FEDERATED HERMES, INC. Management's Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Item 1- Business, Item 1A - Risk Factors and Item 8 - Financial Statements and Supplementary Data. GeneralFederated Hermes is one of the largest investment managers in theU.S. with$619.4 billion in managed assets as ofDecember 31, 2020 . The majority ofFederated Hermes' revenue is derived from advising Federated Hermes Funds and Separate Accounts in both domestic and international markets.Federated Hermes also derives revenue from providing administrative and other fund-related services (including distribution and shareholder servicing) and stewardship and real estate development services. For additional information onFederated Hermes' markets, see Item 1 - Business under the caption Distribution Channels and Product Markets. 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 Hermes' 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 Generally, managed assets inFederated Hermes' investment products and strategies can be redeemed or withdrawn at any time with no advance notice requirement. Fee rates forFederated Hermes' services generally vary by asset and service type and may vary based on changes in asset levels. Generally, advisory fees charged for services provided to equity and multi-asset products and strategies are higher than advisory fees charged to fixed-income and alternative/private markets products and strategies, which in turn are higher than advisory fees charged to money market products and strategies. Likewise, Federated Hermes Funds typically have higher advisory fees than Separate Accounts. Similarly, revenue is also dependent upon the relative composition of average AUM across both asset and product types.Federated Hermes may implement Fee Waivers for competitive reasons such as to maintain certain fund expense ratios, to maintain positive or zero net yields, to meet regulatory requirements or to meet contractual requirements. SinceFederated Hermes' products are largely distributed and serviced through financial intermediaries,Federated Hermes 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 Hermes generally pays out a larger portion of the revenue earned from managed assets in money market and multi-asset funds than the revenue earned from managed assets in equity, fixed-income and alternative/private markets funds.Federated Hermes' most significant operating expenses are Compensation and Related expense and Distribution expense. 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 ofFederated Hermes , investment management performance and sales performance. The discussion and analysis ofFederated Hermes' financial condition and results of operations are based onFederated Hermes' Consolidated Financial Statements. Management evaluatesFederated Hermes' performance at the consolidated level. Therefore,Federated Hermes operates in one 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 Hermes' 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. 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 ofFederated Hermes' financial performance include AUM, gross and net product sales, total revenue and net income, both in total and per diluted share. 46 -------------------------------------------------------------------------------- Business Developments Covid-19 Pandemic The outbreak of the Covid-19 respiratory disease was first detected inChina in late 2019 and spread internationally in 2020. Covid-19 has resulted in travel bans, closing of borders, changes to the ways in which healthcare workers prepare and deliver services, enhanced monitoring and increased health screenings/testing, increased data analytics, efforts to develop effective vaccines and identify effective therapeutics, enhanced disinfection and contamination procedures, stay-at-home orders, quarantines, cancellations and disruptions to supply chains, workflow operations and customer activity, as well as general concern and uncertainty. Covid-19 also has resulted in economic uncertainty, market volatility, trading halts, market illiquidity and declining and variable stock prices, among other effects. See Item 1A - Risk Factors under the caption General Risk Factors - Other General Risks - Potential Adverse Effects of Unpredictable Events or Consequences (including Covid-19) for additional information regarding the impacts, and potential impacts, resulting from Covid-19. Policymakers responded to certain apparent and acute economic and market consequences with monetary and fiscal policy actions. Regulators have taken actions focused on facilitating market function and preserving market integrity, as well as providing guidance and relief to market participants affected by Covid-19. See Item 1 - Business under the caption Regulatory Matters for additional information regarding the monetary and fiscal policy actions taken by governmental authorities. While vaccines have been developed and are beginning to be disseminated in various countries, economic, market, regulatory and other uncertainty persists. As national, state/provincial and local governments have begun to lessen or remove requirements for staying-at-home, quarantining, and travel, as well as other Covid-19 imposed restrictions, a new variant of Covid-19 was first identified in theUK , and later in theU.S. , a second variant was identified inSouth Africa and a third variant was identified inBrazil . These variants are reportedly more contagious and potentially more deadly than the initial strain. Certain jurisdictions (particularly in theU.S. and theUK ) also have seen a spike in the number of diagnosed Covid-19 cases and hospitalizations. These new variants and spikes have resulted in the re-imposition of certain Covid-19 restrictions, although in many cases not to the extent of those initially imposed. As a result, while certain governments are taking action to open economies, economic uncertainty and market volatility has continued, but in many cases not to the degree initially seen in late first quarter and early second quarter 2020.Federated Hermes has not instituted its business continuity plans in itsU.S. offices as there has not been a significant disruption of its business processes, allowing it to remain fully operational and to continue to provide services to its customers.Federated Hermes' London office, which includes the international business ofFederated Hermes , did implement its business continuity plans onMarch 20, 2020 to support the transition to a remote working environment per the advice of theUK's government and regulators.Federated Hermes designated an internal task force (which continues to meet regularly) to address events related to Covid-19 that have impacted or that can impactFederated Hermes' business.Federated Hermes also implemented a number of other prudent steps to provide for the safety of our employees, to seek to ensure the resiliency ofFederated Hermes' business and to keep our customers informed through the related market volatility. For example,Federated Hermes is complying with the requirements applicable toFederated Hermes under relevant Federal and state government orders, as well as the requirements applicable toFederated Hermes under theCDC 's and state health departments' guidance and enhanced disinfection and decontamination procedures. These steps continue to be implemented, reviewed and, in certain cases, revised or enhanced. Technology investments in laptops for employees, expanded internet bandwidth, and new video conferencing and collaboration software have allowedFederated Hermes to remain fully operational while implementing remote working arrangements, supporting physical distancing, and continuing to deliverFederated Hermes' investment products and services to customers, while at the same time taking steps to safeguard the health and safety of employees. Among other actions,Federated Hermes has taken the following steps: •As a result of a travel advisory issued by theCDC , the company instituted a travel ban to certain countries, including those designated as high risk by theCDC onFebruary 27, 2020 .Federated Hermes now recommends to employees that they follow national, state/provincial, local andCDC recommendations for self-quarantining and testing after travel. •No commercial air travel occurred in the second quarter of 2020. Limited hotel and car rental reservations resumed inJune 2020 and continued throughout the remaining months of 2020. Limited commercial air travel re-commenced in the third quarter of 2020. Commercial air travel in the fourth quarter of 2020 was also minimal. 47 -------------------------------------------------------------------------------- •While Federated Hermes'U.S. offices remain open, and limited, physically distanced, in-person meetings have begun to occur more frequently, remote working arrangements continue to be implemented for much of our global workforce with approximately 95 percent ofFederated Hermes' employees working from home successfully.Federated Hermes has increased usage and reliance on virtual meeting tools and prioritized the deployment of additional equipment and technology to provide enhanced remote-work options. •FederatedHermes Fund Board meetings held in August andNovember 2020 were held in person as well as via teleconference allowing those who preferred to participate remotely to do so.Federated Hermes held theMay 2020 FederatedHermes Fund Board meetings, via teleconference, rather than in person.Federated Hermes had previously held itsApril 2020 annual shareholder meeting via teleconference and plans to hold itsApril 2021 annual shareholder meeting in the same manner. Offshore fund and subsidiary board meetings are being held via telephone or video conference. •Federated Hermes has continued to on-board new hires, shipping necessary equipment to them and conducting training remotely. •Federated Hermes investment professionals and strategists are frequently publishing fresh content to the Insights section ofFederated Hermes' website offering customers unique perspectives during these difficult markets.Federated Hermes is also prepared to continue to implement a variety of other strategies to ensure the resiliency of our business. Examples include transferring processes to alternate personnel, prioritizing technology resources to service critical processing, and leveraging service providers and counterparties for the most efficient delivery of services. In addition to the implementation of advanced cleaning protocols and other measures,Federated Hermes has made provisions for hand sanitizer stations and is encouraging everyone to take standard precautions such as physically distancing, washing their hands with soap and water, wearing face masks, avoiding shaking hands and staying home if sick.Federated Hermes is evaluating options and considering details of its plans for when and how to bring more employees back to our offices. For example,Federated Hermes developed and implemented a series of return to the office protocols intended to assure employees thatFederated Hermes is taking the safety and well-being of our employees seriously as more employees begin to return to the office. The company plans to take a measured approach that involves implementing procedures aimed at safeguarding employee health while continuing to provide a high level of client service.Federated Hermes expects those procedures and related timelines to vary by location in order to meet local regulatory guidelines and support community health practices. As ofDecember 31, 2020 ,Federated Hermes has advised its employees that it is delaying a significant return to the office forU.S. employees until mid- tolate-April 2021 . In theUK , in accordance with government guidance,Federated Hermes' London office remains open only for those employees who are unable to work from home and will continue to be limited until government guidance is updated.Federated Hermes continues to monitor the ongoing global health situation through contact with theCDC , theSEC , theWorld Health Organization and theSecurities Industry and Financial Markets Association (SIFMA), a financial services industry trade association, among others. As ofDecember 31, 2020 , whileFederated Hermes' stock price has fluctuated and been lower than it was at the beginning of 2020 prior to Covid-19 amidst the volatility in stock prices on major exchanges, andFederated Hermes' business operations have had to adapt to a remote working environment, Covid-19 has not materially affectedFederated Hermes' financial condition or cash flows. See Item 1A - Risk Factors under the caption General Risk Factors - Other General Risks - Potential Adverse Effects of Unpredictable Events or Consequences (including Covid-19) for information regarding the risks toFederated Hermes presented by Covid-19. Low Short-Term Interest Rates InMarch 2020 , in response to disrupted economic activity as a result of Covid-19,FOMC decreased the federal funds target rate range to 0% - 0.25%. The federal funds target rate drives short-term interest rates. As a result of the near-zero interest-rate environment, the gross yield earned by certain money market funds is not sufficient to cover all of the fund's operating expenses. Beginning in the first quarter 2020,Federated Hermes began to implement Voluntary Yield-related Fee Waivers. These Voluntary Yield-related Fee Waivers have been partially offset by related reductions in distribution expense as a result ofFederated Hermes' mutual understanding and agreement with third-party intermediaries to share the impact of the Voluntary Yield-related Fee Waivers. For the year endedDecember 31, 2020 , Voluntary Yield-related Fee Waivers totaled$113.0 million . These fee waivers were partially offset by related reductions in distribution expenses of$98.4 million , such that the net negative pre-tax impact toFederated Hermes was$14.6 million . Assuming asset levels and mix remain constant and based on recent and expected market conditions, including potential additional government measures to further stimulate the economy, Voluntary Yield-related Fee Waivers for the first quarter of 2021 may result in a negative pre-tax impact on income of approximately$14 million . While the level of these fee waivers is impacted by various factors, increases in short-term interest rates that result in higher yields on securities purchased in money 48 -------------------------------------------------------------------------------- market fund portfolios would likely reduce the negative pre-tax impact of these fee waivers. The actual amount of future Voluntary Yield-related Fee Waivers and the resulting negative impact of these fee waivers could vary significantly from management's estimates as they are contingent on a number of variables including, but not limited to, changes in assets within the money market funds, changes in yields on instruments available for purchase by the money market funds, changes due to the level of government measures to further stimulate the economy which could result in the issuance of additionalTreasury debt instruments, actions by theFOMC , theU.S. Department of Treasury , theSEC , FSOC and other governmental entities, changes in fees and expenses of the money market funds, changes in the mix of money market customer assets, changes in customer relationships, changes in money market product structures and offerings, demand for competing products, changes in distribution models, changes in the distribution fee arrangements with third parties,Federated Hermes' willingness to continue the Voluntary Yield-related Fee Waivers and changes in the extent to which the impact of these fee waivers is shared by any one or more third parties. Current Regulatory EnvironmentFederated Hermes and its investment management business are subject to extensive regulation both within and outside theU.S. Federated Hermes and its products, such as the Federated Hermes Funds, and strategies are subject to: federal securities laws, principally the 1933 Act, the 1934 Act, the 1940 Act and the Advisers Act; state laws regarding securities fraud and registration; regulations or other rules promulgated by various regulatory authorities, self-regulatory organizations or exchanges; and foreign laws, regulations or other rules promulgated by foreign regulatory or other authorities. See Item 1 - Business under the caption Regulatory Matters and Item 1A - Risk Factors under the caption General Risk Factors - Regulatory and Legal Risks - Potential Adverse Effects of Changes in Laws, Regulations and Other Rules for additional information. 49 -------------------------------------------------------------------------------- Asset Highlights Managed Assets at Period End
2020
in millions as of December 31, 2020 2019 vs. 2019 By Asset Class Equity$ 91,788 $ 89,011 3 % Fixed-Income 84,277 69,023 22 Alternative / Private Markets1 19,084 18,102 5 Multi-Asset 3,948 4,199 (6) Total Long-Term Assets 199,097 180,335 10 Money Market 420,333 395,539 6 Total Managed Assets$ 619,430 $ 575,874 8 % By Product Type Funds: Equity$ 54,312 $ 48,112 13 % Fixed-Income 53,557 44,223 21 Alternative / Private Markets1 12,100 11,389 6 Multi-Asset 3,744 4,000 (6) Total Long-Term Assets 123,713 107,724 15 Money Market 301,855 286,612 5 Total Fund Assets 425,568 394,336 8 Separate Accounts: Equity 37,476 40,899 (8) Fixed-Income 30,720 24,800 24 Alternative / Private Markets 6,984 6,713 4 Multi-Asset 204 199 3 Total Long-Term Assets 75,384 72,611 4 Money Market 118,478 108,927 9 Total Separate Account Assets 193,862 181,538 7 Total Managed Assets$ 619,430 $ 575,874 8 % 1 The balance atDecember 31, 2019 includes$8.2 billion of fund assets managed by a previously non-consolidated entity, HGPE, in whichFederated Hermes held an equity method investment. EffectiveMarch 1, 2020 , HGPE became a consolidated subsidiary. See Note (3) to the Consolidated Financial Statements for additional information. 50
-------------------------------------------------------------------------------- Average Managed Assets in millions for the years ended 2020 2019 December 31, 2020 2019 2018 vs. 2019 vs. 2018 By Asset Class Equity$ 80,591 $ 81,212 $ 70,680 (1) % 15 % Fixed-Income 74,403 65,375 63,454 14 3 Alternative / Private Markets1 18,206 17,896 9,397 2 90 Multi-Asset 3,813 4,192 4,764 (9) (12) Total Long-Term Assets 177,013 168,675 148,295 5 14 Money Market 436,895 340,505 267,093 28 27 Total Average Managed Assets$ 613,908 $ 509,180 $ 415,388 21 % 23 % By Product Type Funds: Equity$ 45,585 $ 42,712 $ 36,984 7 % 15 % Fixed-Income 46,899 41,938 40,952 12 2 Alternative / Private Markets1 11,424 11,317 5,784 1 96 Multi-Asset 3,622 4,003 4,554 (10) (12) Total Long-Term Assets 107,530 99,970 88,274 8 13 Money Market 324,490 238,876 182,828 36 31 Total Average Fund Assets 432,020 338,846 271,102 27 25 Separate Accounts: Equity 35,006 38,500 33,696 (9) 14 Fixed-Income 27,504 23,437 22,502 17 4 Alternative / Private Markets 6,782 6,579 3,613 3 82 Multi-Asset 191 189 210 1 (10) Total Long-Term Assets 69,483 68,705 60,021 1 14 Money Market 112,405 101,629 84,265 11 21 Total Average Separate Account Assets 181,888 170,334 144,286 7 18 Total Average Managed Assets$ 613,908 $ 509,180 $ 415,388 21 % 23 % 1 The average for the year endedDecember 31, 2019 includes$8.2 billion of average fund assets managed by a previously non-consolidated entity, HGPE, in whichFederated Hermes held an equity method investment. EffectiveMarch 1, 2020 , HGPE became a consolidated subsidiary. See Note (3) to the Consolidated Financial Statements for additional information. 51 --------------------------------------------------------------------------------
Changes in
2020 2019
Equity Funds
Beginning Assets $ 48,112 $ 36,584
Sales 14,457 12,380
Redemptions (15,675) (11,757)
Net Sales (Redemptions) (1,218) 623
Net Exchanges (64) 181
Acquisitions 0 2,191
Impact of Foreign Exchange1 509 54
Market Gains and (Losses)2 6,973 8,479
Ending Assets $ 54,312 $ 48,112
Equity Separate Accounts
Beginning Assets $ 40,899 $ 35,913
Sales3 6,006 7,842
Redemptions3 (11,046) (10,037)
Net Sales (Redemptions)3 (5,040) (2,195)
Net Exchanges (6) 0
Acquisitions/(Dispositions) (71) 53
Impact of Foreign Exchange1 686 (82)
Market Gains and (Losses)2 1,008 7,210
Ending Assets $ 37,476 $ 40,899
Total Equity
Beginning Assets $ 89,011 $ 72,497
Sales3 20,463 20,222
Redemptions3 (26,721) (21,794)
Net Sales (Redemptions)3 (6,258) (1,572)
Net Exchanges (70) 181
Acquisitions/(Dispositions) (71) 2,244
Impact of Foreign Exchange1 1,195 (28)
Market Gains and (Losses)2 7,981 15,689
Ending Assets $ 91,788 $ 89,011
1 Reflects the impact of translating non-U.S. dollar denominated AUM into U.S.
dollars for reporting purposes.
2 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions and
net investment income.
3 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
52--------------------------------------------------------------------------------
Changes in
in millions for the years ended December 31, 2020 2019
Fixed-Income Funds
Beginning Assets $ 44,223 $ 40,490
Sales 29,453 16,730
Redemptions (22,564) (16,311)
Net Sales (Redemptions) 6,889 419
Net Exchanges (16) (98)
Acquisitions 0 450
Impact of Foreign Exchange1 129 72
Market Gains and (Losses)2 2,332 2,890
Ending Assets $ 53,557 $ 44,223
Fixed-Income Separate Accounts
Beginning Assets $ 24,800 $ 22,668
Sales3,4 7,830 4,694
Redemptions3,4 (3,574) (5,232)
Net Sales (Redemptions)3,4 4,256 (538)
Net Exchanges 1 (110)
Acquisitions/(Dispositions) (1) 0
Impact of Foreign Exchange1 61 (12)
Market Gains and (Losses)2,4 1,603 2,792
Ending Assets $ 30,720 $ 24,800
Total Fixed-Income
Beginning Assets $ 69,023 $ 63,158
Sales3,4 37,283 21,424
Redemptions3,4 (26,138) (21,543)
Net Sales (Redemptions)3,4 11,145 (119)
Net Exchanges (15) (208)
Acquisitions/(Dispositions) (1) 450
Impact of Foreign Exchange1 190 60
Market Gains and (Losses)2,4 3,935 5,682
Ending Assets $ 84,277 $ 69,023
1 Reflects the impact of translating non-U.S. dollar denominated AUM into U.S.
dollars for reporting purposes.
2 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions and
net investment income.
3 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
4 For one fixed-income Separate Account, Sales, Redemptions, Net Sales
(Redemptions) and Market Gains and (Losses) were previously incorrectly reported
for the quarters ended March 31, 2020 and June 30, 2020 . Total assets were
reported correctly and are not impacted. The nine months ended September 30,
2020 included corrections that increased Redemptions by $390 million and
decreased Sales by $1.1 billion , with the offset increasing Market Gains and
(Losses) by $1.5 billion .
53
--------------------------------------------------------------------------------
Changes in Alternative /
2020 2019
Alternative / Private Markets Funds1 Beginning Assets$ 11,389 $ 11,365 Sales 2,277 1,062 Redemptions (2,047) (1,721) Net Sales (Redemptions) 230 (659) Net Exchanges (4) (65) Impact of Foreign Exchange2 400 430 Market Gains and (Losses)3 85 318 Ending Assets$ 12,100 $ 11,389 Alternative / Private Markets Separate Accounts Beginning Assets$ 6,713 $ 6,953 Sales4 563 381 Redemptions4 (568) (738) Net Sales (Redemptions)4 (5) (357) Acquisitions 452 0 Impact of Foreign Exchange2 215 264 Market Gains and (Losses)3 (391)
(147)
Ending Assets$ 6,984 $ 6,713 Total Alternative / Private Markets1 Beginning Assets$ 18,102 $ 18,318 Sales4 2,840 1,443 Redemptions4 (2,615) (2,459) Net Sales (Redemptions)4 225 (1,016) Net Exchanges (4) (65) Acquisitions 452 0 Impact of Foreign Exchange2 615 694 Market Gains and (Losses)3 (306) 171 Ending Assets$ 19,084 $ 18,102 1 The balance atDecember 31, 2019 includes$8.2 billion of fund assets managed by a previously non-consolidated entity, HGPE, in whichFederated Hermes held an equity method investment. EffectiveMarch 1, 2020 , HGPE became a consolidated subsidiary. See Note (3) to the Consolidated Financial Statements for additional information. 2 Reflects the impact of translating non-U.S. dollar denominated AUM intoU.S. dollars for reporting purposes. 3 Reflects the approximate changes in the fair value of the securities held by the portfolios and, to a lesser extent, reinvested dividends, distributions and net investment income. 4 For certain accounts, Sales and Redemptions are calculated as the remaining difference between beginning and ending assets after the calculation of total investment return. 54 --------------------------------------------------------------------------------
Changes in
in millions for the years ended December 31, 2020 2019
Multi-Asset Funds
Beginning Assets $ 4,000 $ 3,920
Sales 214 317
Redemptions (688) (864)
Net Sales (Redemptions) (474) (547)
Net Exchanges (19) 55
Acquisitions 0 11
Market Gains and (Losses)1 237 561
Ending Assets $ 3,744 $ 4,000
Multi-Asset Separate Accounts
Beginning Assets $ 199 $ 173
Sales2 27 15
Redemptions2 (36) (29)
Net Sales (Redemptions)2 (9) (14)
Net Exchanges (1) 0
Impact of Foreign Exchange3 1 0
Market Gains and (Losses)1 14 40
Ending Assets $ 204 $ 199
Total Multi-Asset
Beginning Assets $ 4,199 $ 4,093
Sales2 241 332
Redemptions2 (724) (893)
Net Sales (Redemptions)2 (483) (561)
Net Exchanges (20) 55
Acquisitions 0 11
Impact of Foreign Exchange3 1 0
Market Gains and (Losses)1 251 601
Ending Assets $ 3,948 $ 4,199
1 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions and
net investment income.
2 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
3 Reflects the impact of translating non-U.S. dollar denominated AUM into U.S.
dollars for reporting purposes.
55
--------------------------------------------------------------------------------
Changes in Total Long-Term Assets
in millions for the years ended December 31, 2020 2019
Total Long-Term Fund Assets1
Beginning Assets $ 107,724 $ 92,359
Sales 46,401 30,489
Redemptions (40,974) (30,653)
Net Sales (Redemptions) 5,427 (164)
Net Exchanges (103) 73
Acquisitions 0 2,652
Impact of Foreign Exchange2 1,038 556
Market Gains and (Losses)3 9,627 12,248
Ending Assets $ 123,713 $ 107,724
Total Long-Term Separate Accounts Assets
Beginning Assets $ 72,611 $ 65,707
Sales4,5 14,426 12,932
Redemptions4,5 (15,224) (16,036)
Net Sales (Redemptions)4,5 (798) (3,104)
Net Exchanges (6) (110)
Acquisitions/(Dispositions) 380 53
Impact of Foreign Exchange2 963 170
Market Gains and (Losses)3,5 2,234 9,895
Ending Assets $ 75,384 $ 72,611
Total Long-Term Assets1
Beginning Assets $ 180,335 $ 158,066
Sales4,5 60,827 43,421
Redemptions4,5 (56,198) (46,689)
Net Sales (Redemptions)4,5 4,629 (3,268)
Net Exchanges (109) (37)
Acquisitions/(Dispositions) 380 2,705
Impact of Foreign Exchange2 2,001 726
Market Gains and (Losses)3,5 11,861 22,143
Ending Assets $ 199,097 $ 180,335
1 The balance at December 31, 2019 includes $8.2 billion of fund assets managed
by a previously non-consolidated entity, HGPE, in which Federated Hermes held an
equity method investment. Effective March 1, 2020 , HGPE became a consolidated
subsidiary. See Note (3) to the Consolidated Financial Statements for additional
information.
2 Reflects the impact of translating non-U.S. dollar denominated AUM into U.S.
dollars for reporting purposes.
3 Reflects the approximate changes in the fair value of the securities held by
the portfolios and, to a lesser extent, reinvested dividends, distributions and
net investment income.
4 For certain accounts, Sales and Redemptions are calculated as the remaining
difference between beginning and ending assets after the calculation of total
investment return.
5 For one fixed-income Separate Account, Sales, Redemptions, Net Sales
(Redemptions) and Market Gains and (Losses) were previously incorrectly reported
for the quarters ended March 31, 2020 and June 30, 2020 . Total assets were
reported correctly and are not impacted. The nine months ended September 30,
2020 included corrections that increased Redemptions by $390 million and
decreased Sales by $1.1 billion , with the offset increasing Market Gains and
(Losses) by $1.5 billion .
56
--------------------------------------------------------------------------------
Changes in Federated Hermes' average asset mix year-over-year across both asset
classes and product types have a direct impact on Federated Hermes' operating
income. Asset mix impacts Federated Hermes' total revenue due to the difference
in the fee rates earned on each asset class and product type per invested dollar
and certain components of distribution expense can vary depending upon the asset
class, distribution channel and/or the size of the customer relationship. The
following table presents the relative composition of average managed assets and
the percent of total revenue derived from each asset class and product type over
the last three years:
Percent of Total Average Managed Assets Percent of Total Revenue
2020 2019 2018 2020 2019 2018
By Asset Class
Money Market 71 % 67 % 64 % 40 % 40 % 37 %
Equity 13 % 16 % 17 % 38 % 40 % 41 %
Fixed-Income 12 % 13 % 16 % 13 % 14 % 16 %
Alternative / Private Markets 3 % 3 % 2 % 6 % 3 % 2 %
Multi-Asset 1 % 1 % 1 % 2 % 2 % 3 %
Other 0 % 0 % 0 % 1 % 1 % 1 %
By Product Type
Funds:
Money Market 53 % 47 % 44 % 37 % 37 % 34 %
Equity 7 % 8 % 9 % 29 % 30 % 31 %
Fixed-Income 8 % 8 % 10 % 11 % 12 % 14 %
Alternative / Private Markets 2 % 2 % 1 % 3 % 1 % 1 %
Multi-Asset 1 % 1 % 1 % 2 % 2 % 3 %
Other 0 % 0 % 0 % 0 % 0 % 0 %
Separate Accounts:
Money Market 18 % 20 % 20 % 3 % 3 % 3 %
Equity 6 % 8 % 8 % 9 % 10 % 10 %
Fixed-Income 4 % 5 % 6 % 2 % 2 % 2 %
Alternative / Private Markets 1 % 1 % 1 % 3 % 2 % 1 %
Multi-Asset 0 % 0 % 0 % 0 % 0 % 0 %
Other 0 % 0 % 0 % 1 % 1 % 1 %
Total managed assets represent the balance of AUM at a point in time. By
contrast, total average managed assets represent the average balance of AUM
during a period of time. Because substantially all revenue and certain
components of distribution expense are generally calculated daily based on AUM,
changes in average managed assets are typically a key indicator of changes in
revenue earned and asset-based expenses incurred during the same period.
Average managed assets increased 21% for 2020 as compared to 2019. Period-end
managed assets increased 8% at December 31, 2020 as compared to December 31,
2019 primarily due to an increase in money market assets and, to a lesser
extent, an increase in fixed-income assets. Total average money market assets
increased 28% for 2020 compared to 2019. Period-end money market assets
increased 6% at December 31, 2020 as compared to December 31, 2019 . Average
equity assets decreased 1% for 2020 as compared to 2019. Period-end equity
assets increased 3% at December 31, 2020 as compared to December 31, 2019
primarily due to market appreciation, partially offset by net redemptions.
Average fixed income assets increased 14% for 2020 as compared to 2019.
Period-end fixed-income assets increased 22% at December 31, 2020 as compared to
December 31, 2019 , primarily due to net sales and market appreciation. Even
though 2020 was a presidential election year, market activity was dominated by
the Covid-19 pandemic. Its near simultaneous arrival around the world in the
first quarter of 2020 pushed the global economy into recession, spurring a steep
sell-off in risk assets, pushing the equity markets into a bear market at the
fastest pace in history and challenging credit markets as investors flocked to
U.S. Treasuries and cash. The Fed and Congress responded with unprecedented
monetary and fiscal stimulus, actions mirrored by policymakers the world over,
helping to stem the economic slide and boost risk assets on expectations for
stronger economic growth and earnings. By year's end, the domestic equity
markets were setting new highs, with the technology-laden Nasdaq Composite Index
returning 44.92% for the year ended December 31, 2020 , the S&P 500 rising 18.40%
and the Dow Jones Industrial Average climbing 9.72%. In fixed-income, the
10-year Treasury yield plunged 128 basis points in the first quarter on pandemic
worries before settling into a narrow trading range through summer and fall
before drifting higher to end 2020 at 0.92%, a percentage point below where it
started the year. After the FOMC dropped its federal funds target range in March
to 0-0.25%,
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short-term rates remained anchored at historic lows on the central bank's pledge
to hold benchmark rates near zero-bound through at least 2022 or until average
inflation hits and holds at 2%.
For an explanation of the changes in managed assets at December 31, 2019
compared to December 31, 2018 and changes in average managed assets for 2019 as
compared to 2018, see Federated Hermes' Annual Report on Form 10-K for the year
ended December 31, 2019 , Item 7 Management's Discussion and Analysis of
Financial Condition and Results of Operations under the caption Asset
Highlights.
Results of Operations
For an explanation of changes for 2019 as compared to 2018, see Federated
Hermes' Annual Report on Form 10-K for the year ended December 31, 2019 , Item 7
Management's Discussion and Analysis of Financial Condition and Results of
Operations under the caption Results of Operations.
Revenue. Revenue increased $121.4 million in 2020 as compared to 2019 primarily
due to (1) an increase in money market revenue of $41.5 million primarily due to
higher average money market assets (includes a decrease in revenue related to
$113.0 million in Voluntary Yield-related Fee Waivers) (see Business
Developments - Low Short-Term Interest Rates for additional information,
including the impact to expense and the net pre-tax impact), (2) an increase in
alternative/private market revenue of $33.0 million primarily due to the revenue
of a previously nonconsolidated entity being recorded in operating revenue
beginning in March 2020 , (3) an increase in equity revenue of $18.6 million due
to a change in the mix of average assets, (4) an increase in fixed-income
revenue of $16.8 million due to higher average assets and (5) an increase in
performance fees of $15.6 million .
Federated Hermes' ratio of revenue to average managed assets for 2020 was 0.23%
as compared to 0.26% for 2019. The decrease in the rate was primarily due to the
reduction of revenue from Voluntary Yield-related Fee Waivers and the result of
a lower proportion of revenue earned on average equity assets during 2020 as
compared to 2019.
Operating Expenses. Total operating expenses for 2020 increased $51.2 million
compared to 2019. Compensation and Related expense increased $61.3 million in
2020 as compared to 2019 primarily related to (1) an increase in incentive
compensation of $28.2 million driven primarily by sales efforts and investment
management performance and (2) a $23.7 million increase due to the activity
related to first quarter 2020 acquisitions being included in the Consolidated
Financial Statements. Distribution expense decreased $22.3 million primarily
related to $98.4 million in Voluntary Yield-related Fee Waivers (see Business
Developments - Low Short-Term Interest Rates for additional information,
including the impact to revenue and the net pre-tax impact), partially offset by
an increase in distribution expense of $80.2 million due to higher average money
market fund assets. Systems and Communications expense increased $11.7 million
in 2020 compared to 2019 primarily related to $7.3 million due to increased
market data services. Professional Service Fees expense increased $11.4 million
primarily due to technology-related projects. Travel and Related expenses
decreased $12.1 million due to decreased travel during the year as a result of
Covid-19.
Nonoperating Income (Expenses). Nonoperating Income (Expenses), net, increased
$10.6 million in 2020 as compared to 2019. The increase is primarily due to
(1) an increase of $13.1 million to Gain (Loss) on Securities, net due primarily
to an increase in the market value of investments, and (2) a $7.5 million gain
recorded in Nonoperating Income (Expenses) - Other, net from a fair value
adjustment to the equity investment of a previously nonconsolidated entity
recorded in the first quarter of 2020. These increases were partially offset by
a decrease of $10.6 million related to the income of this previously
nonconsolidated entity no longer being recorded in Nonoperating Income
(Expenses) - Other, net beginning in March 2020 .
Income Taxes. The income tax provision for 2020 and 2019 was $110.0 million and
$88.1 million , respectively. The provision for 2020 increased $21.9 million as
compared to 2019 primarily due to higher income before income taxes as a result
of the changes in revenues, operating expenses and nonoperating income
(expenses) noted above. The effective tax rate was 24.7% for 2020 and 24.1% for
2019. See Note (16) to the Consolidated Financial Statements for additional
information on the effective tax rate, as well as other tax disclosures.
Net Income Attributable to Federated Hermes, Inc. Net income increased $54.0
million in 2020 as compared to 2019 primarily as a result of the changes in
revenue, operating expenses, nonoperating income (expenses) and income taxes
noted above. Diluted earnings per share for 2020 increased $0.54 as compared to
2019 primarily due to increased net income.
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Liquidity and Capital Resources
Liquid Assets. At December 31, 2020 , liquid assets, net of noncontrolling
interests, consisting of cash and cash equivalents, investments and receivables,
totaled $432.5 million as compared to $359.1 million at December 31, 2019 . The
change in liquid assets is discussed below.
At December 31, 2020 , Federated Hermes' liquid assets included investments in
certain money market and fluctuating-value Federated Hermes Funds that may have
direct and/or indirect exposures to international sovereign debt and currency
risks. Federated Hermes continues to actively monitor its investment portfolios
to manage sovereign debt and currency risks with respect to certain European
countries (such as the UK in light of Brexit), China and certain other countries
subject to economic sanctions. Federated Hermes' experienced portfolio managers
and analysts work to evaluate credit risk through quantitative and fundamental
analysis. Further, regarding international exposure, certain money market funds
(representing approximately $231 million ), that meet the requirement of Rule
2a-7 or operate in accordance with requirements similar to those in Rule 2a-7,
include holdings with indirect short-term exposures invested primarily in
high-quality international bank names that are subject to Federated Hermes'
credit analysis process.
Cash Provided by Operating Activities. Net cash provided by operating activities
totaled $373.2 million for 2020 as compared to $334.9 million for 2019. The
increase of $38.3 million was primarily due to (1) an increase in cash received
related to the $121.4 million increase in revenue previously discussed less
$11.8 million in accrued performance fees at December 31, 2020 , (2) a decrease
in cash paid related to the $22.3 million decrease in Distribution expense
previously discussed and (3) a decrease of $13.5 million in cash paid for
trading securities as compared to 2019. These increases were partially offset by
(1) an increase of $30.7 million in cash paid for incentive compensation for the
year ended December 31, 2020 as compared to 2019, (2) an increase of $26.1
million in cash paid for taxes primarily due to higher taxable income for the
year ended December 31, 2020 as compared to 2019 and (3) an increase in cash
paid related to the $23.7 million increase in compensation expense related to
first quarter 2020 acquisitions.
Cash Used by Investing Activities. In 2020, net cash used by investing
activities was $24.8 million which primarily represented $25.5 million paid for
purchases of Investments-Affiliates and Other and $13.5 million paid for
property and equipment, partially offset by $11.5 million in cash received from
redemptions of Investments-Affiliates and Other.
Cash Used by Financing Activities. In 2020, net cash used by financing
activities was $295.1 million . Of this amount, Federated Hermes paid $207.8
million or $2.08 per share in dividends to holders of its common shares, paid
$125.0 million in connection with its debt obligations and paid $66.8 million to
repurchase shares of Class B common stock primarily in connection with its stock
repurchase program (see Note (15) to the Consolidated Financial Statements for
additional information). This activity was partially offset by $100.0 million
borrowed from Federated Hermes' revolving credit facility.
Borrowings. In 2017, Federated Hermes entered into an unsecured Third Amended
and Restated Credit Agreement by and among Federated Hermes , 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 consists of a $375 million revolving credit facility with an
additional $200 million available via an optional increase (or accordion)
feature. The original proceeds were used for general corporate purposes
including cash payments related to acquisitions, dividends, investments and
share repurchases. As of December 31, 2020 , Federated Hermes has $300 million
available to borrow under the Credit Agreement. See Note (12) to the
Consolidated Financial Statements for additional information.
The Credit Agreement includes an interest coverage ratio covenant (consolidated
earnings before interest, taxes, depreciation and amortization (EBITDA) to
consolidated interest expense) and a leverage ratio covenant (consolidated debt
to consolidated EBITDA) as well as other customary terms and conditions.
Federated Hermes was in compliance with all of its covenants, including its
interest coverage and leverage ratios at and during the year ended December 31,
2020 . An interest coverage ratio of at least 4 to 1 is required and, as of
December 31, 2020 , Federated Hermes' interest coverage ratio was 223 to 1. A
leverage ratio of no more than 3 to 1 is required and, as of December 31, 2020 ,
Federated Hermes' leverage ratio was 0.16 to 1. 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.
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Dividends. Cash dividends of $207.8 million , $109.1 million and $106.9 million
were paid in 2020, 2019 and 2018 respectively, to holders of Federated Hermes
common stock. Of the amount paid in 2020, $99.3 million represented a $1.00 per
share special dividend paid in the fourth quarter. All dividends were considered
ordinary dividends for tax purposes.
Future Cash Needs. In addition to the contractual obligations described below,
management expects that principal uses of cash will include funding business
acquisitions and global expansion, funding distribution expenditures, paying
incentive and base compensation, paying shareholder dividends, repaying debt
obligations, paying taxes, repurchasing company stock, developing and seeding
new products and strategies, modifying existing products, strategies and
relationships, and funding property and equipment (including technology). Any
number of factors may cause Federated Hermes' future cash needs to increase. As
a result of the highly regulated nature of the investment management business,
management anticipates that aggregate expenditures for compliance and investment
management personnel, compliance systems and technology and related professional
and consulting fees may continue to increase.
On January 28, 2021 , the board of directors declared a $0.27 per share dividend.
The dividend was payable to shareholders of record as of February 5, 2021 ,
resulting in $26.8 million being paid on February 12, 2021 .
After evaluating Federated Hermes' existing liquid assets, expected continuing
cash flow from operations, its borrowing capacity under the Credit Agreement and
its ability to obtain additional financing arrangements and issue debt or stock,
management believes it will have sufficient liquidity to meet its present and
reasonably foreseeable cash needs.
Financial Position
The following discussion summarizes significant changes in assets and
liabilities that are not discussed elsewhere in Management's Discussion and
Analysis of Financial Condition and Results of Operations. This discussion
excludes certain material fluctuations primarily due to the HCL Acquisition. See
Note (3) to the Consolidated Financial Statements for additional information.
Investments-Consolidated Investment Companies at December 31, 2020 increased
$26.8 million from December 31, 2019 primarily due to (1) an increase of $15.2
million due to the consolidation of two variable interest entities (VIE) and a
voting rights entity (VRE) during 2020, (2) an increase of $15.0 million related
to net purchases in existing consolidated products and (3) an increase of $12.6
million of market appreciation for existing consolidated products, partially
offset by a $16.0 million decrease related to the deconsolidation of a VRE and
the liquidation of a VIE during the first half of 2020.
Investments-Affiliates and Other at December 31, 2020 increased $18.7 million
from December 31, 2019 primarily due to net purchases of $9.0 million , an
increase of $5.9 million of market appreciation and the deconsolidation of a VRE
in the first half of 2020 which reclassified Federated Hermes' investment of
$2.5 million into Investments-Affiliates and Other.
Right-of-Use Assets, net at December 31, 2020 increased $21.6 million from
December 31, 2019 and Long-Term Lease Liabilities at December 31, 2020 increased
$14.4 million from December 31, 2019 primarily due to a new lease for office
space in London .
Accrued Compensation and Benefits at December 31, 2020 increased $33.2 million
from December 31, 2019 primarily due to 2020 incentive compensation accruals
recorded at December 31, 2020 ($134.5 million ), partially offset by the 2019
accrued annual incentive compensation being paid in the first quarter of 2020
($107.0 million ).
Long-Term Deferred Tax Liability, net at December 31, 2020 increased $22.6
million from December 31, 2019 primarily due to certain tax amortization
deductions being in excess of book amortization ($7.9 million ) and an increase
in intangible assets associated with first quarter 2020 acquisitions ($5.5
million ).
Off-Balance Sheet Arrangements
As of December 31, 2020 and 2019, Federated Hermes did not have any material
off-balance sheet arrangements.
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Contractual Obligations
The following table presents, as of December 31, 2020 , Federated Hermes'
significant minimum noncancelable contractual obligations by payment date. The
payments represent amounts contractually due to the recipient and do not include
any carrying value adjustments. Further discussion of the nature of each
obligation is included below the table.
Payments Due in
in millions 2021 2022-2023 2024-2025 After 2025 Total
Long-Term Debt Obligations $ 0.0 $ 75.0 $ 0.0 $ 0.0 $ 75.0
Operating Lease Obligations 19.8 40.5 33.6 63.1 157.0
Purchase Obligations 33.3 17.4 6.9 5.8 63.4
Other Obligations 2.5 0.7 0.0 0.0 3.2
Total $ 55.6 $ 133.6 $ 40.5 $ 68.9 $ 298.6
Long-Term Debt Obligations. Outstanding principal is to be paid no later than
the expiration date of the Credit Agreement. Amount includes principal only. The
interest is variable, based on LIBOR plus a 112.5 basis point spread, in
accordance with the Credit Agreement. Assuming management's current plan for
repayment of the Credit Agreement and LIBOR as of December 31, 2020 , Federated
Hermes' interest payments are estimated to be $0.8 million and $0.2 million for
2021 and 2022, respectively. Any changes in future cash needs can impact the
projected repayment schedule. As such, management's repayment plan is subject to
change at management's discretion, which may impact the estimated interest
payments. See Note (12) to the Consolidated Financial Statements for additional
information.
Operating Lease Obligations. See Note (18) to the Consolidated Financial
Statements for additional information.
Purchase Obligations. Federated Hermes is a party to various contracts pursuant
to which it receives certain services, including services for marketing and
information technology, access to various fund-related information systems and
research databases, trade order transmission and recovery services as well as
other services. These contracts contain certain minimum noncancelable payments,
cancellation provisions and renewal terms. The contracts require payments
through the year 2027. Costs for such services are expensed as incurred.
Variable Interest Entities
Federated Hermes is involved with various entities in the normal course of
business that may be deemed to be VIEs. Federated Hermes determined that it was
the primary beneficiary of certain Federated Hermes Fund VIEs and, as a result,
consolidated the assets, liabilities and operations of these VIEs in its
Consolidated Financial Statements. See Note (6) to the Consolidated Financial
Statements for more information.
Recent Accounting Pronouncements
For a complete list of new accounting standards applicable to Federated Hermes ,
see Note (2) to the Consolidated Financial Statements.
Critical Accounting Policies
Federated Hermes' Consolidated Financial Statements have been prepared in
accordance with U.S. generally accepted accounting principles (GAAP). In
preparing the financial statements, management is required to make estimates and
assumptions that affect the amounts reported in the Consolidated Financial
Statements and accompanying notes. Management continually evaluates the
accounting policies and estimates it uses to prepare the Consolidated Financial
Statements. In general, management's estimates are based on historical
experience, information from third-party professionals and various other
assumptions that are believed to be reasonable under the facts and
circumstances. Actual results may differ from those estimates made by management
and those differences may be material.
Of the significant accounting policies described in Note (1) to the Consolidated
Financial Statements, management believes that its policies regarding accounting
for asset acquisitions and business combinations, goodwill and intangible assets
and HFML redeemable noncontrolling interest involves a higher degree of judgment
and complexity.
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Asset Acquisitions and Business Combinations. Federated Hermes performs an
analysis to determine whether a transaction meets the definition of a business
under U.S. GAAP. When determining whether a set of assets and activities
constitute a business, management considers whether substantially all of the
fair value of the gross assets acquired is concentrated in a single identifiable
asset or a group of similar identifiable assets. If this threshold is met, these
assets and activities do not meet the definition of a business and the
transaction is accounted for as an asset acquisition. If not met, management
then evaluates whether these assets and activities meet the requirement of a
business including, at a minimum, an input and a substantive process that
together significantly contribute to the ability to create outputs. If these
assets and activities do not meet these requirements, the transaction is
accounted for as an asset acquisition.
A transaction that does not meet the definition of a business is accounted for
as an asset acquisition. Asset acquisitions are accounted for using a cost
accumulation and allocation method where the cost of the transaction is
allocated on a relative fair value basis to the qualifying assets acquired and
liabilities assumed on the acquisition date. The cost of the transaction
includes both the consideration transferred to the seller and any direct
transaction costs incurred. The primary asset acquired in previous asset
acquisitions has been the rights to manage fund assets. The rights to manage
fund assets is an intangible asset valued using the excess earnings method,
under the income approach, which estimates fair value by quantifying the amount
of discounted cash flows generated by the asset. No goodwill is recognized in an
asset acquisition.
A transaction that meets the definition of a business is accounted for as a
business combination under the acquisition method of accounting. The
consideration transferred to the seller in a business combination is measured at
fair value and calculated as the sum of the acquisition date fair values of the
assets transferred by Federated Hermes , the liabilities incurred by Federated
Hermes from the seller and any equity interests issued by Federated Hermes .
Direct transaction costs are expensed as incurred in a business combination.
Results of operations of an acquired business are included in Federated Hermes'
results from the date of acquisition.
Rights to manage fund assets and trade names acquired in a business combination
are recorded at fair value. The fair value of the rights to manage fund assets
is determined using the excess earnings method, under the income approach. The
fair value of the trade name is determined using the relief from royalty method,
under the income approach. Each method considers various factors to project
future cash flows expected to be generated from the asset. After the fair values
of all separately identifiable assets and liabilities have been estimated,
goodwill is recorded to the extent that the consideration paid exceeds the sum
of the fair values of the separately identifiable acquired assets, net of
assumed liabilities.
For both asset acquisitions and business combinations, the significant
assumptions used in the valuation of the intangible assets acquired typically
include: (1) the asset's estimated useful life; (2) projected AUM; (3) projected
revenue growth rates;(4) projected pre-tax profit margins; (5) tax rates;
(6) discount rates and (7) in the case of a trade name valuation, a royalty
rate. Federated Hermes has determined that certain acquired assets, primarily
certain rights to manage fund assets and trade names, have indefinite useful
lives. In reaching this conclusion, management considered the acquired assets'
legal, regulatory and agreed-upon provisions, the highest and best use of the
asset, the level of cost and effort required in agreed-upon renewals, and the
effects of obsolescence, demand, competition and other economic factors that
could impact the assets' fair value. Management estimates a rate of change for
underlying managed assets based on a combination of an estimated rate of market
appreciation or depreciation and an estimated net redemption or sales rate.
Expected revenue per managed asset and incremental operating expenses of the
acquired asset are generally based on agreed-upon terms, average market
participant data and historical experience. The assumptions for tax rates are
based on current and projected rates. The discount rates are estimated at the
current market rate of return. The royalty rate is estimated after consideration
of comparable third-party royalty rate licensing agreements, pre-tax profit
margins and the age and importance of the trade name. Given the complexity and
judgment involved in accounting for asset acquisitions and business
combinations, management may utilize the services of an independent valuation
expert to assist in this process.
Goodwill and Intangible Assets. The process of determining the amount of
goodwill and the fair value of identifiable intangible assets at the date of
acquisition requires significant management estimates and judgment. If
subsequent changes in these assumptions differ significantly from those used in
the initial valuation, the goodwill and/or intangible asset amounts recorded in
the financial statements could be subject to possible impairment. In addition,
finite-lived intangible assets could require an acceleration in amortization
expense. These adjustments could have a material adverse effect on Federated
Hermes' business, results of operations and financial condition.
Goodwill is reviewed for impairment annually as of June 30 , or when indicators
of a potential impairment exist. Federated Hermes has a single reporting unit,
consistent with Federated Hermes' single operating segment, to which all
goodwill has been assigned. Federated Hermes first performs a qualitative
analysis and considers various factors including macroeconomic and
entity-specific considerations, industry and market conditions, and overall
financial performance. A quantitative impairment
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test is performed if there are indications that it is more likely than not that
the fair value of the reporting unit is less than its carrying value. At
December 31, 2020 , Federated Hermes had $800.3 million in goodwill recorded on
its Consolidated Balance Sheets. No impairments were recorded during the years
ended December 31, 2020 , 2019 or 2018.
Indefinite-lived intangible assets are reviewed for impairment at the accounting
unit level annually as of October 1 , or when indicators of a potential
impairment exist. Management may use a qualitative or quantitative approach
which requires the weighting of positive and negative evidence collected through
the consideration of various factors to determine whether it is more likely than
not that an indefinite-lived intangible asset or asset group is impaired. In
2020, management used both a quantitative and qualitative approach. Management
considers macroeconomic and entity-specific factors, including projected AUM,
projected revenue growth rates, projected pre-tax profit margins, tax rates,
discount rates and, in the case of a trade name valuation, a royalty rate. In
addition, management reconsiders on a quarterly basis whether events or
circumstances indicate that a change in the useful life may have occurred.
Indicators of a possible change in useful life monitored by management generally
include changes in the expected use of the asset, a significant decline in the
level of managed assets, changes to legal, regulatory or contractual provisions
of the rights to manage fund assets, the effects of obsolescence, demand,
competition and other economic factors that could impact the funds' projected
performance and existence, and significant reductions in underlying operating
cash flows.
The continued uncertainty caused by Covid-19 resulted in management determining
that an indicator of potential impairment existed as of each quarter end in 2020
for certain indefinite-lived intangible assets totaling £150.3 million ($205.5
million as of December 31, 2020 ) acquired in connection with the 2018 HFML
Acquisition. A discounted cash flow analysis resulted in no impairment as of
each quarter end for 2020 since the estimated fair value of these intangible
assets exceeded the carrying value. An additional discounted cash flow analysis
prepared as of December 31, 2020 resulted in the estimated fair value exceeding
the carrying value by approximately 8%. The key assumptions in the discounted
cash flow analysis include revenue growth rates, pre-tax profit margins and the
discount rate applied to the projected cash flows. The risk of future impairment
increases with a decrease in projected cash flows and/or an increase in the
discount rate. As of December 31, 2020 , an increase or decrease of 10% in
projected revenue growth rates would result in a corresponding change to
estimated fair value of approximately 7%. An increase or decrease of 10% in
pre-tax profit margins would result in a corresponding change to estimated fair
value of approximately 12%. An increase or decrease in the discount rate of 25
basis points would result in an inverse change to estimated fair value of
approximately 3%. The market volatility and other events related to Covid-19
could further reduce the AUM, revenues and earnings associated with these
intangible assets and may result in subsequent impairment tests being based upon
updated assumptions and future cash flow projections, which may result in an
impairment. For additional information on risks related to Covid-19, see Part I,
Item 1A - Risk Factors under the caption General Risk Factors - Other General
Risks - Potential Adverse Effects of Unpredictable Events or Consequences
(including Covid-19).
Finite-lived intangible assets are amortized on a straight-line basis over their
estimated useful lives. Finite-lived intangible assets are reviewed for
impairment at least annually, or when indicators of a potential impairment
exist.
If actual changes in the underlying managed assets or other conditions indicate
that it is more likely than not that the asset is impaired, or if the estimated
useful life is reduced, management estimates the fair value of the intangible
asset using an income approach where future cash flows are discounted.
Impairment is indicated when the carrying value of the intangible asset exceeds
its fair value.
At December 31, 2020 , Federated Hermes had $481.8 million in intangible assets
recorded on its Consolidated Balance Sheets. No impairments were recorded during
the years ended December 31, 2020 , 2019 or 2018.
HFML Redeemable Noncontrolling Interest. The HFML noncontrolling interest
represents equity which is subject to the terms of a Put and Call Option Deed,
redeemable at the option of either the noncontrolling party or Federated Hermes
at future predetermined dates and, therefore, not entirely within Federated
Hermes' control. The subsidiary's net income or loss and any related dividends
are allocated to Federated Hermes and the noncontrolling interest holder based
on their relative ownership percentages.
The HFML redeemable noncontrolling interest carrying value is adjusted on a
quarterly basis to the higher of the carrying value or current redemption value
(fair value), as of the balance sheet date, through a corresponding adjustment
to retained earnings. Management may use an independent valuation expert to
assist in estimating the current redemption value (fair value) using three
methodologies: (1) the discounted cash flow methodology under the income
approach, (2) the guideline public company methodology under the market approach
and (3) the guideline public transaction methodology under the market approach.
The estimated current redemption value is derived from equally weighting the
result of each of the three methodologies. The estimation of the current
redemption value includes significant assumptions concerning: (1) projected AUM;
(2) projected
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revenue growth rates; (3) projected pre-tax profit margins; (4) tax rates and
(5) discount rates. Management estimates a rate of change for underlying managed
assets based on a combination of an estimated rate of market appreciation or
depreciation and an estimated net redemption or sales rate. Expected revenue per
managed asset and incremental operating expenses of the acquired asset are
generally based on agreed-upon terms, average market participant data and
historical experience. The assumptions for tax rates are based on current and
projected rates. The discount rate is estimated at the current market rate of
return. At December 31, 2020 , Federated Hermes had $212.7 million in Redeemable
Noncontrolling Interest in Subsidiaries related to HFML recorded on its
Consolidated Balance Sheets.
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