10-Q 1 fii-20180930x10q.htm 10-Q Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 ____________________________________________________
FORM 10-Q
____________________________________________________
(Mark One)
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
o
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from              to             
Commission File Number 001-14818
___________________________________________________
Federated Investors, Inc.
(Exact name of registrant as specified in its charter)
____________________________________________________
Pennsylvania
 
25-1111467
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
Federated Investors Tower
Pittsburgh, Pennsylvania
 
15222-3779
(Address of principal executive offices)
 
(Zip Code)
(Registrant's telephone number, including area code) 412-288-1900
 ___________________________________________________________________________
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  o.
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  o.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
  
 
 
 
Accelerated filer
o
Non-accelerated filer
o
  
 
 
 
Smaller reporting company
o
 
 
 
 
 
 
Emerging growth company
o
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.    o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes  o    No  x.
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the last practicable date: As of October 25, 2018, the Registrant had outstanding 9,000 shares of Class A Common Stock and 100,491,180 shares of Class B Common Stock.

 

 
Table of Contents





Special Note Regarding Forward-Looking Information
Certain statements in this report on Form 10-Q 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 Investors, Inc. and its consolidated subsidiaries (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. Forward-looking statements are typically identified by words or phrases such as "trend," "potential," "opportunity," "believe," "expect," "anticipate," "current," "intention," "estimate," "position," "projection," "assume," "continue," "remain," "maintain," "sustain," "seek," "achieve," and similar expressions, or future or conditional verbs such as "will," "would," "should," "could," "may" and similar expressions. Among other forward-looking statements, such statements include certain statements relating to: asset flows, levels and mix; business mix; sources and levels of revenues, expenses, gains, losses, income and earnings; when revenue is recognized; expected transaction costs, obligations to make payments relating to acquisitions and additional contingent or other payments pursuant to employment or incentive arrangements; business and market expansion opportunities, including, anticipated, or acceleration of, growth outside of the United States (U.S.).; debt, future cash needs and cash flows; uses of treasury stock; legal proceedings; the components and level of, and prospect for, distribution-related expenses; classification and consolidation of investments; the ability to raise additional capital; management's assessments, beliefs, expectations, assumptions, projections or estimates, including regarding fee rates, the level and impact of reimbursements or assumptions of fund-related expenses (Consideration Payable to Customers) and fee waivers (collectively, Fee Waivers), the effect, and degree of impact, of changes in customer relationships, the level, timing, degree and impact of changes in interest rates, yields or asset levels or mix, the timing of acquisitions, legal proceedings, the timing, impact, effects and other consequences of continuing regulatory oversight, and potential, proposed and final laws, regulations and other rules and possible deregulation, by U.S. and foreign regulators and other authorities, borrowing, taxes and the impact of tax law changes, product and strategy demand, investor preferences, performance, product development and restructuring options and initiatives, including the plans for and timing of such options and initiatives, compliance, and related legal, compliance and other professional services expenses, interest payments or expenses, dedication of resources, accounting policies, indebtedness and certain investments, and liquidity; future principal uses of cash; performance indicators; the adoption and impact of accounting policies, new accounting pronouncements and accounting treatment determinations; auditor independence matters; interest rate, concentration, market and other risks; guarantee and indemnification obligations; and various items set forth under Item 1A - Risk Factors included in Federated's Annual Report on Form 10-K for the year ended December 31, 2017. Among other risks and uncertainties, market conditions may change significantly resulting in changes to Federated's asset flows, asset levels, asset mix 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 net revenue levels and will be affected by the achievement of such levels. The obligation to make purchase price payments in connection with acquisitions is subject to certain adjustments and conditions and the obligation to make additional payments pursuant to employment or incentive arrangements is based on satisfaction of certain conditions set forth in those arrangements. Future cash needs, cash flows 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 developing, structuring and distributing its products and strategies, 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, and potential increased legal, compliance and other professional services expenses stemming from additional or modified regulation or the dedication of such resources to other initiatives. 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, investor preferences and confidence, 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 continued scrutiny of the mutual fund industry by domestic or foreign regulators, and any 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 and additional risks that may impact the forward-looking statements, see Item 1A - Risk Factors included in Federated's Annual Report on Form 10-K for the year ended December 31, 2017.


Part I. Financial Information
Item 1. Financial Statements




Consolidated Balance Sheets
 
 
 
(dollars in thousands)
 
 
 
(unaudited)
 
 
 
 
September 30,
2018
 
December 31,
2017
ASSETS
 
 
 
Current Assets
 
 
 
Cash and Cash Equivalents
$
116,943

 
$
316,264

Investments—Consolidated Investment Companies
31,737

 
45,411

Investments—Affiliates and Other
8,379

 
7,863

Receivables, net of reserve of $11 and $60, respectively
94,852

 
53,482

Prepaid Expenses
18,177

 
11,747

Other Current Assets
1,534

 
2,507

Total Current Assets
271,622

 
437,274

Long-Term Assets
 
 
 
Goodwill
819,069

 
660,040

Intangible Assets, net of accumulated amortization of $8,370 and $5,202, respectively
341,755

 
76,875

Property and Equipment, net of accumulated depreciation of $86,546 and $70,561, respectively
52,644

 
37,670

Other Long-Term Assets
38,567

 
19,551

Total Long-Term Assets
1,252,035

 
794,136

Total Assets
$
1,523,657

 
$
1,231,410

LIABILITIES
 
 
 
Current Liabilities
 
 
 
Accounts Payable and Accrued Expenses
$
57,160

 
$
47,595

Accrued Compensation and Benefits
90,973

 
74,572

Other Current Liabilities
16,168

 
6,682

Total Current Liabilities
164,301

 
128,849

Long-Term Liabilities
 
 
 
Long-Term Debt
160,000

 
170,000

Long-Term Deferred Tax Liability, net
143,651

 
117,620

Other Long-Term Liabilities
35,597

 
23,563

Total Long-Term Liabilities
339,248

 
311,183

Total Liabilities
503,549

 
440,032

Commitments and Contingencies (Note (15))

 

TEMPORARY EQUITY
 
 
 
Redeemable Noncontrolling Interest in Subsidiaries
192,744

 
30,163

PERMANENT EQUITY
 
 
 
Federated Investors, Inc. 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, 109,505,456 Shares Issued
361,405

 
343,189

Additional Paid-In Capital from Treasury Stock Transactions
15

 
0

Retained Earnings
765,176

 
697,359

Treasury Stock, at Cost, 9,014,276 and 8,405,003 Shares Class B Common Stock, respectively
(294,154
)
 
(278,732
)
Accumulated Other Comprehensive Loss, net of tax
(5,267
)
 
(790
)
Total Permanent Equity
827,364

 
761,215

Total Liabilities, Temporary Equity and Permanent Equity
$
1,523,657

 
$
1,231,410


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

4


Consolidated Statements of Income
(dollars in thousands, except per share data)
(unaudited)
 
 
Three Months Ended

Nine Months Ended
 
 
September 30,

September 30,
 
 
2018


2017


2018


2017

Revenue
 
 
 
 
 
 
 
 
Investment Advisory Fees, net—Affiliates
 
$
159,527

 
$
149,412

 
$
425,288

 
$
442,536

Investment Advisory Fees, net—Other
 
57,509

 
35,474

 
134,141

 
102,989

Administrative Service Fees, net—Affiliates
 
49,855

 
47,461

 
147,248

 
139,763

Other Service Fees, net—Affiliates
 
39,046

 
44,539

 
119,105

 
134,911

Other Service Fees, net—Other
 
2,679

 
1,429

 
2,679

 
4,413

Total Revenue
 
308,616

 
278,315

 
828,461

 
824,612

Operating Expenses
 
 
 
 
 
 
 
 
Compensation and Related
 
103,092

 
72,454

 
255,613

 
217,226

Distribution
 
72,153

 
84,838

 
214,098

 
262,371

Professional Service Fees
 
13,535

 
6,948

 
32,443

 
20,141

Systems and Communications
 
12,213

 
7,992

 
28,397

 
24,258

Office and Occupancy
 
9,332

 
7,293

 
24,238

 
21,805

Travel and Related
 
4,622

 
3,258

 
10,967

 
9,150

Advertising and Promotional
 
4,502

 
2,345

 
10,967

 
8,396

Other
 
7,269

 
4,497

 
9,412

 
10,591

Total Operating Expenses
 
226,718

 
189,625

 
586,135

 
573,938

Operating Income
 
81,898

 
88,690

 
242,326

 
250,674

Nonoperating Income (Expenses)
 
 
 
 
 
 
 
 
Investment Income, net
 
938

 
1,889

 
5,030

 
5,244

Gain (Loss) on Securities, net
 
261

 
1,667

 
(1,736
)
 
6,463

Debt Expense
 
(1,602
)
 
(1,250
)
 
(4,363
)
 
(3,534
)
Other, net
 
2,240

 
1

 
(26,877
)
 
(32
)
Total Nonoperating Income (Expenses), net
 
1,837

 
2,307

 
(27,946
)
 
8,141

Income Before Income Taxes
 
83,735

 
90,997

 
214,380

 
258,815

Income Tax Provision
 
21,741

 
33,756

 
53,713

 
95,888

Net Income Including the Noncontrolling Interests in Subsidiaries
 
61,994

 
57,241

 
160,667

 
162,927

Less: Net Income Attributable to the Noncontrolling Interests in Subsidiaries
 
2,386

 
802

 
1,906

 
3,396

Net Income
 
$
59,608

 
$
56,439

 
$
158,761

 
$
159,531

Amounts Attributable to Federated Investors, Inc.
 
 
 
 
 
 
 
Earnings Per Common Share—Basic and Diluted
 
$
0.59

 
$
0.56

 
$
1.57

 
$
1.57

Cash Dividends Per Share
 
$
0.27

 
$
0.25

 
$
0.79

 
$
0.75

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


5


Consolidated Statements of Comprehensive Income
(dollars in thousands)
(unaudited)
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
 
 
2018

 
2017

 
2018

 
2017

Net Income Including the Noncontrolling Interests in Subsidiaries
 
$
61,994

 
$
57,241

 
$
160,667

 
$
162,927

 
 
 
 
 
 
 
 
 
Other Comprehensive (Loss) Income, net of tax
 
 
 
 
 
 
 
 
Permanent Equity
 
 
 
 
 
 
 
 
Foreign Currency Items
 
(3,778
)
 
191

 
(4,257
)
 
554

  Reclassification Adjustment Related to Foreign Currency Items
 
0

 
0

 
(191
)
 
0

Unrealized (Loss) Gain on Equity Securities
 
0

 
(43
)
 
0

 
1,350

  Reclassification Adjustment Related to Equity Securities
 
0

 
(58
)
 
(29
)
 
(1,215
)
Temporary Equity
 
 
 
 
 
 
 
 
Foreign Currency Translation Loss
 
(1,781
)
 
0

 
(1,781
)
 
0

Other Comprehensive (Loss) Income, net of tax
 
(5,559
)
 
90

 
(6,258
)
 
689

Comprehensive Income Including the Noncontrolling Interests in Subsidiaries
 
56,435

 
57,331

 
154,409

 
163,616

Less: Comprehensive Income Attributable to Redeemable Noncontrolling Interest in Subsidiaries
 
605

 
802

 
125

 
2,920

Less: Comprehensive Income Attributable to Nonredeemable Noncontrolling Interest in Subsidiary
 
0

 
0

 
0

 
476

Comprehensive Income Attributable to Federated Investors, Inc.
 
$
55,830

 
$
56,529

 
$
154,284

 
$
160,220

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



6


Consolidated Statements of Changes in Equity
(dollars in thousands)
(unaudited)
 
 
Federated Investors, Inc. Shareholders' Equity
 
 
 
 
 
 
 
 
Common
Stock
 
Additional
Paid-in
Capital from
Treasury
Stock
Transactions
 
Retained
Earnings
 
Treasury
Stock
 
Accumulated
Other
Comprehensive
(Loss) Income, net of
tax
 
Total
Shareholders'
Equity
 
Nonredeemable
Noncontrolling
Interest in
Subsidiary
 
Total
Permanent
Equity
 
Redeemable
Noncontrolling
Interest in
Subsidiaries/
Temporary
Equity
Balance at December 31, 2016
 
$
320,982

 
$
0

 
$
529,749

 
$
(255,382
)
 
$
(523
)
 
$
594,826

 
$
958

 
$
595,784

 
$
31,362

Net Income
 
0

 
0

 
159,531

 
0

 
0

 
159,531

 
476

 
160,007

 
2,920

Other Comprehensive Income, net of tax
 
0

 
0

 
0

 
0

 
689

 
689

 
0

 
689

 
0

Subscriptions—Redeemable Noncontrolling Interest Holders
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
4,095

Deconsolidation
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
(1,891
)
Stock Award Activity
 
17,230

 
0

 
(14,131
)
 
14,221

 
0

 
17,320

 
0

 
17,320

 
0

Dividends Declared
 
0

 
0

 
(76,248
)
 
0

 
0

 
(76,248
)
 
0

 
(76,248
)
 
0

Distributions to Noncontrolling Interest in Subsidiaries
 
0

 
0

 
0

 
0

 
0

 
0

 
(1,434
)
 
(1,434
)
 
(7,495
)
Purchases of Treasury Stock
 
0

 
0

 
0

 
(42,321
)
 
0

 
(42,321
)
 
0

 
(42,321
)
 
0

Balance at September 30, 2017
 
$
338,212

 
$
0

 
$
598,901

 
$
(283,482
)
 
$
166

 
$
653,797

 
$
0

 
$
653,797

 
$
28,991

Balance at December 31, 2017

$
343,378


$
0


$
697,359


$
(278,732
)

$
(790
)

$
761,215


$
0


$
761,215


$
30,163

Adoption of New Accounting Pronouncements

0


0


125


0


(254
)

(129
)

0


(129
)

0

Net Income

0


0


158,761


0


0


158,761


0


158,761


1,906

Other Comprehensive Loss, net of tax
 
0

 
0

 
0

 
0

 
(4,223
)
 
(4,223
)
 
0

 
(4,223
)
 
(1,781
)
Subscriptions—Redeemable Noncontrolling Interest Holders
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
4,425

Deconsolidation
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
(1,751
)
Stock Award Activity
 
18,216

 
15

 
(11,288
)
 
11,495

 
0

 
18,438

 
0

 
18,438

 
0

Dividends Declared
 
0

 
0

 
(79,781
)
 
0

 
0

 
(79,781
)
 
0

 
(79,781
)
 
0

Distributions to Noncontrolling Interest in Subsidiaries
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
(9,778
)
Business Acquisition
 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
0

 
169,560

Purchases of Treasury Stock
 
0

 
0

 
0

 
(26,917
)
 
0

 
(26,917
)
 
0

 
(26,917
)
 
0

Balance at September 30, 2018
 
$
361,594

 
$
15

 
$
765,176

 
$
(294,154
)
 
$
(5,267
)
 
$
827,364

 
$
0

 
$
827,364

 
$
192,744

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




7


Consolidated Statements of Cash Flows
(dollars in thousands)
(unaudited)
 
 
Nine Months Ended
 
 
September 30,
 
 
2018

 
2017

Operating Activities
 
 
 
 
Net Income Including the Noncontrolling Interests in Subsidiaries
 
$
160,667

 
$
162,927

Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities
 
 
 
 
Amortization of Deferred Sales Commissions
 
2,319

 
6,580

Depreciation and Other Amortization
 
10,767

 
7,788

Share-Based Compensation Expense
 
18,244

 
17,290

Gain on Disposal of Assets
 
(7
)
 
(5,358
)
Provision for Deferred Income Taxes
 
7,813

 
8,226

Fair-Value Adjustments for Contingent Liabilities
 
97

 
0

Net Unrealized Loss (Gain) on Investments
 
1,801

 
(1,019
)
Net Sales of Investments—Consolidated Investment Companies
 
9,302

 
21,314

Deferred Sales Commissions Paid
 
(43
)
 
(3,737
)
Contingent Deferred Sales Charges Received
 
0

 
1,484

Other Changes in Assets and Liabilities:
 
 
 
 
Increase in Receivables, net
 
(9,462
)
 
(303
)
(Increase) Decrease in Prepaid Expenses and Other Assets
 
(1,009
)
 
1,477

Decrease in Accounts Payable and Accrued Expenses
 
(121,611
)
 
(23,360
)
Increase in Other Liabilities
 
7,492

 
4,054

Net Cash Provided by Operating Activities
 
86,370

 
197,363

Investing Activities
 
 
 
 
Purchases of Investments—Affiliates and Other
 
(3,081
)
 
(4,730
)
Cash Paid for Business Acquisitions, Net of Cash Acquired
 
(168,430
)
 
(4,352
)
Proceeds from Redemptions of Investments—Affiliates and Other
 
19,986

 
17,235

Cash Paid for Property and Equipment
 
(11,900
)
 
(6,791
)
Net Cash (Used) Provided by Investing Activities
 
(163,425
)
 
1,362

Financing Activities
 
 
 
 
Dividends Paid
 
(79,808
)
 
(76,286
)
Purchases of Treasury Stock
 
(27,064
)
 
(44,152
)
Distributions to Noncontrolling Interest in Subsidiaries
 
(9,778
)
 
(8,929
)
Contributions from Noncontrolling Interest in Subsidiaries
 
4,425

 
4,095

Cash Paid for Amended and Restated Credit Agreement
 
0

 
(483
)
Proceeds from Shareholders for Share-Based Compensation
 
222

 
90

Proceeds from New Borrowings
 
79,150

 
0

Payments on Contingent Consideration Liabilities
 
(228
)
 
(210
)
Payments on Debt
 
(89,150
)
 
(16,250
)
Net Cash Used by Financing Activities
 
(122,231
)
 
(142,125
)
Net (Decrease) Increase in Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents
 
(199,286
)
 
56,600

Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents, Beginning of Period
 
316,809

 
105,355

Cash, Cash Equivalents, Restricted Cash and Restricted Cash Equivalents, End of Period
 
117,523

 
161,955

Less: Restricted Cash and Restricted Cash Equivalents Recorded in Other Long-Term Assets
 
580

 
545

Cash and Cash Equivalents
 
$
116,943

 
$
161,410

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

8

 
Notes to the Consolidated Financial Statements
(unaudited)


 
(1) Basis of Presentation

Federated Investors, Inc. and its consolidated subsidiaries, including Hermes Fund Managers Limited (Hermes) beginning July 1, 2018, (collectively, Federated) provides investment advisory, administrative, distribution and other services to various investment products, including sponsored investment companies and other funds (Federated Funds) and Separate Accounts (which include separately managed accounts, institutional accounts, sub-advised funds and other managed products) in both domestic and international markets, as well as stewardship services to various companies. The interim Consolidated Financial Statements of Federated included herein have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). In the opinion of management, the financial statements reflect all adjustments that are of a normal recurring nature and necessary for a fair presentation of the results for the interim periods presented.

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. Actual results may differ from those estimates, and such differences may be material to the Consolidated Financial Statements.

These financial statements should be read in conjunction with Federated's Annual Report on Form 10-K for the year ended December 31, 2017. Certain items previously reported have been reclassified to conform to the current period's presentation.

(2) Recent Accounting Pronouncements

(a) Recently Adopted Accounting Guidance
 
Revenue Recognition
On May 28, 2014, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes virtually all existing revenue recognition guidance under GAAP. The update's core principle is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. During 2016, the FASB issued ASU 2016-08, which clarified principal versus agent considerations, ASU 2016-10, which clarified identifying performance obligations and the licensing implementation guidance, ASU 2016-12, which addressed implementation issues and provided additional practical expedients and ASU 2016-20, which provided technical corrections to narrow aspects of the guidance (collectively, with ASU 2014-09, Topic 606).
Effective January 1, 2018, Federated adopted Topic 606 using the modified retrospective method, which did not require the restatement of prior years. In connection with the adoption of Topic 606, Federated has applied the guidance to all contracts that were not completed on the effective date of adoption.
Management reevaluated the capitalization and amortization policies of deferred sales commission assets, which resulted in a shorter amortization period. Upon adoption, Federated recorded a cumulative-effect adjustment of $8.1 million as a reduction to Other Long-Term Assets and Retained Earnings. Contingent deferred sales charges (CDSCs) received, which were previously recorded as a reduction of deferred sales commission assets, are now being recorded as revenue. Upon adoption, Federated recorded a cumulative-effect adjustment of $8.0 million as an increase to Other Long-Term Assets and Retained Earnings.
For the three and nine months ended September 30, 2018, $0.4 million and $1.2 million, respectively, of CDSCs received were recorded as revenue in Other Service Fees, net—Affiliates on the Consolidated Statements of Income. Consideration Payable to Customers (which includes reimbursements or assumptions of fund-related expenses) of $8.7 million and $25.6 million, for the three and nine months ended September 30, 2018, respectively, was recorded as a reduction of revenue in Investment Advisory Fees, net—Affiliates (previously recorded primarily as Distribution expense) on the Consolidated Statements of Income. Additionally, certain revenue is now being recorded as a single asset management fee, as it is part of a unitary fee arrangement with a single performance obligation. As such, $1.5 million and $4.8 million, for the three and nine months ended September 30, 2018, respectively, was recorded in Investment Advisory Fees, net—Other (previously recorded in Other Service Fees, net—Other) on the Consolidated Statements of Income.
Financial Instruments
Effective January 1, 2018, Federated adopted ASU 2016-01, Financial Instruments - Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities. The ASU significantly revises an entity's accounting related to (1) the classification and measurement of investments in equity securities, including investments in mutual funds and (2) the presentation of certain fair value changes for financial liabilities. The ASU also amends certain disclosure requirements

9

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

associated with the fair value of financial instruments. Management elected the modified retrospective transition method which was applied by means of a cumulative-effect adjustment to the Consolidated Balance Sheets. While the modified retrospective transition method did not require the restatement of prior years, management elected to reclassify certain prior year presentations and disclosures, primarily the investment and fair value measurement footnotes and the Consolidated Statements of Cash Flows, to ensure comparability with current year investment classifications. The adoption did not have a material impact to Federated's Consolidated Financial Statements.
Statement of Cash Flows
On January 1, 2018, Federated adopted ASU 2016-15, Statement of Cash Flows (Topic 230): Classification of Certain Cash Receipts and Cash Payments. The standard addresses eight specific cash flow issues to reduce diversity in practice in how certain cash receipts and payments are presented on the Statement of Cash Flows. One relevant issue addressed contingent consideration payments made after a business combination. However, Federated was already classifying these payments appropriately. While the ASU required the retrospective adoption approach, the adoption did not have an impact to Federated's Consolidated Financial Statements.     
On January 1, 2018, Federated adopted ASU 2016-18, Statement of Cash Flows (Topic 230): Restricted Cash, a consensus of the FASB Emerging Issues Task Force. Under this ASU, amounts generally described as restricted cash and restricted cash equivalents should be included with cash and cash equivalents when reconciling the beginning-of-period and end-of-period total amounts shown on the statements of cash flows. The ASU required the retrospective adoption approach, which required the restatement of prior periods presented. The adoption did not have a material impact to Federated's Consolidated Financial Statements.
Clarifying the Definition of a Business
On January 1, 2018, Federated adopted ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business. The amendments in this update require that when substantially all of the fair value of the gross assets acquired (or disposed of) is concentrated in a single identifiable asset (or a group of similar identifiable assets), the assets are not considered to be a business. To be considered a business, an acquisition or disposal must include, at a minimum, an input and a substantive process that together significantly contribute to the ability to create outputs. The amendments also narrow the definition of the term "outputs" to be consistent with Topic 606. The ASU was required to be applied prospectively. The adoption did not have a material impact to Federated's Consolidated Financial Statements.
Reporting on Comprehensive Income
Effective January 1, 2018, Federated adopted ASU 2018-02, Income Statement - Reporting Comprehensive Income (Topic 220): Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. Due to the revaluation of deferred taxes resulting from the Tax Cuts and Jobs Act of 2017 (Tax Act) being required to be included in income, regardless of the source of income or loss to which the deferred item related, the tax effects of items within Accumulated Other Comprehensive Loss, net of tax did not reflect the appropriate tax rate. The amendments in this update allow a reclassification from Accumulated Other Comprehensive Loss, net of tax to Retained earnings for these stranded tax effects resulting from the Tax Act. Management elected to apply the guidance in the period of adoption, which did not require the restatement of prior years, and was applied by means of a cumulative-effect adjustment to the Consolidated Balance Sheets. The adoption did not have a material impact to Federated's Consolidated Financial Statements.
(b) Recently Issued Accounting Guidance Not Yet Adopted
 
Leases
On February 25, 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The core principle is that a lessee should recognize the assets and liabilities that arise from leases on the balance sheet, while retaining a distinction between finance and operating leases. The update is effective for Federated on January 1, 2019. While early adoption is permitted, Federated does not plan to early adopt. In the third quarter of 2018, the FASB issued ASU 2018-10, which provides improvements to narrow aspects of the guidance and ASU 2018-11, which provides an optional alternative transition method to initially apply the new leases standard at the adoption date (collectively, with ASU 2016-02, Topic 842). Topic 842 now allows for the use of either the modified retrospective adoption method or the alternative transition method.
Management has substantially completed contract scoping, with the exception of the Hermes' contracts. Management has elected the package of practical expedients, which allows entities to not reassess (1) whether contracts are or contain leases, (2) lease classification and (3) initial direct costs. Management has also elected the practical expedient to not separate lease components from non-lease components, and will not be electing the hindsight practical expedient to determine the lease term. Management has made an accounting policy election to apply the short-term lease exception, which does not require the capitalization of leases with terms of 12 months or less. Management plans to elect the alternative transition method, which

10

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

does not require the restatement of prior years. Management continues to evaluate the appropriate incremental borrowing rates and the new disclosure requirements, as well as the potential impact of adoption to Federated's Consolidated Financial Statements.
Goodwill Impairment
On January 26, 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment. Under this ASU, an entity should perform its annual or interim goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount, and recognize an impairment charge for the amount by which the carrying amount exceeds the reporting unit's fair value. However, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. Additionally, the ASU retains the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. The update is effective for Federated on January 1, 2020, with early adoption permitted, and requires the prospective adoption method. Management is currently evaluating the potential impact of adoption to Federated's Consolidated Financial Statements.
Fair Value Measurement
On August 28, 2018, the FASB issued ASU 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. The amendments in this update remove, modify or add disclosure requirements for fair value measurements to improve the effectiveness of disclosures. The update is effective for Federated on January 1, 2020, with early adoption permitted, and allows for either the prospective or retrospective adoption method. Management is currently evaluating the potential impact of adoption to Federated's Consolidated Financial Statements.
Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement
On August 29, 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force). The amendments in this update align the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The update is effective for Federated on January 1, 2020, with early adoption permitted, and allows for either the prospective or retrospective adoption method. Management plans to elect the prospective adoption approach, which does not require the restatement of prior years. Management is currently evaluating the potential impact of adoption to Federated's Consolidated Financial Statements.

(3) Significant Accounting Policies

As a result of the adoptions of Topic 606 and ASU 2016-01, as well as second quarter derivative activity, the following accounting policies have been updated. For a complete listing of Federated's significant accounting policies, please refer to Federated's Annual Report on Form 10-K for the year ended December 31, 2017.

Deferred Sales Commissions
Federated pays upfront commissions to broker/dealers (Deferred Sales Commissions) to promote the sale of certain fund shares. For share classes that pay both a distribution fee and a CDSC, Federated generally capitalizes the Deferred Sales Commissions. The deferred sales commission asset (included in Other Long-Term Assets on the Consolidated Balance Sheets) is amortized over the estimated period of benefit of six years. Deferred sales commission amortization expense was $2.3 million and $6.6 million for the nine months ended September 30, 2018 and 2017, respectively, and was included in Distribution expense on the Consolidated Statements of Income.

Federated reviews the carrying value of deferred sales commission assets on a periodic basis to determine whether a significant long-term decline in the equity or bond markets or other events or circumstances indicate that an impairment in value may have occurred. Should there be an indication of an impairment in value, Federated compares the carrying value of the asset to the probability-weighted undiscounted future cash flows of the underlying asset to determine whether an impairment has occurred. If the carrying value of the asset exceeds the undiscounted future cash flows, the deferred sales commission asset is written down to its estimated fair value determined using discounted future cash flows. There were no impairments to the deferred sales commission asset during the nine months ended September 30, 2018 and 2017.

For share classes that do not pay both a distribution fee and CDSC, Federated may be entitled to receive an upfront commission, which is collected from subscribing shareholders and recognized as revenue in Other Service Fees, net—Affiliates on the Consolidated Statements of Income upon investor subscription. For Deferred Sales Commissions that are not capitalized,

11

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

the Deferred Sales Commissions paid are expensed as incurred and totaled $3.7 million and $1.1 million as of September 30, 2018 and 2017, respectively, and were included in Distribution expense on the Consolidated Statements of Income.

Revenue Recognition
All of Federated's revenue is earned from contracts with customers, which are generally terminable upon no more than 60 days' notice. Revenue is measured in an amount that reflects the consideration to which Federated expects to be entitled in exchange for providing those services. This amount may be reduced by Fee Waivers. See Note (7) for information about current period Fee Waivers.

Revenue from providing investment advisory, administrative and the majority of other service fees is recognized when a performance obligation is satisfied, which occurs when control of the services is transferred to customers. For these revenue streams, control is transferred over time as the customer simultaneously consumes the benefit of the service as it is provided. Federated utilizes a time-based measure of progress for which each day is a distinct service period over the life of the contract. Investment advisory, administrative and certain other service fees are generally calculated as a percentage of average net assets of the investment portfolios managed by Federated. Based on the nature of the calculation, the revenue for these services is accounted for as variable consideration, and is subject to factors outside of Federated's control including investor activity and market volatility and is recognized as these uncertainties are resolved. Certain other service fees are earned on fixed-rate contracts which are recorded over the life of the contract as services are performed. See Note (5) for information about expected future revenue.

For the distribution performance obligation, control is transferred to the customer at a point in time upon investor subscription and/or redemption. Based on the nature of the calculation, the revenue for these services is accounted for as variable consideration, and is subject to factors outside of Federated's control including investor activity and market volatility and is recognized as these uncertainties are resolved. For certain revenue, primarily related to distribution fees, Federated may recognize revenue in the current period that pertains to performance obligations satisfied in prior periods, as it represents variable consideration and is recognized as uncertainties are resolved.

The fair value of these investment portfolios managed by Federated is primarily determined using quoted market prices, independent third-party pricing services and broker/dealer price quotes or the NAV Practical Expedient. In limited circumstances, a quotation or price evaluation is not readily available from a pricing source. In these cases, pricing is determined by management based on a prescribed valuation process that has been approved by the directors/trustees of the Federated Funds. For each period presented, an immaterial amount of assets under management (AUM) was priced in this manner by Federated management. For Separate Accounts that are not registered investment companies under the Investment Company Act of 1940 (1940 Act), the fair value of portfolio investments is primarily determined as specified in applicable customer agreements, including in agreements between the customer and the customer's third-party custodian. For Separate Accounts that are registered investment companies under the 1940 Act (e.g., sub-advised mutual funds), the fair value of portfolio investments is determined based on a prescribed valuation process approved by the board of directors/trustees of the sub-advised fund.

Federated has contractual arrangements with third parties to provide certain fund-related services. Management considers whether Federated is acting as the principal service provider or as an agent to determine whether its revenue should be recorded based on the gross amount payable by the funds or net of payments to third-party service providers, respectively. Federated would be considered a principal service provider if it controls the service that is transferred to the customer. Alternatively, Federated would be considered an agent when it does not control the service, but rather arranges for the service to be provided by another party. Generally, the less the customer is directly involved with or participates in making decisions regarding the ultimate third-party service provider, the more supportive the facts are that Federated is acting as the principal in these transactions and should therefore report revenues on a gross basis. All of Federated's revenue is recorded gross of payments made to third parties.

Significant judgments are used when reviewing newly-created contracts and/or materially-modified contracts to determine whether: (1) Federated is the principal or agent; (2) a contract has multiple performance obligations when Federated is paid a single fee; and (3) two or more contracts should be combined. A change in the conclusion of whether Federated is the principal or agent would result in a change in the revenue being recorded gross or net of payments made to third parties. Different conclusions for the remaining two judgments may change the line items to which revenue is being recorded. There are no significant judgments that would impact the timing of revenue recognition.


12

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

Investments
Federated's investments are categorized as Investments—Consolidated Investment Companies or Investments—Affiliates and Other on the Consolidated Balance Sheets. Investments—Consolidated Investment Companies represent securities held by Federated as a result of consolidating certain Federated Funds. Investments—Affiliates and Other represent Federated's investments in fluctuating-value Federated Funds and investments held in Separate Accounts for which Federated owns the underlying debt and equity securities. All investments are carried at fair value with unrealized gains or losses on these securities recognized in Gain (Loss) on Securities, net on the Consolidated Statements of Income. Realized gains and losses on these securities are computed on a specific-identification basis and recognized in Gain (Loss) on Securities, net on the Consolidated Statements of Income.

The fair value of Federated's investments is generally based on quoted market prices in active markets for identical instruments. If quoted market prices are not available, fair value is generally based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, or model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. In the absence of observable market data inputs and/or value drivers, internally generated valuation techniques may be utilized in which one or more significant inputs or significant value drivers are unobservable in the market place. See Note (9) for additional information regarding the fair value of investments held as of September 30, 2018 and December 31, 2017.

Derivatives and Hedging Instruments
From time to time, Federated may consolidate an investment product that holds freestanding derivative financial instruments for trading purposes. Federated reports such derivative instruments at fair value and records the changes in fair value in Gain (Loss) on Securities, net on the Consolidated Statements of Income.

From time to time, Federated may also enter into derivative financial instruments to hedge against the risk of movement in foreign exchange rates. Federated records all derivative financial instruments as either assets or liabilities on its Consolidated Balance Sheets and measures these instruments at fair value. Federated has not designated any derivative financial instrument as a hedging instrument for accounting purposes. The gain or loss on these derivative instruments is recognized in Other, net on the Consolidated Statements of Income. See Note (10) for additional information on second quarter derivative instrument activity.

(4) Business Combinations

On April 12, 2018, Federated entered into an agreement to acquire a controlling interest in Hermes from BT Pension Scheme (BTPS). The addition of London-based Hermes, which has had multi-year significant asset growth, will further accelerate Federated's growth in markets outside of the U.S.

On July 2, 2018, Federated completed, effective as of July 1, 2018, the acquisition of a controlling interest in Hermes (Hermes Acquisition). BTPS retained a 29.5 percent interest in Hermes and contributed the remaining 10.5 percent interest into an Employee Benefit Trust (EBT) for the benefit of certain members of Hermes' management and other key employees under a long-term incentive plan (LTIP). Federated paid a total of £260.7 million ($344.3 million). Federated funded the transaction through a combination of cash and an $18.0 million drawdown from its existing revolving credit facility (see Note (11) for additional information).

Federated and BTPS entered into a Put and Call Option Deed pursuant to which Federated has a right to exercise a call option to acquire BTPS's remaining 29.5 percent interest in Hermes at fair value and BTPS has a right to exercise a put option to sell its remaining interest in Hermes to Federated at fair value, after the third, fourth or fifth anniversaries, and subject to certain contingencies, the sixth anniversary, of the date of the purchase agreement. Federated does not consider BTPS's 29.5 percent noncontrolling interest in Hermes to be permanent equity, due to it being redeemable at the option of BTPS and therefore, outside of Federated's control.

Hermes granted equity awards from the EBT in the form of restricted nonpublic subsidiary stock pursuant to the LTIP to certain members of Hermes management and other key employees. These awards, which are subject to continued service vesting requirements, vest over a period of three to five years. At various predetermined dates, but no earlier than 9 months after vesting, award holders have a right to exercise a put option to sell shares to Federated at fair value and Federated has a right to exercise a call option to acquire shares at fair value. The grant date fair value of the awards is recognized as Compensation and Related expense in the Consolidated Statements of Income over the relevant vesting periods, with a corresponding adjustment

13

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

to Redeemable Noncontrolling Interest in Subsidiaries in the Consolidated Balance Sheets. As a result of the grant of the equity awards in a nonpublic consolidated subsidiary under the terms of the LTIP and EBT, the shares are not included in the attribution of the subsidiary's income and losses to noncontrolling interest holders until the awards vest. Therefore, Federated will initially recognize the fair value of 33 percent of Hermes as Redeemable Noncontrolling Interest in Subsidiaries on the Consolidated Balance Sheets. The attribution of the subsidiary's income and loss is recognized in Net Income Attributable to the Noncontrolling Interests in Subsidiaries on the Consolidated Statements of Income and is expected to fluctuate as the LTIP awards vest and put/call options are exercised. Federated's diluted earnings per share calculation is adjusted for the proportionate share of net income related to the unvested equity awards in a nonpublic consolidated subsidiary (see Note (14) for additional information). As of September 30, 2018, Redeemable Noncontrolling Interest in Subsidiaries related to Hermes was $172.4 million.

Federated has expensed $14.5 million in transaction costs directly attributable to the Hermes Acquisition. Of this amount, $12.7 million has been expensed to date in 2018, primarily recorded in Professional Service Fees on the Consolidated Statements of Income. The transaction costs exclude a derivative loss (see Note (10) for additional information) and a $1.7 million foreign exchange gain recognized in the second quarter of 2018 as a result of holding British pound sterling at quarter end. Federated anticipates future transaction costs of approximately $1 million may be recorded in the fourth quarter of 2018. Actual results may differ from this estimate, and such difference may be material to the Consolidated Financial Statements.

Federated has performed a valuation of the fair market value of the Hermes Acquisition. Due to the timing of the acquisition and status of the valuation work, the purchase price allocation for all assets and liabilities acquired is preliminary. Although preliminary results of the valuation are reflected in the Consolidated Financial Statements as of September 30, 2018 and for the three and nine months then ended, the final purchase price allocation may reflect adjustments to this preliminary valuation and such adjustments may be material. The following table summarizes the allocation of the preliminary purchase price as of the acquisition date:
(in millions)
 
 
Cash and Cash Equivalents
 
$
175.8

Other Current Assets1
 
53.7

Goodwill2
 
161.2

Intangible Assets3
 
271.7

Other Long-Term Assets4
 
34.7

Less: Long-Term Deferred Tax Liability, net
 
(20.9
)
Less: Liabilities Acquired5
 
(162.3
)
Less: Fair Value of Redeemable Noncontrolling Interest in Subsidiary6
 
(169.6
)
Total Purchase Price Consideration
 
$
344.3

1
Includes $31.9 million of receivables, substantially all of which has been collected as of September 30, 2018.
2
The goodwill recognized is attributable to enhanced revenue and AUM growth opportunities from future investors and the assembled workforce of Hermes. In this instance, goodwill is not deductible for tax purposes.
3
Includes $92.4 million for customer relationships with a weighted-average useful life of 8.4 years, $130.2 million for indefinite-lived renewable investment advisory contracts and $49.1 million for an indefinite-lived trade name, all of which are recorded in Intangible Assets, net on the Consolidated Balance Sheets.
4
Includes $11.2 million of property and equipment.
5
Includes $130.3 million related to accrued compensation and benefits.
6
The fair value of the noncontrolling interest was determined utilizing the market approach and consideration of the overall business enterprise value.

The financial results of Hermes have been included in Federated's Consolidated Financial Statements from the July 1, 2018 effective date of the acquisition. For the three months ended September 30, 2018, Hermes earned revenue of $49.7 million and net income of $5.7 million (which excludes acquisition-related intangible amortization and amounts attributable to the noncontrolling interests).


14

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

The following table summarizes unaudited pro forma financial information assuming the Hermes Acquisition occurred at the beginning of the periods presented. This pro forma financial information is for informational purposes only and is not indicative of actual results that would have occurred had the Hermes Acquisition been completed on the assumed dates and it is not indicative of future results. In addition, the following pro forma financial information does not reflect the realization of any cost savings (nor does management expect to realize any cost savings) or other synergies from the Hermes Acquisition following the completion of the business combination. The pro forma results include adjustments for the effect of acquisition-related expenses (including the loss on foreign currency forward transactions noted below, compensation and related expense, income tax expense and amortization related to newly acquired intangibles) as well as adjustments to conform to Federated's U.S. GAAP accounting policies.
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
(in millions)
2018

 
2017

 
2018

 
2017

Revenue
$
308.6

 
$
317.1

 
$
923.3

 
$
951.5

Net Income1
$
59.6

 
$
76.5

 
$
179.9

 
$
229.6

1
The nine months ended September 30, 2018 excludes a $29.0 million loss on foreign currency forward transactions entered into in order to hedge against foreign exchange rate fluctuations associated with the payment for the Hermes Acquisition.

(5) Revenue from Contracts with Customers
The following table presents Federated's revenue disaggregated by asset class:
 
Three Months Ended
 
Nine Months Ended
(in thousands)
September 30, 2018
 
September 30, 2018
Equity
$
138,624

 
$
344,323

Money Market
101,257

 
304,662

Fixed-Income
45,897

 
135,442

Other1
22,838

 
44,034

Total Revenue
$
308,616

 
$
828,461

1
Includes Alternative / Private Markets (including but not limited to private equity, real estate and infrastructure), Multi-Asset and stewardship services revenue.

The following table presents Federated's revenue disaggregated by performance obligation:
 
Three Months Ended
 
Nine Months Ended
(in thousands)
September 30, 2018
 
September 30, 2018
Asset Management1
$
217,036

 
$
559,429

Administrative Services
49,855

 
147,248

Distribution2
36,226

 
111,206

Other3
5,499

 
10,578

Total Revenue
$
308,616

 
$
828,461

1
The performance obligation may include administrative, distribution and other services recorded as a single asset management fee under Topic 606, as it is part of a unitary fee arrangement with a single performance obligation.
2
The performance obligation is satisfied at a point in time and may include CDSC's and upfront commissions. A portion of this revenue relates to a performance obligation that has been satisfied in a prior period.
3
Includes shareholder service fees and stewardship services revenue.


15

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

The following table presents Federated's revenue disaggregated by geographical market:
 
Three Months Ended
 
Nine Months Ended
(in thousands)
September 30, 2018
 
September 30, 2018
Domestic
$
251,683

 
$
756,647

Foreign1
56,933

 
71,814

Total Revenue
$
308,616

 
$
828,461

1
This represents revenue earned by non-U.S. domiciled subsidiaries.

The following table presents Federated's revenue disaggregated by product type:
 
Three Months Ended
 
Nine Months Ended
(in thousands)
September 30, 2018
 
September 30, 2018
Federated Funds
$
248,428

 
$
691,641

Separate Accounts
57,508

 
134,140

Other1
2,680

 
2,680

Total Revenue
$
308,616

 
$
828,461

1
Includes stewardship services revenue.

Federated is not required to disclose certain estimates of revenue expected to be recorded in future periods as a result of applying the following exemptions: (1) contract terms are short-term in nature (i.e., expected duration of one year or less due to termination provisions) and (2) the expected variable consideration would be allocated entirely to future service periods.

Federated expects to recognize revenue in the future related to the unsatisfied portion of the stewardship services performance obligations at September 30, 2018. Generally, contracts are billed in arrears on a quarterly basis and have a three year duration, after which the customer can terminate the agreement with a six to twelve month notice. Based on existing contracts as of September 30, 2018, Federated may record future fixed revenue of approximately $3 million per quarter for stewardship services contracts.

(6) Concentration Risk

(a) Revenue Concentration by Asset Class

The following table presents Federated's revenue concentration by asset class:
 
 
Nine Months Ended
 
 
September 30,
 
 
2018

 
2017

Equity Assets
 
42
%
 
38
%
Money Market Assets
 
37
%
 
41
%
Fixed-Income Assets
 
16
%
 
17
%

The change in the relative proportion of Federated's revenue attributable to equity assets for the first nine months of 2018, as compared to the same period in 2017, was primarily the result of higher average equity assets mostly as a result of the July 2018 Hermes Acquisition. Because the Hermes Acquisition was primarily comprised of equity assets and alternative/private markets assets, the relative proportion of Federated's revenue attributable to money market assets decreased for the first nine months of 2018 as compared to the same period in 2017. Furthermore, Federated's revenue attributable to money market assets decreased as a result of a change in the mix of average money market assets.


16

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

(b) Revenue Concentration by Investment Strategy/Fund

The following table presents Federated's revenue concentration by investment strategy/fund:
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018

 
2017

 
2018

 
2017

Federated Strategic Value Dividend strategy1
13
%
 
18
%
 
15
%
 
18
%
Federated Kaufmann Mid-Cap Growth strategy2
10
%
 
9
%
 
10
%
 
9
%
1    Strategy includes Federated Funds and Separate Accounts.
2    Strategy includes Federated Funds.

A significant and prolonged decline in the AUM in either of these strategies/funds could have a material adverse effect on Federated's future revenues and, to a lesser extent, net income, due to a related reduction in distribution expenses associated with the Federated Funds managed in accordance with these strategies/funds.

(c) Revenue Concentration by Intermediary

Approximately 12% and 13% of Federated's total revenue for the three- and nine-month periods ended September 30, 2018, respectively, and 16% for both the three- and nine-month periods ended September 30, 2017, respectively, was derived from services provided to one intermediary, The Bank of New York Mellon Corporation, including its Pershing subsidiary. Significant negative changes in Federated's relationship with this intermediary could have a material adverse effect on Federated's future revenues and, to a lesser extent, net income due to a related reduction in distribution expenses associated with this intermediary.

(7) Consolidation

The Consolidated Financial Statements include the accounts of Federated, which include Federated Funds and other entities in which Federated holds a controlling financial interest. Federated is involved with various entities in the normal course of business that may be deemed to be voting rights entities (VREs) or variable interest entities (VIEs). From time to time, Federated invests in Federated Funds for general corporate investment purposes or, in the case of newly launched products, in order to provide investable cash to establish a performance history. Federated's investment in, and/or receivables from, these Federated Funds represents its maximum exposure to loss. The assets of each consolidated Federated Fund are restricted for use by the respective Federated Fund. Generally, neither creditors of, nor equity investors in, the Federated Funds have any recourse to Federated's general credit. Given that the entities follow investment company accounting, which prescribes fair-value accounting, a deconsolidation generally does not result in gains or losses for Federated. Receivables from all Federated Funds for advisory and other services totaled $42.0 million and $27.4 million at September 30, 2018 and December 31, 2017, respectively.

In the ordinary course of business, Federated may implement Fee Waivers for various Federated Funds for competitive, regulatory or contractual reasons. For the three and nine months ended September 30, 2018, Fee Waivers totaled $89.3 million and $264.9 million, respectively, of which $61.3 million and $178.9 million, respectively, related to money market funds which meet the scope exception of the consolidation guidance. For the three and nine months ended September 30, 2017, Fee Waivers totaled $83.8 million and $259.2 million, respectively, of which $53.1 million and $166.7 million, respectively, related to money market funds which meet the scope exception of the consolidation guidance.

Like other sponsors of investment companies, Federated in the ordinary course of business may make capital contributions to certain money market Federated Funds in connection with the reorganization of such funds into certain affiliated money market Federated Funds or in connection with the liquidation of a money market Federated Fund. In these instances, such capital contributions typically are intended to offset realized losses or other permanent impairments to a fund's net asset value (NAV), increase the market-based NAV per share of the fund's portfolio that is being reorganized to equal the market-based NAV per share of the acquiring fund or to bear a portion of expenses relating to a fund liquidation. Under current money fund regulations and Securities and Exchange Commission (SEC) guidance, Federated is required to report these types of capital contributions to U.S. money market mutual funds to the SEC as financial support to the investment company that is being reorganized or liquidated. There were no contributions for the three and nine months ended September 30, 2018. There were no material contributions for the three and nine months ended September 30, 2017.

17

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 


In accordance with Federated's consolidation accounting policy, Federated first determines whether the entity being evaluated is a VRE or a VIE. Once this determination is made, Federated proceeds with its evaluation of whether to consolidate the entity. The disclosures below represent the results of such evaluations as of September 30, 2018 and December 31, 2017.

(a) Consolidated Voting Rights Entities

Most of the Federated Funds meet the definition of a VRE. Federated consolidates certain VREs when it is deemed to have control. Consolidated VREs are reported on Federated's Consolidated Balance Sheets in Investments—Consolidated Investment Companies and Redeemable Noncontrolling Interest in Subsidiaries.

(b) Consolidated Variable Interest Entities

As of September 30, 2018 and December 31, 2017, Federated was deemed to be the primary beneficiary of, and therefore consolidated, certain Federated Funds as a result of its controlling financial interest. The following table presents the balances related to the consolidated Federated Fund VIEs that were included on the Consolidated Balance Sheets as well as Federated's net interest in the consolidated Federated Fund VIEs for each period presented:
(in millions)
 
September 30, 2018

 
December 31, 2017

Cash and Cash Equivalents
 
$
0.0

 
$
0.1

Investments—Consolidated Investment Companies
 
29.9

 
39.7

Receivables
 
0.7

 
1.0

Less: Liabilities
 
0.5

 
0.4

Less: Redeemable Noncontrolling Interest in Subsidiaries
 
19.7

 
27.7

Federated's Net Interest in Federated Fund VIEs
 
$
10.4

 
$
12.7


Federated's net interest in the consolidated Federated Fund VIEs represents the value of Federated's economic ownership interest in these Federated Funds.

Federated did not newly consolidate or deconsolidate any VIEs during the nine months ended September 30, 2018.

(c) Non-Consolidated Variable Interest Entities

Federated's involvement with certain Federated Funds that are deemed to be VIEs includes serving as the investment manager, or at times, holding a minority interest or both. Federated's variable interest is not deemed to absorb losses or receive benefits that could potentially be significant to the VIE. Therefore, Federated is not the primary beneficiary of these VIEs and has not consolidated these entities.

At September 30, 2018, Federated did not have an investment in a non-consolidated VIE. Of the previously disclosed Receivables from all Federated Funds, $19.2 million and $2.3 million related to non-consolidated VIEs at September 30, 2018 and December 31, 2017, respectively, and represented Federated's maximum risk of loss from non-consolidated VIE Receivables. At December 31, 2017, Federated's investment and maximum risk of loss related to an investment in a non-consolidated VIE was $0.9 million (recorded in Investments—Affiliates and Other on the Consolidated Balance Sheets) and was entirely related to one Federated Fund. AUM for this non-consolidated Federated Fund totaled $55.8 million at December 31, 2017.

(8) Investments

At September 30, 2018 and December 31, 2017, Federated held investments in Separate Accounts of $6.4 million and $6.3 million, respectively, and investments in fluctuating-value Federated Funds of $2.0 million and $1.6 million, respectively, that were included in Investments—Affiliates and Other on the Consolidated Balance Sheets.


18

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

Federated's investments held in Separate Accounts as of September 30, 2018 and December 31, 2017, were primarily composed of domestic debt securities ($3.0 million at the end of both periods) and stocks of large U.S. and international companies ($2.7 million and $2.6 million, respectively).

Federated consolidates certain Federated Funds into its Consolidated Financial Statements as a result of Federated's controlling financial interest in these Federated Funds (see Note (7)). All investments held by these Federated Funds were included in Investments—Consolidated Investment Companies on Federated's Consolidated Balance Sheets.

Federated's investments held by consolidated Federated Funds as of September 30, 2018 and December 31, 2017, were primarily composed of domestic and foreign debt securities ($29.6 million and $39.2 million, respectively) and stocks of small and medium-sized companies ($3.8 million at December 31, 2017).

The following table presents gains and losses recognized in Gain (Loss) on Securities, net on the Consolidated Statements of Income in connection with Federated's investments:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands)
 
2018

 
2017

 
2018

 
2017

Investments—Consolidated Investment Companies
 
 
 
 
 
 
 
 
Unrealized Gains (Losses)
 
$
606

 
$
(437
)
 
$
(1,737
)
 
$
659

Realized Gains1
 
99

 
1,110

 
1,424

 
3,184

Realized Losses1
 
(623
)
 
(66
)
 
(1,521
)
 
(765
)
Net Gains (Losses) on Investments—Consolidated Investment Companies
 
82

 
607

 
(1,834
)
 
3,078

Investments—Affiliates and Other
 
 
 
 
 
 
 
 
Unrealized Gains (Losses) Recognized on Securities Still Held
 
142

 
89

 
(64
)
 
360

Net Realized Gains Recognized on Securities Sold1
 
37

 
971

 
162

 
3,025

Net Gains on Investments—Affiliates and Other
 
179

 
1,060

 
98

 
3,385

Gain (Loss) on Securities, net
 
$
261

 
$
1,667

 
$
(1,736
)
 
$
6,463

Realized gains and losses are computed on a specific-identification basis.

(9) Fair Value Measurements

Fair value is the price that would be received to sell an asset or the price that would be paid to transfer a liability as of the measurement date. A fair-value reporting hierarchy exists for disclosure of fair value measurements based on the observability of the inputs to the valuation of financial assets and liabilities. The levels are:
 
Level 1 – Quoted prices for identical instruments in active markets. Level 1 assets may include equity and debt securities that are traded in an active exchange market, including shares of mutual funds.
 
Level 2 – Quoted prices for similar instruments in active markets; quoted prices for identical or similar instruments in markets that are not active; and model-derived valuations in which all significant inputs and significant value drivers are observable in active markets. Level 2 assets and liabilities may include debt and equity securities, purchased loans and over-the-counter derivative contracts whose fair value is determined using a pricing model without significant unobservable market data inputs.
 
Level 3 – Valuations derived from valuation techniques in which one or more significant inputs or significant value drivers are unobservable in active markets.
 
NAV Practical Expedient – Investments that calculate NAV per share (or its equivalent) as a practical expedient. These investments have been excluded from the fair value hierarchy.


19

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

(a) Fair Value Measurements on a Recurring Basis

The following table presents fair value measurements for classes of Federated's financial assets and liabilities measured at fair value on a recurring basis:
(in thousands)
 
Level 1
 
Level 2
 
Level 3
 
NAV Practical Expedient
 
Total
September 30, 2018
 
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents
 
$
116,943

 
$
0

 
$
0

 
$
0

 
$
116,943

Investments—Consolidated Investment Companies
 
 
 
 
 
 
 
 
 
 
Equity Securities
 
1,382

 
719

 
0

 
0

 
2,101

Debt Securities
 
0

 
29,636

 
0

 
0

 
29,636

Investments—Affiliates and Other
 
 
 
 
 
 
 
 
 
 
Equity Securities
 
5,092

 
0

 
39

 
288

 
5,419

Debt Securities
 
0

 
2,960

 
0

 
0

 
2,960

Other1
 
592

 
113

 
70

 
0

 
775

Total Financial Assets
 
$
124,009

 
$
33,428

 
$
109

 
$
288

 
$
157,834

 
 
 
 
 
 
 
 
 
 
 
Total Financial Liabilities2
 
$
7

 
$
3,815

 
$
734

 
$
0

 
$
4,556

 
 
 
 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
 
 
 
Financial Assets
 
 
 
 
 
 
 
 
 
 
Cash and Cash Equivalents
 
$
205,364

 
$
0

 
$
0

 
$
110,900

 
$
316,264

Investments—Consolidated Investment Companies
 
 
 
 
 
 
 
 
 
 
Equity Securities
 
5,424

 
746

 
0

 
0

 
6,170

Debt Securities
 
0

 
39,241

 
0

 
0

 
39,241

Investments—Affiliates and Other
 
 
 
 
 
 
 
 
 
 
Equity Securities
 
4,564

 
0

 
0

 
302

 
4,866

Debt Securities
 
0

 
2,997

 
0

 
0

 
2,997

Other1
 
123

 
357

 
760

 
0

 
1,240

Total Financial Assets
 
$
215,475

 
$
43,341

 
$
760

 
$
111,202

 
$
370,778

 
 
 
 
 
 
 
 
 
 
 
Total Financial Liabilities2
 
$
0

 
$
0

 
$
1,203

 
$
0

 
$
1,203

1
Amounts include restricted cash, structured trade finance loans held by Federated as well as futures contracts and/or foreign currency forward contracts held within certain consolidated Federated Funds.
2
Amounts include derivative liabilities, acquisition-related future contingent consideration liabilities as well as certain liabilities attributable to structured trade finance loans held by Federated and may include foreign currency forward contracts and/or futures contracts held within certain consolidated Federated Funds.

The following is a description of the valuation methodologies used for financial assets and liabilities measured at fair value on a recurring basis. Federated did not hold any nonfinancial assets or liabilities measured at fair value on a recurring basis at September 30, 2018 or December 31, 2017.

Cash and Cash Equivalents
Cash and Cash Equivalents include deposits with banks and investments in money market funds. Investments in money market funds totaled $78.0 million and $311.0 million at September 30, 2018 and December 31, 2017, respectively. Cash investments in publicly available money market funds are valued under the market approach through the use of quoted market prices in an active market, which is the NAV of the funds, and are classified within Level 1 of the valuation hierarchy. For an investment in a money market Federated Fund that is not publicly available but for which the NAV is calculated daily and for which there are no redemption restrictions, the security is valued using NAV as a practical expedient and is excluded from the fair value hierarchy. This investment is included in the NAV Practical Expedient column in the December 31, 2017 table above.

20

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

Investments—Consolidated Investment Companies—Equity Securities
Investments—Consolidated Investment Companies—Equity Securities represent equity securities held by consolidated Federated Funds. For publicly traded equity securities available in an active market, the fair value of these securities is classified as Level 1 when the fair value is based on quoted market prices. The fair value of certain equity securities traded principally in foreign markets and held by consolidated Federated Funds are determined by a third-party pricing service (Level 2).
Investments—Consolidated Investment Companies—Debt Securities
Investments—Consolidated Investment Companies—Debt Securities primarily represent domestic and foreign bonds held by consolidated Federated Funds. The fair value of these securities may include observable market data such as valuations provided by independent pricing services after considering factors such as the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions, indications as to values from dealers and general market conditions (Level 2).
Investments—Affiliates and Other—Equity Securities
Investments—Affiliates and Other—Equity Securities primarily represent equity investments held in Separate Accounts as well as investments in fluctuating-value Federated Funds. For publicly traded equity securities available in an active market, the fair value of these securities is classified as Level 1 when the fair value is based on quoted market prices. For investments in Federated Funds that are publicly available, the securities are valued under the market approach through the use of quoted market prices available in an active market, which is the NAV of the funds, and are classified within Level 1 of the valuation hierarchy. For certain investments in Federated Funds and/or Separate Accounts that are not publicly available but for which the NAV is calculated daily and for which there are no redemption restrictions, the securities are valued using NAV as a practical expedient and are excluded from the fair value hierarchy. These investments are included in the NAV Practical Expedient column in the table above.
Investments—Affiliates and Other—Debt Securities
Investments—Affiliates and Other—Debt Securities primarily represent domestic bonds held in Separate Accounts. The fair value of these securities may include observable market data such as valuations provided by independent pricing services after considering factors such as the yields or prices of investments of comparable quality, coupon, maturity, call rights and other potential prepayments, terms and type, reported transactions, indications as to values from dealers and general market conditions (Level 2).

(b) Fair Value Measurements on a Nonrecurring Basis

Federated did not hold any assets or liabilities measured at fair value on a nonrecurring basis at September 30, 2018.

(c) Fair Value Measurements of Other Financial Instruments

The fair value of Federated's debt is estimated by management using observable market data (Level 2). Based on this fair value
estimate, the carrying value of debt appearing on the Consolidated Balance Sheets approximates fair value.

(10) Derivatives

On April 13, 2018, Federated entered into a foreign currency forward derivative financial instrument with Citi Bank, N.A. (Citi) under an existing International Swaps and Derivatives Association, Inc. Master Agreement dated June 9, 2010 (ISDA) in order to hedge against foreign exchange rate fluctuations associated with the payment for the Hermes Acquisition. This forward was not designated as a hedging instrument for accounting purposes. Under this forward transaction, Federated committed to purchase £250 million at an all-in forward rate of 1.43192 (which is comprised of a spot rate of 1.42522 plus forward points of 0.00670) for settlement on August 1, 2018.

On June 27, 2018, Federated entered into a second foreign currency forward transaction with Citi in which Federated committed to sell £250 million at an all-in forward rate of 1.31601 (which is comprised of a spot rate of 1.31400 plus forward points of 0.00201) for settlement on August 1, 2018. This forward was not designated as a hedging instrument for accounting purposes. This second forward allowed Federated to effectively close the initial forward to lock in the foreign exchange rate and amount due on August 1, 2018. The change in the spot rate and a reduction in the forward points resulted in a payment of $29.0 million to Citi on August 1, 2018 when both derivatives were settled. The $29.0 million change in fair value of these derivatives

21

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

was recorded as a nonoperating expense in Other, net on the Consolidated Statements of Income during the three-month period ended June 30, 2018.

(11) Debt

On June 5, 2017, Federated entered into an unsecured Third Amended and Restated Credit Agreement by and among Federated, certain of its subsidiaries as guarantors party thereto, a syndicate of ten banks as Lenders party thereto, PNC Bank, National Association as administrative agent, PNC Capital Markets LLC, as sole bookrunner and joint lead arranger, Citigroup Global Markets, Inc., as joint lead arranger, Citibank, N.A. as syndication agent, and TD Bank, N.A. as documentation agent (Credit Agreement). The Credit Agreement amended and restated Federated's prior unsecured Second Amended and Restated Credit Agreement, which was dated June 24, 2014 and scheduled to mature on June 24, 2019 (Prior Credit Agreement). The Credit Agreement refinanced $200 million available on the revolving credit facility and $178.5 million outstanding on the term loan facility under the Prior Credit Agreement, replacing both with a $375 million revolving credit facility which has an additional $200 million available via an optional increase (or accordion) feature. The interest on the revolving credit facility is calculated at the monthly London Interbank Offering Rate (LIBOR) plus a spread. The borrowings under the revolving credit facility may include up to $25 million for which interest is calculated at the daily LIBOR plus a spread (Swing Line). Federated had no borrowings under the previous revolving credit facility. The Credit Agreement does not include a term loan facility. On July 1, 2018, Federated entered into an amendment to the Credit Agreement to add certain definitions and to amend certain negative covenants relating to indebtedness, guarantees, and restrictions on dividends, related to the Hermes Acquisition. This amendment contains other customary conditions, representations, warranties and covenants.

The Credit Agreement, which expires on June 5, 2022, has no principal payment schedule, but instead requires that any outstanding principal be repaid by the expiration date. Federated, however, may elect to make discretionary principal payments prior to the expiration date. As of September 30, 2018 and December 31, 2017, the amounts outstanding under the revolving credit facility were $160 million and $170 million, respectively, and were recorded as Long-Term Debt on the Consolidated Balance Sheets. The interest rate was 3.229% and 2.486% as of September 30, 2018 and December 31, 2017, respectively, which was calculated at LIBOR plus a spread. The commitment fee under the Credit Agreement currently is 0.125% per annum on the daily unused portion of each Lender's commitment. As of September 30, 2018, Federated has $215 million available for borrowings.

The Credit Agreement, similar to the Prior Credit Agreement, includes representations and warranties, affirmative and negative financial covenants, including an interest coverage ratio covenant and a leverage ratio covenant, reporting requirements and other non-financial covenants. Federated was in compliance with all covenants at and during the nine months ended September 30, 2018 (see the Liquidity and Capital Resources section of Management's Discussion and Analysis for additional information). The Credit Agreement also has certain stated events of default and cross default provisions which would permit the lenders/counterparties to accelerate the repayment of debt outstanding 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, notice of lien or assessment, and other proceedings, whether voluntary or involuntary, that would require the repayment of amounts borrowed. The Credit Agreement also requires certain subsidiaries to enter into a Second Amended and Restated Continuing Agreement of Guaranty and Suretyship to guarantee payment of all obligations incurred through the Credit Agreement.

(12) Share-Based Compensation Plans

During the first nine months of 2018, Federated awarded 491,769 shares of restricted Federated Class B common stock, nearly all of which was granted in connection with a bonus program in which certain key employees received a portion of their bonus in the form of restricted stock under Federated's Stock Incentive Plan. This restricted stock, which was granted on the bonus payment date and issued out of treasury, will generally vest over a three-year period. The remaining shares were awarded to certain key employees and generally vest over a ten-year period.

During 2017, Federated awarded 946,570 shares of restricted Federated Class B common stock under its Stock Incentive Plan. Of this amount, 513,570 shares were awarded in connection with the aforementioned bonus program in 2017. The remaining shares were awarded to certain key employees and generally vest over a ten-year period.


22

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

(13) Equity

In October 2016, the board of directors authorized a share repurchase program with no stated expiration date that allows Federated to buy back up to 4 million shares of Federated Class B common stock. No other programs existed as of September 30, 2018. The program authorizes executive management to determine the timing and the amount of shares for each purchase. The repurchased stock is to be held in treasury for employee share-based compensation plans, potential acquisitions and other corporate activities, unless Federated's board of directors subsequently determines to retire the repurchased stock and restore the shares to authorized but unissued status (rather than holding the shares in treasury). During the first nine months of 2018, Federated repurchased 1.1 million shares of its Class B common stock for $26.9 million, nearly all of which were repurchased in the open market. At September 30, 2018, 1.1 million shares remain available to be purchased under Federated's buyback program.

(14) Earnings Per Share Attributable to Federated Investors, Inc. Shareholders

The following table sets forth the computation of basic and diluted earnings per share using the two-class method for amounts attributable to Federated:
 
 
Three Months Ended
 
Nine Months Ended
 
 
September 30,
 
September 30,
(in thousands, except per share data)
 
2018

 
2017

 
2018

 
2017

Numerator – Basic and Diluted
 
 
 
 
 
 
 
 
Net Income Attributable to Federated Investors, Inc.
 
$
59,608

 
$
56,439

 
$
158,761

 
$
159,531

Less: Total Net Income Available to Participating Unvested Restricted Shareholders1
 
(2,835
)
 
(2,220
)
 
(6,741
)
 
(6,342
)
Total Net Income Attributable to Federated Common Stock2
 
$
56,773

 
$
54,219

 
$
152,020

 
$
153,189

Denominator
 
 
 
 
 
 
 
 
Basic Weighted-Average Federated Common Stock2
 
96,664

 
97,128

 
97,013

 
97,521

Dilutive Potential Shares from Stock Options
 
0

 
1

 
1

 
1

Diluted Weighted-Average Federated Common Stock2
 
96,664

 
97,129

 
97,014

 
97,522

Earnings Per Share
 
 
 
 
 
 
 
 
Net Income Attributable to Federated Common Stock – Basic and Diluted2
 
$
0.59

 
$
0.56

 
$
1.57

 
$
1.57

1
Net Income available to participating unvested restricted shareholders includes dividends paid on unvested restricted shares and their proportionate share of undistributed earnings attributable to Federated shareholders ($2.4 million and $6.3 million for the three and nine months ended September 30, 2018, respectively) and unvested shareholders of a nonpublic consolidated subsidiary beginning July 1, 2018.
2
Federated Common Stock excludes unvested restricted shares which are deemed participating securities in accordance with the two-class method of computing earnings per share.

(15) Commitments and Contingencies

(a) Guarantees and Indemnifications
On an intercompany basis, various wholly owned subsidiaries of Federated guarantee certain financial obligations of Federated Investors, Inc., and Federated Investors, Inc. guarantees certain financial and performance-related obligations of various wholly owned subsidiaries. In addition, in the normal course of business, Federated has entered into contracts that provide a variety of indemnifications. Typically, obligations to indemnify third parties arise in the context of contracts entered into by Federated, under which Federated agrees to hold the other party harmless against losses arising out of the contract, provided the other party's actions are not deemed to have breached an agreed-upon standard of care. In each of these circumstances, payment by Federated is contingent on the other party making a claim for indemnity, subject to Federated's right to challenge the other party's claim. Further, Federated's obligations under these agreements may be limited in terms of time and/or amount. It is not possible to predict the maximum potential amount of future payments under these or similar agreements due to the conditional nature of Federated's obligations and the unique facts and circumstances involved in each particular agreement. As of September 30, 2018, management does not believe that a material loss related to any of these matters is reasonably possible.


23

 
Notes to the Consolidated Financial Statements (continued)
(unaudited)
 
 

(b) Legal Proceedings
Like other companies, Federated has claims asserted and threatened against it in the ordinary course of business. As of September 30, 2018, Federated does not believe that a material loss related to these claims is reasonably possible.
See Item 1A - Risk Factors included in Federated's Annual Report on Form 10-K for the year ended December 31, 2017 for additional information regarding risks related to claims asserted or threatened against Federated.

(16) Income Taxes

On December 22, 2017, the Tax Act was signed into law. The Tax Act significantly modified the federal tax code and, among other changes, reduced the federal corporate income tax rate from a maximum of 35% to a flat 21%. In addition, as a result of this rate change, Federated's 2017 results included a $70.4 million reduction to the income tax provision resulting from the revaluation of its net deferred tax liability. This represents a provisional estimate based on management's initial analysis and interpretation of the legislation. Given the complexity of the legislation, anticipated guidance from the U.S. Department of Treasury (Treasury Department) and the potential for additional guidance from the SEC and/or the FASB, this estimate may be adjusted during 2018. As of September 30, 2018, management does not anticipate a material change to the estimate.
The Tax Act's international provisions regarding Global Intangible Low-Taxed Income (GILTI) and the Base Erosion Anti-Avoidance Tax (BEAT) are not expected to have a material impact on Federated's financial statements. However, this assessment is based on a preliminary review and analysis of these provisions and may change as Federated continues its evaluation of these highly complex rules, for which interpretive guidance is needed and expected. In addition, the Hermes Acquisition increases the potential impact of these U.S. international tax provisions.
In January 2018, the FASB released guidance on the accounting for the GILTI provisions, indicating that a company can elect an accounting policy either to account for the GILTI tax as an expense in the period incurred or to factor the GILTI tax into the measurement of deferred taxes. As Federated requires additional time to evaluate the GILTI provisions and their accounting implications, it has not yet elected its accounting policy with regard to this item.
(17) Subsequent Events

On October 25, 2018, the board of directors declared a $0.27 per share dividend to shareholders of record as of November 8, 2018 to be paid on November 15, 2018.
On October 25, 2018, pursuant to authority granted under Federated's Stock Incentive Plan (the Plan), Federated's compensation committee and board of directors approved a UK Sub-Plan to the Federated Investors, Inc. Stock Incentive Plan (UK Sub-Plan). The UK Sub-Plan supplements certain provisions of the Plan to allow awards of shares of restricted Federated Class B common stock, and other types of awards permitted under the Plan, to be granted to employees in the United Kingdom (UK). In connection with any award, payment representing dividends or interest or their equivalent may be made to participants. The UK Sub-Plan does not have a fixed expiration date but may be terminated by Federated's board of directors at any time. The compensation committee has full authority to make awards under the UK Sub-Plan, to determine the terms and conditions of such awards, and to interpret and make all other determinations affecting the UK Sub-Plan, subject to the provisions of the UK Sub-Plan and the Plan, and direction by Federated's board of directors. As determined by the compensation committee, among other terms, awards under the UK Sub-Plan may have a purchase price of $3.00 per share, have a five year cliff vesting schedule and be subject to certain vesting acceleration, forfeiture or malus and clawback provisions that may apply depending upon the circumstances surrounding a participant's termination of employment or the occurrence of certain other events. The compensation committee may delegate some or all of its authority and responsibility under the UK Sub-Plan consistent with the Plan. The compensation committee has delegated its full power and authority under the UK Sub-Plan to Federated's Chief Executive Officer with respect to all employees other than those subject to Section 16 of the Securities Exchange Act of 1934. Please refer to the description of the Plan set forth under "Summary of Stock Incentive Plan" in Federated's Information Statement, dated March 15, 2018, the Plan attached to such Information Statement, and the UK Sub-Plan attached to this Quarterly Report on Form 10-Q as Exhibit 10.1. The Form of Restricted Stock Award Agreement for use in connection with awards under the UK Sub-Plan is attached to this Quarterly Report on Form 10-Q as Exhibit 10.2.
On October 26, 2018, Federated entered into a second amendment to the Credit Agreement to clarify that a subsidiary created to be the general partner of a private fund, as well as the private fund, would not be required to execute a guarantee agreement to guarantee payment of all obligations incurred through the Credit Agreement. The Second Amendment to the Credit Agreement is attached to this Quarterly Report on Form 10-Q as Exhibit 10.3.

24


Part I, Item 2. Management's Discussion and Analysis

 
of Financial Condition and Results of Operations (unaudited)
 

The discussion and analysis below should be read in conjunction with the consolidated financial statements appearing elsewhere in this report. Management has presumed that the readers of this interim financial information have read or have access to Management's Discussion and Analysis of Financial Condition and Results of Operations appearing in Federated's Annual Report on Form 10-K for the year ended December 31, 2017.

General

Federated is one of the largest investment managers in the U.S. with $437.2 billion in managed assets as of September 30, 2018. The majority of Federated's revenue is derived from advising Federated Funds and Separate Accounts in both domestic and international markets. Federated also derives revenue from providing administrative and other fund-related services (including distribution and shareholder servicing) and stewardship services.
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 average net assets of managed investment portfolios. 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. Generally, managed assets in Federated's investment products and strategies can be redeemed or withdrawn 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 and strategies are higher than management-fee rates charged to fixed-income products and strategies, which are higher than management-fee rates charged to money market products and strategies. Likewise, Federated Funds typically have a higher management-fee rate than Separate Accounts. Similarly, revenue is also dependent upon the relative composition of average AUM across both asset and product types. Federated may implement Fee Waivers for competitive reasons such as to maintain certain fund expense ratios, to maintain positive or zero net yields on certain money market funds, 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 and strategies. These payments are generally calculated as a percentage of net assets attributable to the applicable financial intermediary and represent 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 expenses are Compensation and Related expense and Distribution expense, as described above. Compensation and Related expense includes base salary and wages, incentive compensation and other employee expenses including payroll taxes and benefits. Incentive compensation, which includes stock-based compensation, can vary depending on various factors including, but not limited to, the overall results of operations of 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. Management evaluates Federated's performance at the consolidated level. Therefore, Federated operates in a single operating segment, the investment management business. 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 Fee Waivers (including management's decisions regarding Voluntary Yield-related Fee Waivers). Fees for mutual fund-related services are ultimately subject to the approval of the independent directors or trustees of the mutual funds. Management believes that meaningful indicators of Federated's financial performance include AUM, gross and net product sales, total revenue and net income, both in total and per diluted share.


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Management's Discussion and Analysis (continued)
of Financial Condition and Results of Operations (unaudited)
 

Business Developments

Business Combination

On July 2, 2018, Federated completed the Hermes Acquisition, effective as of July 1, 2018. See Note (4) to the Consolidated Financial Statements for additional information.

Current Regulatory Environment

Domestic
Certain rules and regulations adopted by the SEC, among other regulatory authorities, self-regulatory organizations or exchanges, have continued to become or are expected to become effective in 2018 or 2019. While increased regulation continues in 2018, the pace of new regulation slowed in late 2017 and 2018, with the possibility for deregulation continuing to exist. The rules and regulations that have or are expected to become effective, and any new proposed rules and regulations, continue to impact the investment management industry (collectively, both domestically and abroad, as applicable, Regulatory Developments).
Through a series of Executive Orders and Presidential Memoranda issued in the first quarter of 2017, U.S. regulators were instructed to take steps to reduce regulation and control regulatory costs. As a result, the possibility continues for repeal or modification of certain aspects of the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) or the modification, or delay in the final implementation, of other laws, rules or regulations, as well as other deregulation. For example, the SEC reduced its 2017 regulatory agenda by about one-half and further streamlined its regulatory agenda in 2018.
The Treasury Department issued a report in October 2017 on asset management and insurance (Treasury Asset Management Report). In that report, the Treasury Department made various recommendations for deregulation of the asset management industry. Among other recommendations, the Treasury Department recommended amending rules to avoid dual SEC and Commodity Futures Trading Commission registration requirements for investment companies and to eliminate Dodd-Frank Act imposed stress testing requirements for investment advisors and investment companies in favor of stress testing requirements under Rule 2a-7 under the 1940 Act (Rule 2a-7). In a July 2018 report titled "A Financial System That Creates Economic Opportunities Nonbank Financials, Fintech, and Innovation," among other recommendations, the Treasury Department further recommended streamlining the regulatory environment to foster innovation across business models.
Deregulation also is a focus of certain legislative efforts. The House Financial Services Committee advanced a bill seeking to reverse certain aspects of money market fund reform and a hearing on that bill was held in the Senate in June 2018. For example, the proposed law would permit the use of amortized cost valuation by, and override the floating NAV and certain other requirements for, institutional and municipal (or tax-exempt) money market funds. These requirements were imposed under the SEC's structural, operational and other money market fund reforms adopted through amendments to Rule 2a-7, and certain other regulations, on July 23, 2014 (2014 Money Fund Rules) and related guidance (collectively, the 2014 Money Fund Rules and Guidance).
The current regulatory environment has affected, and is expected to continue to affect, to varying degrees, Federated's business, results of operations, financial condition and/or cash flows. Increased regulation and Regulatory Developments have required, and are expected to continue to require, additional internal and external resources to be devoted to technology, legal, compliance, operations and other efforts to address regulatory-related matters, and have caused, and may continue to cause, product structure, pricing, offering and development effort adjustments, as well as changes in asset flows and mix, customer relationships, revenues and operating income. Given the possibility for deregulation that exists in the current regulatory environment in the U.S., the degree of impact of Regulatory Developments can vary and is uncertain.
On December 11, 2015, the SEC proposed a rule that, if adopted as proposed, would increase the regulation of the use of derivatives by investment companies by imposing, among others, requirements to comply with portfolio leverage limitations, to segregate certain assets, and to establish a formalized derivatives risk management program. It is unclear if or when the derivatives rule will be finalized. While the proposed derivatives rule remains on the SEC's Spring 2018 regulatory agenda management does not expect this rule to be finalized until the fourth quarter of 2018 at the earliest, with an extended compliance period. Among other recommendations on derivatives regulation, the Treasury Asset Management Report recommended that the SEC consider a derivatives rule that would include a derivatives risk management program and an asset segregation requirement, but reconsider what, if any, portfolio limits should be part of the rule. Government regulatory policies, and the possibility for deregulation in the U.S., could further delay or result in modifications to this rule or result in this rule not being adopted.

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Management's Discussion and Analysis (continued)
of Financial Condition and Results of Operations (unaudited)
 

On April 18, 2018, the SEC issued three new proposals, including a proposed Regulation Best Interest, which would require broker/dealers to act in the best interest of a retail customer when making a recommendation of any securities transaction or investment strategy involving securities, and makes it clear that a broker/dealer may not put its financial interests ahead of the interests of a retail customer when making recommendations. Under Regulation Best Interest as proposed, a broker/dealer would discharge its duty to act in the best interests of a retail customer by complying with each of three specific obligations: (1) Disclosure to the retail customer of the key facts about its relationship with the customer, including material conflicts of interest; (2) Exercising reasonable diligence, care, skill, and prudence, to (a) understand the product; (b) have a reasonable basis to believe that the product is in the retail customer's best interest; and (c) have a reasonable basis to believe that a series of transactions is in the retail customer's best interest; and (3) Establishing, maintaining and enforcing policies and procedures reasonably designed to identify and then, at a minimum, to disclose and mitigate, or eliminate, material conflicts of interest arising from financial incentives, as well as at least disclosing other material conflicts of interest. In a companion release, the SEC proposed interpretations designed to reaffirm, and, in certain cases, clarify, the SEC's views on the fiduciary duty investment advisors owe to their clients under the Advisers Act. In another companion release, the SEC proposed Form CRS, which would be a short client or customer relationship summary disclosure intended to help address retail investor confusion about the nature of their relationships with investment professionals, and would supplement other more detailed disclosures required to be provided by advisors in Form ADV, Part 2A, and by brokers under Regulation Best Interest. The SEC also proposed to restrict certain broker/dealers and their financial professionals from using the terms "adviser" or "advisor" as part of their name or title with retail investors. Investment advisors and broker/dealers would also need to disclose their registration status with the SEC in certain retail investor communications. The public comment period on each proposing release ended on August 7, 2018.
Although the Department of Labor's rule imposing a modified fiduciary standard for retirement plan advisors (DOL Fiduciary Rule) has been vacated in its entirety, both the SEC and the investment management industry had already taken action or begun to make changes in light of the DOL Fiduciary Rule before it was vacated. For example, in response to questions raised in connection with the sale and distribution of mutual fund shares under the 1940 Act, the SEC issued guidance in late 2016 and early 2017 addressing mutual fund fee structures. That guidance permits sales load variation disclosure for multiple intermediaries and permits, subject to certain conditions being satisfied, broker/dealers, when acting as brokers, to charge a commission outside of the mutual fund for sales or distribution services on sales of mutual fund shares that do not have any front-end or contingent deferred sales loads or other asset-based sales charges (so called "clean shares"). Certain broker-dealers have eliminated commission-based compensation arrangements and made other conflict of interest and policy changes. Certain intermediaries also reduced the number of mutual funds offered on their platforms. It is uncertain whether, and to what degree, broker-dealers and other intermediaries will roll-back or continue the changes that were already implemented, or in the process of being implemented, in light of the DOL Fiduciary Rule being vacated, particularly given that the SEC's Regulation Best Interest, as proposed, appears to allow for more flexibility than the DOL Fiduciary Rule.
On October 13, 2016, the SEC adopted rules relating to the modernization of investment company reporting and disclosure, the enhancement of liquidity risk management by open-end investment companies and the permitted use of "swing pricing" by open-end investment companies. The SEC later issued Investment Company Reporting Modernization Frequently Asked Questions, which were last updated on April 27, 2018. Among other requirements and changes, the reporting modernization rules require registered investment companies to make certain disclosures regarding securities lending activities and, using a standardized data format, require registered investment companies (other than money market funds) to report portfolio-wide and position-level holding data monthly on Form N-PORT, and registered investment companies (other than face-amount certificate companies) to report certain census-type information annually on Form N-CEN. The rules also require standardized and enhanced disclosure regarding derivatives in fund financial statements. The Federated Funds that are registered under the 1940 Act are required to report on Form N-PORT and Form N-CEN. In December 2017, in light of a cyber incident disclosed by the SEC in September 2017 and requests from industry participants, the SEC postponed the compliance date for filing Form N-PORT from June 1, 2018 to April 30, 2019. For larger fund complexes, such as Federated's, required information has to be compiled, maintained and made available to the SEC from and after June 1, 2018. The compliance date for Form N-CEN was June 1, 2018.
The liquidity risk management rules require open-end investment companies (other than money market funds and certain exchange traded funds (ETFs)) to establish liquidity risk management programs that contain certain required elements, including (among others): (1) classification of the liquidity of fund portfolio investments into four "buckets" (i.e., highly liquid, moderately liquid, less liquid and illiquid); (2) assessment, management and periodic review of a fund's liquidity risk; (3) establishment of a highly liquid investment minimum (i.e., a minimum percentage of cash and investments that can be liquidated in three business days without significantly changing the market value of the investment); (4) limitation on illiquid investments (i.e., 15% of net assets) with board reporting of exceptions; and (5) fund board review and approval of the liquidity management program and the designation of a fund advisor or officer to administer the program. In addition to certain other

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Management's Discussion and Analysis (continued)
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policy and procedure, disclosure and recordkeeping requirements, the rules require confidential reporting on Form N-LIQUID when a fund's level of illiquid assets exceeds 15% of its net assets or when the fund's highly liquid investments fall below its highly liquid investment minimum for more than a brief period of time. Larger fund complexes, such as Federated's, are required to establish their liquidity risk management programs by December 1, 2018. Compliance with disclosure and certain other requirements was required by June 1, 2017. In July 2017, the Investment Company Institute requested the SEC to adjust the compliance schedule for the liquidity risk management rule's asset classification and related requirements to allow the SEC to adopt amendments permitting each fund to formulate its own policies and procedures to determine how to classify the liquidity of its investments and, in any event, to postpone the December 1, 2018 compliance date for at least one year. The Treasury Asset Management Report, while supporting robust liquidity risk management programs, endorsed the current 15% limitation on illiquid assets applicable to investment companies and rejected any highly prescriptive regulatory approach to liquidity risk management, such as the bucketing requirement. In addition, it recommended that the SEC adopt a principles-based approach to liquidity risk management rules, and any associated bucketing requirements, and postpone the currently scheduled December 2018 implementation of the bucketing requirement. In December 2017, the SEC postponed the requirement to report on Form N-LIQUID until April 1, 2019, in light of the cyber incident disclosed by the SEC in September 2017. On January 10, 2018, the SEC issued Investment Company Liquidity Risk Management Programs Frequently Asked Questions, which clarified certain of the rules' requirements for sub-advised funds and ETFs. Given the possibility for deregulation in the U.S., it is uncertain whether the current compliance dates will be delayed or whether aspects of the liquidity risk management rules will be modified or eliminated prior to the final required compliance date. In February 2018, the SEC postponed the implementation of the bucketing requirement until June 1, 2019, and, based on comments from certain SEC Commissioners, industry participants, including Federated, are requesting the SEC to consider eliminating the bucketing requirements because, among other reasons, they are highly burdensome, defective and costly, and will not provide the SEC or fund managers with meaningful insights into fund liquidity during times of market stress or other intended benefits. Other provisions of the liquidity risk management rules, including the requirement to establish risk management programs and the limitation of illiquid investments to 15% of net assets, are still scheduled to take effect on December 1, 2018.
On June 28, 2018, the SEC issued adopted amendments to the public liquidity-related disclosure requirements for open-end mutual funds to assist in providing investors with accessible and useful information about the liquidity risk management practices of the funds in which they invest. Under the amendments, funds will be required to discuss in their annual or semi-annual shareholder reports the operation and effectiveness of their liquidity risk management program, replacing a pending requirement that funds publicly provide the aggregate liquidity classification profile of their portfolios on Form N-PORT. The amendments to Form N-PORT will provide funds the flexibility to split their portfolio holdings into more than one classification category in three specified circumstances when split reporting equally or more accurately reflects the liquidity of the investment or eases cost burdens. Under the amendments, Form N-PORT also will require that funds disclose their holdings of cash and cash equivalents not reported elsewhere on the Form. This rule became effective on September 10, 2018, with a compliance date for the Form N-PORT amendments being June 1, 2019, and a compliance date for the shareholder report disclosure requirements of December 1, 2019, for larger fund complexes.
The swing pricing rule, which will be effective on November 19, 2018, permits open-end investment companies (other than money market funds and ETFs) to use swing pricing to effectively pass on the costs resulting from shareholder purchase and redemption transactions to the transacting shareholders. The Treasury Asset Management Report encouraged further analysis of whether, and to what extent, swing pricing will be implemented by funds and recommended that particular focus should be placed on investor protection and whether funds are appropriately setting the amount of the swing factor as justified by relevant trading costs. Given government regulatory policies, and the possibility for deregulation in the U.S., it is uncertain whether aspects of the swing pricing rule will be delayed or modified prior to the effective date. As of September 30, 2018, management does not believe there is interest in the U.S. fund industry generally to adopt swing pricing.
At the time the SEC finalized the rules relating to the modernization of investment company reporting and disclosure, the SEC did not adopt a proposed rule that would have permitted delivery of fund shareholder reports through website posting in lieu of mailing. The Treasury Asset Management Report recommended that the SEC finalize its proposed rule to modernize its shareholder report disclosure requirements and permit the use of implied consent for electronic disclosures, while retaining a shareholder's choice to continue receiving paper disclosures. On June 6, 2018, the SEC adopted rule 30e-3 under the 1940 Act (Rule 30e-3). While Rule 30e-3 becomes effective January 1, 2019, the rule has an extended transition period under which funds may replace delivery of paper shareholder reports with electronic reports beginning January 1, 2021. If funds elect to rely on Rule 30e-3 beginning January 1, 2021 and before January 1, 2022, funds would be required to provide two years of notice to shareholders before relying on the rule. The rule creates an optional "notice and access" method for delivering shareholder reports. Subject to certain accessibility, quarterly holdings availability, formatting, notice, print upon request, and paper copy election conditions in the rule, the rule will allow funds to deliver their shareholder reports by making them publicly accessible on a website, free of charge, and sending investors a paper notice of each report's availability by mail.

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Management's Discussion and Analysis (continued)
of Financial Condition and Results of Operations (unaudited)
 

On May 23, 2018, the SEC issued proposed rules under the Securities Act of 1933 and 1940 Act that, if adopted, would establish, subject to certain conditions, a safe harbor for unaffiliated brokers or dealers participating in a securities offering of a covered investment fund to publish or distribute a covered investment fund research report. The proposed rule is intended to reduce obstacles to providing research on investment funds by harmonizing the treatment of such research with research on other public entities. The SEC proposed this rule in furtherance of the Fair Access to Investment Research Act of 2017. The public comment period for the proposed rule ended on July 9, 2018.
On June 5, 2018, the SEC issued a request for comment seeking public input on enhancing mutual fund, ETF and other investment fund disclosures to improve the investor experience and help investors to make informed investment decisions. Among other matters, this request for comment also solicits feedback on investor preferences for means of delivery and how to make better use of 21st century technology, including how to make disclosures more interactive and personalized. The public comment period ends on October 31, 2018.
On June 5, 2018, in light of the adoption of Rule 30e-3, the SEC also issued a request for public comment and additional data on the current processing fee framework intermediaries charge for forwarding fund materials, such as shareholder reports and prospectuses, to beneficial shareholders under current rules of the New York Stock Exchange and other self-regulatory organizations, to better understand the potential effects on funds and their investors. The public comment period ends on October 31, 2018.
On June 28, 2018, the SEC issued a proposed rule 6c-11 under the 1940 Act (Rule 6c-11) that would permit ETFs that satisfy certain conditions to operate without the expense and delay of obtaining an exemptive order. In that proposed rule, among other proposals, the SEC also proposed enhanced disclosure requirements to provide investors who purchase and sell ETF shares on the secondary market with additional information regarding ETF trading costs and amendments to Form N-CEN to require ETFs to report whether they rely on Rule 6c-11 and to report additional information to allow the SEC to confirm compliance with Rule 6c-11. The public comment period on the proposed rule ended on October 1, 2018.
On June 28, 2018, the SEC issued a final rule that requires the use of the Inline eXtensible Business Reporting Language (XBRL) format for the submission of operating company financial statement information and fund risk/return summary information and eliminates the 15 business day XBRL filing period for fund risk/return summaries and the requirement for operating companies and funds to post "Interactive Data Files" on their websites. The new rule became effective on September 17, 2018, and must be complied with by large mutual fund complexes beginning September 17, 2020 and for public companies such as Federated with respect to fiscal periods ending on or after June 15, 2019.
The SEC staff has been engaging in a series of investigations, enforcement actions and/or examinations involving investment management industry participants, including investment management companies and investment advisors. The SEC examinations have included certain sweep examinations of investment management companies and investment advisors involving various topics, including, but not limited to, compliance with the 2014 Money Fund Rules and Guidance, "distribution in guise," marketing support payments, intermediary and other payments and related disclosures, allocation of initial public offerings, allocation of portfolio security litigation proceeds, manager of managers arrangements, monitoring social network use, target date funds, the impact of the United Kingdom's (UK) vote to exit the European Union (EU) (known as "Brexit"), valuation practices, share class selection, fixed-income and high yield liquidity, liquidity controls, liquid alternatives, cybersecurity, side-by-side management of private funds, private placements, mutual fund waivers, direct and indirect custody of client assets by investment advisors, separately managed or wrap-fee accounts, performance reporting and excessive trading. The SEC staff also has announced that, among other areas of focus, cybersecurity, anti-money laundering, wrap fee programs, mutual funds and ETFs, disclosure of costs of investing and retirement products will be examination priorities in 2018. These investigations, actions and examinations have led, and may lead, to further regulation and scrutiny of the investment management industry. Over the past three years, the SEC staff also issued various guidance statements on cyber-security, investment company business continuity, mutual fund distribution, revising fund disclosure in light of changing market conditions, inadvertent custody, and sales load variation disclosure, among other topics. On October 26, 2017, Steven Peikin, co-director of the SEC's enforcement division, indicated that the SEC, while continuing to pursue tough enforcement in cases involving intentional wrongdoing that results in losses to investors, would drop the "broken windows" strategy of pursuing many enforcement actions over smaller enforcement issues, and may also pull back from trying to make some companies admit to wrongdoing as a condition of settling with the SEC in certain cases. Given government regulatory policies, the changes in SEC management, and the possibility for deregulation in the U.S., the degree to which regulatory investigations, actions and examinations will continue, as well as their frequency and scope, can vary and is uncertain.
Regulation or potential regulation by other regulators, in addition to the SEC, also continued, and may continue, to affect investment management industry participants, including Federated. For example, the Financial Industry Regulatory Authority (FINRA) has undertaken a cybersecurity sweep examination and various state legislatures or regulators have adopted or are

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Management's Discussion and Analysis (continued)
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beginning to adopt state-specific cybersecurity and/or privacy requirements that may apply to varying degrees in addition to federal regulation.
The Financial Stability Oversight Council (FSOC) indicated in 2014 that it intended to monitor the effectiveness of the 2014 Money Fund Rules. This prompted concerns that the FSOC may recommend new or heightened regulation for "non-bank financial companies" under Section 120 of the Dodd-Frank Act, which the Board of Governors of the Federal Reserve System have indicated can include open-end investment companies, such as money market funds and other mutual funds. The FSOC has since moved away from potential systemically important financial institution designations of asset managers or investment products, in favor of studying and evaluating the financial stability implications of the asset management sector. The FSOC has focused on potential risks arising from liquidity/redemptions and leverage, as well as securities lending, operational risks of service provider concentrations and resolvability and transition planning. The FSOC also continues to review and monitor SEC efforts on reporting modernization, liquidity management and derivatives. In September 2018, it was reported that Craig Phillips, counselor to Treasury Secretary Steven Mnuchin, announced that FSOC intends to publish more guidance later in 2018 on a shift from targeting specific non-bank financial companies for enhanced oversight to flagging activities across multiple firms. While the FSOC's focus appears to have shifted, it retains its authority to designate non-bank financial companies as systemically important financial institutions.
Efforts also continue to improve the transparency, and to seek to curtail certain authority, of the FSOC. For example, on February 28, 2017, the Republican Staff of the Committee on Financial Services, U.S. House of Representatives, issued a report entitled "The Arbitrary and Inconsistent FSOC Nonbank Designation Process." The report criticized the FSOC for not following its own rules and guidance relating to designations on systemically important non-bank financial institutions and for inconsistent and arbitrary analysis of companies. On March 28, 2017, ten U.S. Senators sent a letter to the Secretary of the Treasury criticizing the FSOC's process for designating systemically important non-bank financial institutions as lacking transparency and accountability, insufficiently tracking data, and not having a consistent methodology for determinations. In the letter, the 10 Senators expressed their support for ending the FSOC's "too big to fail" policy. On April 21, 2017, President Trump issued a Presidential Memorandum for the Secretary of the Treasury that, among other matters, directed him to consider whether the FSOC's processes for making determinations and designations are sufficiently transparent, provide adequate due process, adequately consider the costs of any determination or designation on the regulated entity, and are consistent with President Trump's Executive Order on core principles for regulating the U.S. financial system. On June 12, 2017, the Treasury Department issued a report in which it recommended, among other proposals, that Congress expand FSOC's authority to play a larger role in the coordination and direction of regulatory and supervisory policies, including by giving FSOC the authority to appoint a lead regulator on any issue on which multiple agencies may have conflicting and overlapping regulatory jurisdiction. On October 6, 2017, the Treasury Department issued a second report addressing banks and credit unions. In that report, it indicated that it would issue a separate report on its review of the process by which the FSOC determines that a non-bank financial company could pose a threat to the financial stability of the United States, subjecting such an entity to supervision by the Federal Reserve and enhanced prudential standards. The Treasury Asset Management Report, noting that entity-based systemic risk evaluations of asset managers or their funds are generally not the best approach for mitigating risk, recommended that, while the FSOC should maintain a risk identification and evaluation function, the FSOC should look to the SEC to address systemic risks through regulation within and across the asset management industry in the U.S. On November 17, 2017, the Treasury issued a third report in which it made the following recommendations, among others, to enhance the analytical process, engagement, and transparency of FSOC's non-bank financial company designation process: (1) FSOC should revise its guidance to provide that it will assess the likelihood of a firm's material financial distress as part of its analysis; (2) FSOC should revise its guidance to provide that it will conduct a cost-benefit analysis as part of its process, and should only designate a company if the expected benefits to financial stability outweigh the costs of designation; (3) FSOC should enhance its communication with non-bank financial companies under review and their primary financial regulators; and (4) FSOC should provide a clear "off-ramp" to designated non-bank financial companies and adopt a more robust and transparent process for its annual reevaluations. At its April 12, 2018 and June 15, 2018 meetings, the FSOC discussed efforts underway to develop potential amendments to the FSOC's interpretative guidance on nonbank financial company designations in light of the November 17, 2017 Treasury report. On April 12, 2018, the Financial Stability Oversight Council Improvement Act, which was originally introduced in the U.S. House of Representatives on October 12, 2017 and subsequently approved, was referred to the Senate Committee on Banking, Housing, and Urban Affairs. The bill, if passed and signed into law, would amend the Financial Stability Act of 2010 to require the FSOC, in determining whether a nonbank financial company should be designated as systemically important and consequently supervised by the Federal Reserve Board and subject to prudential standards, to consider the appropriateness of imposing such standards as opposed to other forms of regulation to mitigate identified risks to U.S. financial stability. Specifically, in amending the procedural requirements applicable to the FSOC, the bill would require the FSOC to: (1) undertake certain procedures for initial evaluations; (2) provide an opportunity, during an annual reevaluation of such a determination by FSOC for a nonbank financial company, for the company to submit written materials to, and meet with, the FSOC in order to contest FSOC's determination; and (3) every five years, upon request by a nonbank financial

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Management's Discussion and Analysis (continued)
of Financial Condition and Results of Operations (unaudited)
 

company, reevaluate such a determination by FSOC and hold a vote on whether to rescind FSOC's determination. Given the possibility of deregulation in the U.S., coupled with the efforts underway to improve the transparency and to seek to curtail certain authority of the FSOC, the degree to which actions by the FSOC can impact the investment management industry, including Federated, is uncertain.
The current regulatory environment has impacted, and will continue to impact, Federated's business, results of operations, financial condition and/or cash flows. For example, changes required under the 2014 Money Fund Rules and Guidance resulted in a shift in asset mix from institutional prime and municipal (or tax-exempt) money market funds to stable NAV government money market funds across the investment management industry and at Federated, which impacted its AUM, revenues and operating income. While management believes that, as interest rates rise, money market funds will benefit generally from increased yields, particularly as compared to deposit account alternatives, and that, as spreads widen, investors who exited prime money market funds will likely continue to reconsider their investment options over time, including Federated's prime private money market fund and prime collective fund, the degree of improvement to Federated's prime money market business can vary and is uncertain. While the DOL Fiduciary Rule has been vacated, the DOL Fiduciary Rule impacted, and may likely continue to impact, Federated's AUM, revenues and operating income. For example, while the extent to which broker-dealers and other intermediaries will roll-back actions taken to comply or to prepare to comply with the vacated DOL Fiduciary Rule is uncertain, if intermediaries continue to reduce the number of Federated Funds offered on their platforms, mutual fund-related sales and distribution fees earned by Federated may decrease. In that case, similar to other investment management industry participants, Federated could experience a further shift in asset mix and AUM, and a further impact on revenues and operating income. On the other hand, management believes that Federated's business may be positively affected because separately managed account/wrap-fee strategies work well in level wrap fee account structures and can provide transparency and potential tax advantages to clients, and Federated's experience with bank trust departments and fiduciary experience and resources presents an opportunity to add value for clients.
Federated has dedicated, and continues to dedicate, significant internal and external resources to analyze and address Regulatory Developments, and their effect on Federated's business, results of operations, financial condition and/or cash flows. This effort includes considering and/or effecting legislative, regulatory, product structure and development, information system development, reporting capability, business and other options that have been or may be available in an effort to minimize the potential impact of any adverse consequences. Federated's efforts include having conversations with intermediary customers regarding Regulatory Developments, and analyzing product offering and structure adjustments, regulatory alternatives and other means to comply, and to assist its customers to comply, with new fiduciary rules, the 1940 Act and other applicable laws and regulations. Among other actions, Federated developed an educational website to assist clients with compliance with the DOL Fiduciary Rule (now vacated), increased the number of Federated Funds that offer clean shares, including R6 shares, and added T Shares, which currently are not being offered, to 33 Federated Funds. As appropriate, Federated participated, and will continue to participate, either individually or with industry groups, in the comment process for proposed regulations. Federated also continues to expend legal and compliance resources to examine corporate governance and public company disclosure proposals issued by the SEC and to adopt, revise and/or implement policies and procedures and to respond to examinations, inquiries and other matters involving its regulators, including the SEC, customers or other third parties. Federated continues to devote resources to technology and system investment, cybersecurity and information governance, and the development of other investment management and compliance tools, to enable Federated to, among other things, be in a better position to address new or modified regulatory requirements. The Regulatory Developments discussed above, and related regulatory oversight, also impacted, and/or may impact, Federated's customers and vendors, their preferences and their businesses. For example, these developments have caused, and/or may cause, certain product line-up, structure, pricing and product development changes, as well as money market, equity, fixed income or balanced fund products to be less attractive to institutional and other investors, reductions in the number of Federated Funds offered by intermediaries, changes in the fees Federated, retirement plan advisors and intermediaries will be able to earn on investment products and services sold to retirement plan clients, and reductions in AUM, revenues and operating profits. In addition, these developments have caused, and/or may cause changes in asset flows, levels and mix, as well as customer relationships.
Federated will continue to monitor Regulatory Developments as necessary, and may implement additional changes to its business and practices as it deems necessary or appropriate. Further analysis and planning, or additional refinements to Federated's product line and business practices, may be required in response to market, customer or regulatory changes and developments, such as further money market fund regulation or potential deregulation, new fiduciary rules and other Regulatory Developments, or any additional regulation or guidance issued by the SEC or other regulatory authorities.
Management believes that the floating NAV, and fees and gates, required by the 2014 Money Fund Rules, as well as other Regulatory Developments, have been and will continue to be detrimental to Federated's fund business. In addition to the impact on Federated's AUM, revenues, operating income and other aspects of Federated's business described above, on a cumulative basis, Federated's regulatory, product development and restructuring, and other efforts in response to the Regulatory

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Management's Discussion and Analysis (continued)