or the projected useful life of the intangible asset, among other assumptions, differ significantly from the estimates and judgments used in determining the initial fair value, the intangible asset amounts recorded in the financial statements could be subject to possible impairment or could require an acceleration in amortization expense that could have a material adverse effect on Federated’s consolidated financial position and results of operations.
Indefinite-lived intangible assets are reviewed for impairment annually as of October 1 using a qualitative approach which requires the weighing of positive and negative evidence collected through the consideration of various factors to determine whether it is more likely than not that an indefinite-lived intangible asset or asset group is impaired. Management considers entity-specific and macroeconomic factors and their potential impact on significant inputs used to determine the fair value measurement for the indefinite-lived intangible assets including, primarily, changes in AUM, net revenue rates, operating margins, tax rates and discount rates. In addition, management reconsiders on a quarterly basis whether events or circumstances indicate that a change in the useful life may have occurred. Indicators of a possible change in useful life monitored by management include a significant decline in the level of managed assets, changes to legal, regulatory or contractual provisions of the renewable investment advisory contracts and reductions in underlying operating cash flows.
If actual changes in the underlying managed assets or other conditions indicate that it is more likely than not that the asset is impaired, or if the estimated useful life is reduced, management estimates the fair value of the intangible asset using an income approach where future cash flows are discounted. Impairment is indicated when the carrying value of the intangible asset exceeds its fair value.
At December 31, 2012, Federated had $70.4 million in indefinite-lived intangible assets recorded on its Consolidated Balance Sheets. Based on testing performed in 2012, 2011 and 2010, it was determined that no impairment or change in useful life existed for these assets. For the $8.7 million in finite-lived intangible assets, no indicators of impairment existed as of December 31, 2012 or 2011 and no impairments were recorded during the years then ended.
In 2010, in light of declines in AUM related to certain quantitative investment products acquired in 2006, and given the performance of these products relative to peers and indices, the carrying values of the related intangible assets were deemed to be impaired. Accordingly, Federated recorded $10.2 million in impairment charges on the Consolidated Statements of Income during 2010, $8.2 million of which was included in Intangible asset related expense with the remainder in Operating expenses – Other. See Note (6)(b) to the Consolidated Financial Statements for additional information.
Accounting for Acquisition-Related Future Consideration Liabilities. For acquisitions completed since January 1, 2009, Federated is required to carry its liability for future consideration payments at fair value each period end with changes in fair value recorded in earnings. As of December 31, 2012, the fair value of all acquisition-related future consideration liabilities was $11.8 million. Future consideration payments will be calculated as a percentage of revenue less certain distribution expenses directly attributed to eligible assets. The process of estimating the fair value of the related liabilities requires management estimates and judgment as to expectations for the amount of net revenue to be earned on the applicable AUM, net sales/redemptions for such AUM and the discount rate. Expected net revenue per managed asset is generally based on contract terms, historical experience and management's expectation regarding the impact of potential future fee waivers for certain money market funds to maintain positive or zero net yields. Net flow rates are estimated by evaluating historical net flow rates in similar funds and recent trends in the eligible AUM. The discount rate is estimated as the current market rate of return.
If actual amounts or management’s estimates and judgment regarding changes in the related managed assets, revenue earned from the managed assets or the discount rate, among other assumptions, differ significantly at a period-end date as compared to the estimates and judgments used in determining the fair value as of the prior period-end date, the adjustment to record the change in the fair value of the respective liability could result in a significant favorable or unfavorable adjustment to earnings which could have a material effect on Federated’s consolidated financial position and results of operations. See Note (6)(a) to the Consolidated Financial Statements for additional information regarding this liability.

24
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

  
Accounting for Income Taxes. Significant management judgment is required in developing Federated’s provision for income taxes and the determination of any valuation allowances related to deferred tax assets. As of December 31, 2012, Federated had recorded a valuation allowance on $3.5 million of its $4.0 million of deferred tax assets relating to capital losses (recognized for tax purposes). Federated considered various factors in connection with its evaluation of the partial realizability of these assets including: the five-year carry-forward period for capital losses, Federated's continued investment of available cash with the intent to generate capital gains and its history of generating capital gains in times of favorable market conditions. Based on these factors, management believes it is more likely than not that Federated will be able to utilize a portion of these losses in the future. In the event that Federated’s strategies do not materialize, Federated may be required to record an additional valuation allowance of as much as $0.5 million for these deferred tax assets.
Significant management judgment is required to account for uncertainty in income taxes. The processes of determining (1) whether it is more likely than not that a position will be sustained upon examination and (2) the largest amount of tax benefit that is greater than 50% likely of being realized upon ultimate settlement with the taxing authority require management estimates and judgment as to expectations of the amounts and probabilities of the outcomes that could be realized. Management considers the facts and circumstances available as of the reporting date in order to determine the appropriate tax benefit to recognize including tax legislation and statutes, legislative intent, regulations, rulings and case law. Significant differences could exist between the ultimate outcome of the examination of a tax position and management’s estimate. These differences could have a material impact on Federated’s effective tax rate, results of operations, financial position and/or cash flows.
Risk Factors
Potential Adverse Effects of a Material Concentration in Revenue. For 2012, approximately 47% of Federated’s total revenue was attributable to money market assets as compared to 46% and 50% for 2011 and 2010, respectively. The change in the relative proportion of Federated's revenue attributable to money market assets from 2011 to 2012 was primarily the result of decreases in fee waivers for certain money market funds to maintain positive or zero net yields. The decline in the relative proportion of Federated's revenue attributable to money market assets from 2010 to 2011 was primarily the result of increases in fee waivers for certain money market funds to maintain positive or zero net yields. A significant change in Federated’s money market business or a significant reduction in money market assets due to regulatory changes, changes in the financial markets including significant increases in interest rates over a short period of time, significant deterioration in investor confidence, further persistent declines in or additional prolonged periods of historically low short-term interest rates and resulting fee waivers or other circumstances, could have a material adverse effect on Federated’s results of operations.
Potential Adverse Effects of Historically Low Interest Rates. In December 2008, the Federal Reserve cut the federal funds target rate, a benchmark used by banks to set rates paid on many types of consumer and business loans, to a range between 0% and 0.25%. This action by the Federal Reserve negatively impacts the yields of money market funds, in particular treasury and government agency money market funds. Money market fund yields reflect the return on short-term investments (e.g. Treasury bills), less fund expenses. With short-term interest rates at or near zero, money market funds may not be able to maintain positive yields for shareholders. Based on recent commentary from the Federal Reserve Bank in its January 30, 2013 press release, “the current highly accommodative stance of monetary policy will remain appropriate for a considerable time…,” Federated is unable to predict when the Federal Reserve will increase its target for the federal funds rate. As such, economic conditions are likely to warrant exceptionally low levels for the federal funds rate for the foreseeable future. Federated voluntarily waives certain fees or assumes expenses of certain funds for competitive reasons such as to maintain positive or zero net yields, which has and could continue to cause material adverse effects on Federated’s results of operations. Federated, however, is not obligated to make such fee waivers or to assume any such fund expenses.
Since the fourth quarter 2008, Federated has voluntarily waived fees in order for certain money market funds to maintain positive or zero net yields. These fee waivers were partially offset by related reductions in distribution expense and net income attributable to noncontrolling interests as a result of Federated's mutual understanding and agreement with third-party intermediaries to share the impact of the waivers.

These voluntary fee waivers are calculated as a percent of AUM in certain money market funds and thus will vary dependent upon the asset levels in such funds. In addition, the level of waivers are dependent on several other factors including, but not limited to, available yields on instruments held by the money market funds, changes in expenses of the money market funds and changes in the mix of money market assets. In any given period, a combination of these factors drives the amount of fee waivers necessary in order for certain funds to maintain positive or zero net yields. As an isolated variable, an increase in yields on instruments held by the money market funds will cause fee waivers to decrease. Conversely, as an isolated variable, an increase in expenses of the money market fund would cause fee waivers to increase.

 
2012 Annual Report
25

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations


With regard to asset mix, changes in the relative amount of money market fund assets in prime and government money market funds as well as the distribution among certain share classes that vary in pricing structure will impact the level of fee waivers. Generally, prime money market funds waive less than government money market funds as a result of higher gross yields on the underlying investments. As such, as an isolated variable, an increase in the relative proportion of average managed assets invested in prime money market funds as compared to total average money market fund assets should typically result in lower waivers to maintain positive or zero net yields. Conversely, the opposite would also be true.
The impact of such fee waivers on various components of Federated's Consolidated Statements of Income was as follows for the years ended December 31:
 
 
 
 
 
 
 
 
2012

 
2011

in millions
 
2012

 
2011

 
2010

 
vs. 2011

 
vs. 2010

Investment advisory fees
 
$
(177.2
)
 
$
(201.6
)
 
$
(134.3
)
 
12
 %
 
(50
)%
Other service fees
 
(113.8
)
 
(119.1
)
 
(107.3
)
 
4
 %
 
(11
)%
   Total Revenue
 
(291.0
)
 
(320.7
)
 
(241.6
)
 
9
 %
 
(33
)%
Less: Reduction in Distribution expense
 
218.5

 
232.3

 
186.6

 
(6
)%
 
24
 %
   Operating income
 
(72.5
)
 
(88.4
)
 
(55.0
)
 
18
 %
 
(61
)%
Less: Reduction in Noncontrolling interest
 
1.3

 
6.5

 
1.0

 
(80
)%
 
550
 %
Pre-tax impact
 
$
(71.2
)
 
$
(81.9
)
 
$
(54.0
)
 
13
 %
 
(52
)%
The negative pre-tax impact of fee waivers to maintain positive or zero net yields decreased in 2012 as compared to 2011 primarily as a result of improved yields on instruments held by the money market funds. During 2011, further declines in interest rates for certain money market investments drove an increase in these fee waivers as compared to 2010. (See Note (22) to the Consolidated Financial Statements for information regarding the quarterly pre-tax impact of these fee waivers.)
Based on the above-mentioned Federal Reserve Bank commentary, Federated is unable to predict when the Federal Reserve will increase its target for the federal funds rate. As such, fee waivers to maintain positive or zero net yields and the related reduction in distribution expense and net income attributable to noncontrolling interests could continue for the foreseeable future. Assuming asset levels and mix remain constant and based on recent market conditions including the lower short-term interest rate environment in the first quarter of 2013 as compared to the fourth quarter of 2012, fee waivers for the first quarter 2013 may result in a negative pre-tax impact on income of approximately $21 million. While the level of fee waivers are impacted by various factors, increases in short-term interest rates that result in higher yields on securities purchased in money market fund portfolios would reduce the negative pre-tax impact of these waivers. Management estimates that an increase of 10 basis points in gross yields on securities purchased in money market fund portfolios will likely reduce the negative pre-tax impact of these waivers by approximately forty percent from the current levels and an increase of 25 basis points would reduce the impact by approximately seventy percent from the current levels. The actual amount of future fee waivers could vary significantly from management’s estimates as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, available yields on instruments held by the money market funds, actions by the Federal Reserve, the U.S. Department of the Treasury, FSOC and other governmental entities, changes in expenses of the money market funds, changes in the mix of money market customer assets, Federated’s willingness to continue the fee waivers and changes in the extent to which the impact of the waivers is shared by third parties. 
Potential Adverse Effects of Rising Interest Rates. Despite the expectation that increases in short-term interest rates above the historically low rates of 0% - 0.25% will reduce the impact of fee waivers to maintain positive or zero net yields, increases in interest rates could also have an adverse effect on Federated’s revenue from money market and other fixed-income products. In a rising short-term interest rate environment, certain investors using money market products and other short-term duration fixed-income products for cash management purposes may shift these investments to direct investments in comparable instruments in order to realize higher yields than those available in money market and other fund products holding lower-yielding instruments. In addition, rising interest rates will tend to reduce the fair value of securities held in various investment portfolios and other products. Management cannot estimate the impact of rising interest rates on Federated’s revenue, but such impact could be material.
Potential Adverse Effects of a Decline or Disruption in the Economy or Financial Markets. Economic or financial market downturns (domestic or international), including disruptions in securities and credit markets, may adversely affect the profitability and performance of, demand for and investor confidence in Federated’s investment products and services. In

26
Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

addition, Federated's products may be adversely affected by potential deterioration in international sovereign or currency market conditions. At December 31, 2012, Federated's liquid assets of $282.7 million included investments in certain Federated-sponsored money market and fluctuating-value funds that may have direct and/or indirect exposures to international sovereign debt and currency risks. Federated actively monitors its money market, fixed-income and equity portfolios to manage sovereign debt and currency risks with respect to recent events in certain euro-zone countries. Federated's experienced portfolio managers and analysts work to evaluate credit risk through quantitative and fundamental analysis. Further, for cash invested in certain money market funds (approximately $53 million), only indirect short-term exposures exist primarily to high-quality international bank names that are subject to Federated's credit analysis process and meet the requirements of Rule 2a-7. Although investments held by sponsored money market and fluctuating-value funds are subject to Federated's proprietary investment research process, there can be no assurance that potential losses that may be realized as a result of these exposures will not have a material adverse effect on Federated's business, financial condition or results of operations.
The ability of Federated to compete and sustain asset and revenue growth is dependent, in part, on the relative attractiveness of the types of investment products Federated offers and its investment performance and strategies under prevailing market conditions. In the event of extreme circumstances, including economic, political, or business crises, Federated’s products may suffer significant net redemptions in AUM causing severe liquidity issues in its short-term sponsored investment products and declines in the value of and returns on AUM, all of which could cause material adverse effects on Federated’s reputation, financial position, results of operations or liquidity.
Custody and portfolio accounting services for all of Federated's mutual fund products are outsourced to one of three third-party financial institutions that are leading providers of such mutual fund services. Accounting records for Federated's mutual funds are maintained by these service providers. These service providers, or other vendors of Federated, could also be adversely affected by the adverse market conditions described above. It is not possible to predict with certainty the extent to which the services or products Federated receives from such service providers or vendors would be interrupted or affected by such situations. Accordingly, there can be no assurance that potential service interruption or Federated’s ability to find a suitable replacement would not have a material adverse effect on Federated’s reputation, financial position, results of operations or liquidity.
Potential Adverse Effects of Changes in Laws and Regulations on Federated’s Investment Management Business. Federated and its investment management business are subject to extensive regulation in the United States and abroad. Federated and the Federated Funds are subject to Federal securities laws, principally the Securities Act of 1933, the Investment Company Act of 1940 (Investment Company Act) and the Investment Advisers Act of 1940, state laws regarding securities fraud and regulations promulgated by various regulatory authorities, including the SEC, the Financial Industry Regulatory Authority (FINRA) and the New York Stock Exchange (the NYSE). Federated is also affected by the regulations governing banks and other financial institutions. Federated's operations outside of the United States are subject to foreign laws and regulation by foreign regulatory authorities, such as the U.K. Financial Services Authority (FSA) for its London-based operations, the Central Bank of Ireland for its Irish-domiciled operations, the German Federal Financial Supervisory Authority for its Frankfurt-based operations and the Australian Securities and Investments Commission for its Melbourne-based operations. Changes in laws, regulations or governmental policies, both domestically and abroad, and the costs associated with compliance, could materially and adversely affect the business and operations of Federated.
From time to time, the Federal securities laws have been augmented substantially. For example, among other measures, Federated has been impacted by the Sarbanes-Oxley Act of 2002, the Patriot Act of 2001 and the Gramm-Leach-Bliley Act of 1999. The Dodd-Frank Act was enacted into law on July 21, 2010. Under the Dodd-Frank Act, Federated, as well as mutual funds, continue to be primarily regulated by the SEC. The Dodd-Frank Act provides, however, for a new systemic risk regulation regime under which it is possible that Federated and/or any one or more of its mutual funds could be subject to designation as a systemically important financial institution by FSOC thereby resulting in additional regulation by the Federal Reserve Board, in addition to primary regulation by the SEC. Any such designation would subject the designated entity to enhanced prudential measures, including capital and liquidity requirements, leverage limits, enhanced public disclosures and risk management requirements. Other provisions of the Dodd-Frank Act may affect intermediaries in their sale or use of Federated's products. Prior to complete implementation, it will be difficult to assess the full impact of the Dodd-Frank Act on Federated.
In January 2010, the SEC adopted extensive amendments to Rule 2a-7 aimed at enhancing the resiliency of money market funds. These amendments included a series of enhancements including rules that require all money market funds to meet specific portfolio liquidity standards and rules that significantly enhance the public disclosure and regulatory reporting obligations of these funds. In 2010 and 2011, Federated dedicated internal resources to comply with these amendments including efforts to enhance its information systems and improve related reporting capabilities. These efforts were internally

 
2012 Annual Report
27

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

sourced and not material to Federated's financial position, results of operations or cash flows for those years. In Federated's view, the amendments of 2010 meaningfully and sufficiently strengthen money market funds. Recent experience demonstrated that the amendments of 2010 were effective in meeting heightened requests for redemptions occurring in connection with the U.S. credit rating downgrade in 2011 and the ongoing European debt crisis.
On October 21, 2010, the President's Working Group issued its report on Money Market Fund Reform Options (the Report). The President's Working Group was tasked with studying possible additional reforms relating to money market funds that could mitigate systemic risk in the financial markets (including the potential for disruption in the financial markets caused by rapid shareholder redemptions in money market funds). The Report discusses the conditions that could cause money market funds to experience rapid shareholder redemptions and describes the advantages and disadvantages of a variety of policy options that could reduce the risk of such rapid redemptions. The Report suggests that the FSOC examine these options as part of its implementation of the Dodd-Frank Act.
The SEC undertook a project to develop a proposal for additional reforms related to money market funds. In August 2012, then SEC Chairman Mary Schapiro issued a public statement announcing that she did not have sufficient votes from the other SEC commissioners to pursue certain proposed reforms relating to money market funds. In her statement, Ms. Schapiro stated that the SEC had been considering two alternative reform proposals, one which would have required a floating NAV, and the other which would have imposed capital requirements coupled with some form of redemption restriction. In her statement, she invited other policymakers to take up the issue of reform. On September 27, 2012, then Treasury Secretary Timothy Geithner sent a letter to the members of the FSOC announcing his intent to pursue money market fund reform. His letter urged FSOC to use its authority under Section 120 of the Dodd-Frank Act to recommend that the SEC proceed with money market reform. Mr. Geithner outlined three potential options for reform in his letter and stated that he had asked his staff to begin drafting a formal recommendation for FSOC to consider at its November 2012 meeting.
In November 2012, FSOC issued Proposed Recommendations Regarding Mutual Fund Reform citing its authority under Section 120 of the Dodd-Frank Act (Proposed Recommendations). The Proposed Recommendations are in draft form and are subject to a public comment period which ended on February 15, 2013. The Proposed Recommendations include three main alternatives: a floating NAV for money market funds; an NAV capital buffer and minimum balance at risk (or 30-day hold back of up to 3% on certain redemptions); and an NAV capital buffer combined with other measures. In response to the Proposed Recommendations, Federated has filed five comment letters on the Proposed Recommendations pointing out, among other things, that: (1) FSOC exceeded its authority in how it used the Section 120 process; (2) FSOC has not provided justification for further reform efforts; (3) a floating NAV would not prevent “runs” on money market funds; (4) an NAV capital buffer of the kind proposed is impractical and not economically attainable in the current interest rate environment; and (5) the minimum-balance-at-risk concept would impair the utility of money market funds to investors and would be prohibitively costly for both fund groups and intermediaries to implement.
On November 30, 2012, the SEC Staff issued a study entitled Response to Questions Posed by Commissioners Aguilar, Parades and Gallagher. This study responded to questions posed by the Commissioners in response to potential reform measures being advanced by then SEC Chairman Mary Shapiro. The study addressed certain misconceptions about the role of money market funds in the financial crisis of 2008 and confirmed the effectiveness of the 2010 amendments to Rule 2a-7. Federated also filed a comment letter on the study commending the SEC Staff for its work while raising questions on some aspects of the study and recommending further analysis.
Finally, it has been reported that the SEC Staff is working on its own rule proposal and that proposal could include a floating NAV for certain money market funds, in particular prime funds. It could also include a floating NAV proposal for all money market funds as well as other reform measures.
Federated believes the changes currently under consideration, if enacted, would significantly reduce the utility and attractiveness of money market funds for investors who, in Federated's view, value money market funds in their current form as an efficient and effective cash management investment product offering daily liquidity at par.
If ultimately enacted, some or all of these changes would be detrimental to Federated's money market fund business and could materially and adversely affect Federated's operations. The very proposal of such amendments could have an adverse impact on Federated's money market fund business and operations and could also negatively impact the short-term credit markets. Management is carefully monitoring developments in this area and plans to actively participate both individually and with industry groups in the public comment process that would accompany any rule change proposal. Federated is unable to assess the degree of any potential impact such additional reforms may have on its business and operations until such proposals are issued. Even when issued, the final version of any rule amendment could vary significantly from the form in which it is proposed.

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Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

In addition, during the past few years regulators such as the SEC, FINRA and the NYSE have adopted other regulations, rules and amendments that have increased Federated's operating expenses and affected the conduct of its business, and may continue to do so. Rule amendments adopted by the Commodity Futures Trading Commission in the first quarter 2012 may also increase Federated's operating expenses and affect the conduct of its business. International regulators, such as the FSA, have also adopted and proposed regulations that could increase Federated's operating expenses and affect the conduct of its business. Other significant regulations or amendments to regulations have been proposed that, if adopted, will affect Federated and the Federated Funds.
Over the past few years, various service industries, including mutual fund service providers, have been the subject of changes in tax policy that impact their state and local tax liability. Changes that have been adopted or proposed include (1) an expansion of the nature of a service company's activities that subject it to tax in a jurisdiction, (2) a change in the methodology by which multi-state companies apportion their income between jurisdictions, and (3) a requirement that affiliated companies calculate their state tax as one combined entity. As adopted changes become effective and additional jurisdictions effect similar changes, there could be a material adverse effect on Federated's tax liability and effective tax rate and, as a result, net income.
Potential Adverse Effect of Providing Financial Support to Investment Products. Federated may, at its sole discretion, from time to time elect to provide financial support to its sponsored investment products. Providing such support utilizes capital that would otherwise be available for other corporate purposes. Losses on such support, or failure to have or devote sufficient capital to support products, could have a material adverse effect on Federated’s reputation, financial position, results of operations or liquidity.
Risk of Federated’s Money Market Products’ Ability to Maintain a Stable $1.00 Net Asset Value. Approximately 47% of Federated’s total revenue for 2012 was attributable to money market assets. An investment in money market funds is neither insured nor guaranteed by the Federal Deposit Insurance Corporation. Although money market funds seek to preserve an NAV of $1.00 per share, it is possible for an investor to lose money by investing in these funds. Federated devotes substantial resources including significant credit analysis to the management of its products. Federated money market funds have always maintained a $1.00 NAV; however, there is no guarantee that such results will be achieved in the future. Market conditions could lead to severe liquidity issues and/or further persistent declines in or additional prolonged periods of historically low yields in money market products which could impact their NAVs. If the NAV of a Federated money market fund were to decline to less than $1.00 per share, Federated money market funds would likely experience significant redemptions in AUM, loss of shareholder confidence and reputational harm, all of which could cause material adverse effects on Federated’s financial position, results of operations or liquidity.
No Assurance of Access to Sufficient Liquidity. From time to time, Federated’s operations may require more cash than is then available from operations. In these circumstances, it may be necessary to borrow from lending facilities or to raise capital by securing new debt or by selling shares of Federated equity or debt securities. Federated’s ability to raise additional capital in the future will be affected by several factors including Federated’s creditworthiness, the fair value of Federated’s common stock, as well as general market conditions. There can be no assurance that Federated will be able to obtain these funds and financing on acceptable terms, if at all.
Retaining and Recruiting Key Personnel. Federated’s ability to locate and retain quality personnel has contributed significantly to its growth and success and is important to attracting and retaining customers. The market for qualified executives, investment managers, analysts, traders, sales representatives and other key personnel is extremely competitive. There can be no assurance that Federated will be successful in its efforts to recruit and retain the required personnel. Federated has encouraged the continued retention of its executives and other key personnel through measures such as providing competitive compensation arrangements and in certain cases, employment agreements. The loss of any such personnel could have an adverse effect on Federated. In certain circumstances, the departure of key employees could cause higher redemption rates for certain AUM or the loss of client accounts. Moreover, since certain of Federated’s products contribute significantly to its revenues and earnings, the loss of even a small number of key personnel associated with these products could have a disproportionate impact on Federated’s business.
Various executives, investment, sales and other key personnel own restricted stock subject to vesting periods of up to ten years from the date awarded and to provisions that require resale or forfeiture to Federated in certain circumstances upon termination of employment. In addition, certain of these employees are employed under contracts which require periodic review of compensation and contain restrictive covenants with regard to divulging confidential information and engaging in competitive activities.
Potential Adverse Effects of Increased Competition in the Investment Management Business. The investment management business is highly competitive. Federated competes in the management and distribution of mutual funds and Separate Accounts

 
2012 Annual Report
29

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

with other fund management companies, national and regional broker/dealers, commercial banks, insurance companies and other institutions. Many of these competitors have substantially greater resources and brand recognition than Federated. Competition is based on various factors, including business reputation, investment performance, quality of service, the strength and continuity of management and selling relationships, distribution services offered, the range of products offered and fees charged.
Many of Federated’s products are designed for use by institutions such as banks, insurance companies and other corporations. A large portion of Federated’s managed assets, particularly money market and fixed-income assets are held by institutional investors. Because most institutional investment vehicles are sold without sales commissions at either the time of purchase or the time of redemption, institutional investors may be more inclined to transfer their assets among various institutional funds than investors in retail mutual funds.
 
A significant portion of Federated’s revenue is derived from providing mutual funds to the wealth management and trust market, comprising approximately 1,500 banks and other financial institutions. Future profitability of Federated will be affected by its ability to retain its share of this market, and could also be adversely affected by consolidations in the banking industry, as well as regulatory changes.
Potential Adverse Effects of Changes in Federated’s Distribution Channels. Federated acts as a wholesaler of investment products to financial intermediaries including banks, broker/dealers, registered investment advisers and other financial planners. Federated also sells investment products directly to corporations and institutions. Approximately 10% of Federated’s total revenue for 2012 was derived from services provided to one intermediary customer, the Bank of New York Mellon Corporation. If this financial intermediary were to cease operations or limit or otherwise end the distribution of Federated’s investment products, it could have a material adverse effect on Federated’s future revenues and, to a lesser extent, net income. There can be no assurance that Federated will continue to have access to the financial intermediaries that currently distribute Federated products or that Federated’s relationship with such intermediaries will continue over time. In addition, exclusive of the impacts of minimum yield waivers and related reductions in distribution expense to maintain positive or zero net yields, Federated has experienced increases in the cost of distribution as a percentage of total revenue from 31% in 2007 to over 38% in 2012. Federated expects such costs to continue to increase in total due to asset growth and per dollar of revenue due to the competitive pressures of the mutual fund business. Higher distribution costs reduce Federated’s operating and net income.
Adverse Effects of Declines in the Amount of or Changes in the Mix of Assets Under Management. A significant portion of Federated’s revenue is derived from investment advisory fees, which are based on the value of managed assets and vary with the type of asset being managed, with higher fees generally earned on equity products than on fixed-income and money market products and liquidation portfolios. Likewise, mutual fund products generally have a higher management-fee rate than Separate Accounts. Similarly, traditional separate accounts typically have a higher management-fee rate than liquidation portfolios. Additionally, certain components of distribution expense can vary depending upon the asset class, distribution channel and/or the size of the customer relationship. Consequently, significant fluctuations in the fair value of securities held by, or the level of redemptions from, the funds or other products advised by Federated may materially affect the amount of managed assets and thus Federated’s revenue, profitability and ability to grow. Similarly, changes in Federated’s average asset mix across both asset and product types have a direct impact on Federated’s revenue and profitability. Federated generally pays out a larger portion of the revenue earned from managed assets in money market funds than the revenue earned from managed assets in equity or fixed-income funds. Substantially all of Federated’s managed assets are in investment products that permit investors to redeem their investment at any time. Additionally, changing market conditions may continue to cause a shift in Federated’s asset mix towards money market and fixed-income products which may cause a decline in Federated’s revenue and net income.
Adverse Effects of Poor Investment Performance. Success in the investment management business is largely dependent on investment performance relative to market conditions and the performance of competing products. Good performance generally assists retention and growth of managed assets, resulting in additional revenues. Conversely, poor performance tends to result in decreased sales and increased redemptions with corresponding decreases in revenues to Federated. Poor performance could, therefore, have a material adverse effect on Federated’s business, results of operations or business prospects. In terms of revenue concentration by product, approximately 11% and 10% of Federated’s total revenue for 2012 were derived from services provided to two sponsored funds, the Federated Prime Obligations Fund and the Federated Kaufmann Fund, respectively. A significant and prolonged decline in the AUM in these funds could have a material adverse effect on Federated’s future revenues and, to a lesser extent, net income, due to related reductions to distribution expenses associated with these funds.
Operational Risks. Operational risks include, but are not limited to, improper or unauthorized execution and processing of transactions, deficiencies in operating systems, business disruptions, inadequacies or breaches in Federated’s internal control

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Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

processes and noncompliance with regulatory requirements. Management relies on its employees and systems to comply with established procedures, controls and regulatory requirements. Breakdown or improper use of systems, human error or improper action by employees, or noncompliance with regulatory rules could cause material adverse effects on Federated’s reputation, financial position, results of operations and/or liquidity.
No Assurance of Successful Future Acquisitions. Federated’s business strategy contemplates the acquisition of other investment management companies as well as investment assets, both domestically and internationally. There can be no assurance that Federated will find suitable acquisition candidates at acceptable prices, have sufficient capital resources to realize its acquisition strategy, be successful in entering into definitive agreements for desired acquisitions, or successfully integrate acquired companies into Federated, or that any such acquisitions, if consummated, will prove to be advantageous to Federated.
Impairment Risk. At December 31, 2012, Federated had intangible assets including goodwill and a long-term equity-method investment totaling $731.7 million on its Consolidated Balance Sheets, the vast majority of which represents assets capitalized in connection with Federated’s acquisitions and business combinations. Federated may not realize the value of these assets. Management performs an annual review of the carrying values of goodwill and indefinite-lived intangible assets and periodic reviews of the carrying values of all other assets to determine whether events and circumstances indicate that an impairment in value may have occurred. A variety of factors could cause the carrying value of an asset to become impaired. Should a review indicate impairment, a write-down of the carrying value of the asset would occur, resulting in a non-cash charge which would adversely affect Federated’s results of operations for the period.
  
Systems and Technology Risks. Federated utilizes software and related technologies throughout its business including both proprietary systems and those provided by outside vendors. Unanticipated issues could occur and it is not possible to predict with certainty all of the adverse effects that could result from a failure of a third party to address computer system problems. Accordingly, there can be no assurance that potential system interruptions or the cost necessary to rectify the problems would not have a material adverse effect on Federated’s business, financial condition, results of operations or business prospects. In addition, Federated's operating systems are dependent on the effectiveness of its information security policies and procedures which help to ensure that its systems are protected from cyber-security incidents such as attacks by hackers, viruses, worms or other methods. Any such attacks could result in unauthorized access to Federated's systems which could cause a business interruption or the loss of proprietary information and/or sensitive or confidential client information. Federated cannot predict the financial or reputational impact to its business resulting from any such situations.
Potential Adverse Effects of Reputational Harm. Any material losses in client or shareholder confidence in Federated or in the mutual fund industry as a result of potential litigation, economic or financial market downturns or disruptions, material errors in public news reports, misconduct, rumors on the internet or other matters could increase redemptions from and/or reduce sales of Federated funds and other investment management services, resulting in a decrease in future revenues.
Adverse Effects of Termination or Failure to Renew Fund Agreements. A substantial majority of Federated’s revenues are derived from investment management agreements with sponsored funds that, as required by law, are terminable upon 60 days notice. In addition, each such investment management agreement must be approved and renewed annually by each fund’s board of directors or trustees, including independent members of the board, or its shareholders, as required by law. Failure to renew, changes resulting in lower fees, or termination of a significant number of these agreements could have a material adverse impact on Federated. As required by the Investment Company Act, each investment advisory agreement with a mutual fund automatically terminates upon its assignment, although new investment advisory agreements may be approved by the mutual fund’s directors or trustees and shareholders. A sale of a sufficient number of shares of Federated’s voting securities to transfer control of Federated could be deemed an assignment in certain circumstances. An assignment, actual or constructive, will trigger these termination provisions and may adversely affect Federated’s ability to realize the value of these agreements.
Under the terms of a settlement agreement with the SEC and New York State Attorney General, a Federated investment advisory subsidiary may not serve as investment adviser to any registered investment company unless: (1) at least 75% of the fund’s directors are independent of Federated; (2) the chairman of each such fund is independent of Federated; (3) no action may be taken by the fund’s board of directors or trustees or any committee thereof unless approved by a majority of the independent board members of the fund or committee, respectively; and (4) the fund appoints a senior officer who reports to the independent directors or trustees and is responsible for monitoring compliance by the fund with applicable laws and fiduciary duties and for managing the process by which management fees charged to a fund are approved.
Potential Adverse Effects of Unpredictable Events. Unpredictable events, including natural disaster, pandemic, war and terrorist attack, could adversely impact Federated’s ability to conduct business. Such events could cause disruptions in

 
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31

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

economic conditions, system interruption, loss of life, unavailability of personnel or additional costs. As such, there can be no assurance that unpredictable events, or the costs to address such events, would not have a material adverse effect on Federated’s business, financial condition, results of operations or business prospects.
Federated’s status as a "controlled company." Federated has two classes of common stock: Class A Common Stock, which has voting power, and Class B Common Stock, which is non-voting except in certain limited circumstances. All of the outstanding shares of Federated's Class A Common Stock are held by the Voting Shares Irrevocable Trust for the benefit of the members of the family of John F. Donahue. The three trustees of this trust are Chairman of Federated's board of directors, Mr. John F. Donahue, his wife, and his son, Mr. J. Christopher Donahue, who is Federated's President, Chief Executive Officer and a director. Accordingly, Federated qualifies as a “controlled company” under Section 303A of the NYSE Listed Company Manual. As a controlled company, Federated qualifies for and relies upon exemptions from several NYSE corporate governance requirements, including requirements that: (1) a majority of the Board of Directors consists of independent directors; and (2) the entity maintains a nominating/corporate governance committee that is composed entirely of independent directors with a written charter addressing the committee's purpose and responsibilities. As a result, Federated's board does not have a majority of independent directors nor does it maintain a nominating/corporate governance committee.

Quantitative and Qualitative Disclosures About Market Risk
In the normal course of its business, Federated is exposed to fluctuations in the securities market and general economy. As an investment manager, Federated’s business requires that it continuously identify, assess, monitor and manage market and other risks including those risks affecting its own investment portfolio. Federated invests in sponsored investment companies for the primary purpose of generating returns from capital appreciation, investment income, or both, or in the case of newly launched sponsored investment companies, in order to provide the fund with investable cash to establish a performance history. These investments expose Federated to various market risks. A single investment can expose Federated to multiple risks arising from changes in interest rates, credit ratings, equity prices and foreign currency exchange rates. Federated manages its exposure to market risk by diversifying its investments among different asset classes and by altering its investment holdings from time to time in response to changes in market risks and other factors.  In addition, in certain cases, Federated enters into derivative instruments for purposes of hedging its market risks.
Interest-rate risk is the risk that unplanned fluctuations in earnings will result from interest-rate volatility while credit risk is the risk that an issuer of debt securities may default on its obligations. At December 31, 2012 and 2011, Federated was exposed to interest-rate risk as a result of holding investments in fixed-income sponsored funds ($86.3 million and $116.5 million, respectively) and investments in debt securities held by certain consolidated investment companies ($33.8 million and $101.7 million, respectively). At both December 31, 2012 and 2011, management considered a hypothetical 100-basis-point fluctuation in interest rates and determined that the impact of such fluctuations on these investments would not have a material effect on Federated’s financial condition or results of operations.
These investments also exposed Federated to credit risk at December 31, 2012 and 2011. At both December 31, 2012 and 2011, management considered a hypothetical 50-basis-point fluctuation in credit spreads and determined that the impact of such fluctuations on these investments would not have a material effect on Federated’s financial condition or results of operations.
In the second quarter 2011, Federated entered into the Credit Agreement which amended and restated its previous term-loan facility. The Swap associated with the previous term-loan facility remains in effect. Federated entered into the Swap to convert the variable rate on its term loan to a fixed rate thereby mitigating its exposure to interest-rate risk. As of December 31, 2012 and December 31, 2011, Federated’s fair value on the Swap was a liability of $11.2 million and $15.2 million, respectively, which is recognized in earnings as a component of Federated’s fixed interest rate of 3.646% over the term of the Swap. Near-term reductions in the fair value of the Swap are reasonably possible as a result of changes in projected interest rates. Management performed a sensitivity analysis of the fair value of the Swap and considered hypothetical six- and twelve-month forward shifts in the assumed yield curve. The analysis showed that a six- and twelve-month forward shift in the current yield curve would lead to a further decrease in the fair value of the Swap of approximately $0.3 million and $0.4 million, respectively, as of December 31, 2012 and approximately $1 million and $2 million, respectively, as of December 31, 2011. Gains and losses in the fair value of the Swap are recorded in Accumulated other comprehensive loss, net of tax on the Consolidated Balance Sheets.
Price risk is the risk that the market price of an investment will decline and ultimately result in the recognition of a loss. Federated was exposed to price risk as a result of its $62.8 million and $54.3 million investment in sponsored equity products at December 31, 2012 and 2011, respectively. Federated’s investment in these products represents its maximum exposure to loss. At both December 31, 2012 and 2011, management considered a hypothetical 20% fluctuation in fair value and determined that

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Federated Investors, Inc.
 

MANAGEMENT’S DISCUSSION AND ANALYSIS (continued)
of Financial Condition and Results of Operations

the impact of such fluctuations on these investments could impact Federated’s financial condition and results of operations by approximately $12.6 million and $10.9 million, respectively.
Foreign exchange risk is the risk that an investment’s value will change due to changes in currency exchange rates. As of December 31, 2012 and December 31, 2011, Federated was exposed to foreign exchange risk as a result of its investments in sponsored mutual funds holding non-U.S. dollar securities as well as non-U.S. dollar operating cash accounts held at certain foreign operating subsidiaries of Federated ($13.6 million and $90.4 million, respectively). These investments and cash accounts primarily exposed Federated to risk of changes in the Euro and the British pound. Of these investments held as of December 31, 2011, Federated's exposure to the British pound of $77.7 million was fully hedged at December 31, 2011 by certain foreign currency forward contracts. For the remaining investments at both December 31, 2012 and December 31, 2011, management considered a hypothetical 20% fluctuation in these currency exchange rates and determined that the impact of such fluctuation on these investments would not have a material effect on Federated's financial condition or results of operations.
In addition to market risks attributable to Federated’s investments, substantially all of Federated's revenue is calculated based on AUM. Accordingly, changes in the market value of managed assets have a direct impact on Federated's revenue. Declines in the fair values of these assets as a result of changes in the market or other conditions will negatively impact revenue and net income. Assuming the ratio of revenue from managed assets to average AUM for 2012 or 2011 remained unchanged, a 20% decline in the average AUM for either period would result in a corresponding 20% decline in revenue. Certain expenses including distribution and compensation and related expenses may not vary in proportion with changes in the market value of managed assets. As such, the impact on net income of a decline in the market values of managed assets may be greater or less than the percentage decline in the market value of managed assets. For further discussion of managed assets and factors that impact Federated’s revenue, see the sections entitled General, Asset Highlights, Contractual Obligations and Contingent Liabilities and Risk Factors herein as well as the section entitled Regulatory Matters in Federated’s Annual Report on Form 10-K for the year ended December 31, 2012 on file with the SEC.

 
2012 Annual Report
33

MANAGEMENT’S ASSESSMENT OF INTERNAL CONTROL OVER FINANCIAL REPORTING
 

Federated Investors, Inc.’s (Federated) management is responsible for the preparation, integrity and fair presentation of the consolidated financial statements in this annual report. These consolidated financial statements and notes have been prepared in conformity with U.S. generally accepted accounting principles from accounting records which management believes fairly and accurately reflect Federated’s operations and financial position. The consolidated financial statements include amounts based on management’s best estimates and judgments considering currently available information and management’s view of current conditions and circumstances.
Management is responsible for establishing and maintaining adequate internal control over financial reporting that is designed to provide reasonable assurance of the reliability of financial reporting and the preparation of financial statements in accordance with U.S. generally accepted accounting principles. The system of internal control over financial reporting as it relates to the financial statements is evaluated for effectiveness by management and tested for reliability. Actions are taken to correct potential deficiencies as they are identified. Any system of internal control, no matter how well designed, has inherent limitations, including the possibility that a control can be circumvented or overridden and misstatements due to error or fraud may occur and not be detected. Also, because of changes in conditions, internal control effectiveness may vary over time. Accordingly, even an effective system of internal control will provide only reasonable assurance with respect to financial statement preparation.
Management assessed the effectiveness of Federated’s internal control over financial reporting as of December 31, 2012, in relation to criteria for effective internal control over financial reporting as described in Internal Control – Integrated Framework, issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management concluded that, as of December 31, 2012, Federated’s internal controls over financial reporting were effective. Ernst & Young LLP, independent registered public accounting firm, has audited the consolidated financial statements included in this annual report and has issued an attestation report on Federated’s internal control over financial reporting.

Federated Investors, Inc.
        
    
/s/ J. Christopher Donahue
 
/s/ Thomas R. Donahue
President and Chief Executive Officer
 
Chief Financial Officer
 
 
 
February 22, 2013
 
 


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Federated Investors, Inc.
 

REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, ON CONSOLIDATED FINANCIAL STATEMENTS

The Board of Directors and Shareholders
Federated Investors, Inc.
We have audited the accompanying consolidated balance sheets of Federated Investors, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2012. These financial statements are the responsibility of Federated Investors, Inc.’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Federated Investors, Inc. at December 31, 2012 and 2011, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2012, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Federated Investors, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated February 22, 2013 expressed an unqualified opinion thereon.
 
/s/ Ernst & Young LLP
 

Pittsburgh, Pennsylvania
February 22, 2013

 
2012 Annual Report
35

REPORT OF ERNST & YOUNG LLP, INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM, ON EFFECTIVENESS OF INTERNAL CONTROL OVER FINANCIAL REPORTING

The Board of Directors and Shareholders
Federated Investors, Inc.
We have audited Federated Investors, Inc.’s internal control over financial reporting as of December 31, 2012, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Federated Investors, Inc.’s management is responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Assessment of Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Federated Investors, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2012, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Federated Investors, Inc. as of December 31, 2012 and 2011, and the related consolidated statements of income, comprehensive income, changes in equity and cash flows for each of the three years in the period ended December 31, 2012, of Federated Investors, Inc., and our report dated February 22, 2013 expressed an unqualified opinion thereon.
 
/s/ Ernst & Young LLP
 

Pittsburgh, Pennsylvania
February 22, 2013
 

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Federated Investors, Inc.
 

CONSOLIDATED BALANCE SHEETS
(dollars in thousands)

December 31,
 
2012

 
2011

ASSETS
 
 
 
 
Current Assets
 
 
 
 
Cash and cash equivalents
 
$
67,585

 
$
49,273

Investments—affiliates
 
136,023

 
159,539

Investments—other
 
55,020

 
113,505

Receivables, net of reserve of $50 and $121, respectively
 
24,120

 
21,526

Prepaid expenses
 
12,986

 
17,420

Other current assets
 
4,328

 
5,248

Total current assets
 
300,062

 
366,511

Long-Term Assets
 

 

Goodwill
 
648,820

 
642,329

Renewable investment advisory rights
 
68,455

 
64,600

Other intangible assets, net
 
10,582

 
13,997

Property and equipment, net
 
38,912

 
38,228

Other long-term assets
 
23,230

 
25,191

Total long-term assets
 
789,999

 
784,345

Total assets
 
$
1,090,061

 
$
1,150,856

LIABILITIES
 
 
 
 
Current Liabilities
 
 
 
 
Short-term debt
 
$
42,500

 
$
42,500

Accounts payable and accrued expenses
 
45,255

 
41,691

Accrued compensation and benefits
 
68,172

 
59,971

Other current liabilities
 
25,207

 
34,324

Total current liabilities
 
181,134

 
178,486

Long-Term Liabilities
 

 

Long-term debt
 
276,250

 
318,750

Long-term deferred tax liability, net
 
99,399

 
73,246

Other long-term liabilities
 
29,334

 
37,191

Total long-term liabilities
 
404,983

 
429,187

Total liabilities
 
586,117

 
607,673

Commitments and contingencies (Note (20))
 

 

TEMPORARY EQUITY
 
 
 
 
Redeemable noncontrolling interest in subsidiaries
 
7,268

 
506

PERMANENT EQUITY
 
 
 
 
Federated Investors shareholders’ equity
 
 
 
 
Common stock:
 
 
 
 
Class A, no par value, 20,000 shares authorized, 9,000 shares issued and outstanding
 
189

 
189

Class B, no par value, 900,000,000 shares authorized, 129,505,456 shares issued
 
273,697

 
252,950

Retained earnings
 
984,505

 
1,069,913

Treasury stock, at cost, 25,064,280 and 25,762,366 shares Class B common stock, respectively
 
(760,022
)
 
(772,481
)
Accumulated other comprehensive loss, net of tax
 
(2,937
)
 
(8,612
)
Total Federated Investors shareholders’ equity
 
495,432

 
541,959

Nonredeemable noncontrolling interest in subsidiary
 
1,244

 
718

Total permanent equity
 
496,676

 
542,677

Total liabilities, temporary equity and permanent equity
 
$
1,090,061

 
$
1,150,856

(The accompanying notes are an integral part of these Consolidated Financial Statements.)

 
2012 Annual Report
37

 CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)

Years Ended December 31,
 
2012

 
2011

 
2010

Revenue
 
 
 
 
 
 
Investment advisory fees, net—affiliates
 
$
560,978

 
$
524,779

 
$
579,159

Investment advisory fees, net—other
 
69,856

 
61,561

 
60,245

Administrative service fees, net—affiliates
 
225,529

 
220,356

 
215,643

Other service fees, net—affiliates
 
74,103

 
73,343

 
82,476

Other service fees, net—other
 
11,799

 
12,042

 
11,559

Other, net
 
3,441

 
3,033

 
2,861

Total revenue
 
945,706

 
895,114

 
951,943

Operating Expenses
 
 
 
 
 
 
Compensation and related
 
257,622

 
245,439

 
242,853

Distribution
 
253,445

 
235,670

 
259,210

Systems and communications
 
25,716

 
22,971

 
22,828

Office and occupancy
 
24,828

 
24,689

 
22,958

Professional service fees
 
18,925

 
53,737