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Legg restructures debt amid signs of turnaround

Legg Mason plans to close a deal this month to restructure $650 million in debt, a move designed to lock in favorable interest rates for the long term while taking advantage of the market's sustained appetite for corporate bonds.

The money raised from the sale will be used to pay off $650 million of notes due in 2019, which the Baltimore-based money manager issued two years ago at a rate of 5.5 percent. The firm's total debt of just over $1 billion would remain unchanged.

Legg's decision to restructure debt follows the path of dozens of companies, including asset managers Invesco, Janus Capital Group and Icahn Enterprises, that have pursued refinancing in expectation of rising interest rates. It also reflects an increasing use of bonds to finance corporate debt, as traditional bank lenders pulled back after the financial crisis.

For Legg in particular, which has been working to right itself since the financial crisis, the deal represents a kind of public statement about its improving condition.

"It's an accomplishment when you can place long-term debt with investors," said Neal M. Epstein, a vice president and senior credit officer at the debt rating agency Moody's. "It gives them increased cachet."

Since 2008, Legg has struggled to restore its reputation among investors, who were pulling funds from the firm, while reorganizing its decentralized affiliate structure in a climate of lower revenues. Moody's cited that uphill effort when it downgraded its outlook on the company's Baa rating from stable to negative in 2011. (It had previously downgraded the rating from A3.)

But Moody's returned the outlook to stable last August, as Legg increasingly appeared to have turned a corner. Standard & Poor's gave a Legg bond issue earlier this year a positive outlook.

"Their bleeding of assets has subsided. ... They've acquired a couple of companies, which they're trying to use to fill up their product gaps; they're trying to move away from the last three or four years of wrong decisions and bad investment performance," said Sebnem Caglayan, a credit analyst for Standard & Poor's Rating Services.

Legg's debt levels have also fallen. At the end of March 2009, the firm carried $3.2 billion in debt. Interest payments for that fiscal year cost the company $150.5 million, according to the annual report.

Four years later, debt had fallen to $1.1 billion. Interest expenses were $62.9 million.

That's higher than a competitor such as T. Rowe Price, which is debt-free, but not so risky as to raise eyebrows, given Legg's earnings and cash flow, said Mark Johnson, an associate professor of finance at Loyola University Maryland.

"I don't look at them as risky. I don't look at them as reckless," he said. "It's relative is what I would stress."

The June bond issue closes a restructuring cycle for debt incurred in 2008, when Legg sold $1.25 billion in senior notes to New York private equity firm Kohlberg Kravis Roberts & Co. to shore up its balance sheet in the middle of the financial crisis.

The firm repaid KKR in May 2012 through a combination of cash, a $500 million loan from a banking syndicate and $650 million in new notes with a 5.5 percent interest rate. Overall debt was reduced by $350 million.

At the time, the decision to take on public debt was unusual for the historically not-capital-intensive asset-management industry, said Peter Nachtwey, Legg's chief financial officer. But rates were low, and the deal freed the firm from some control by KKR.

Legg was also eyeing acquisitions and wanted to improve its standing with lenders by proving itself on the debt markets, Nachtwey said. It announced a deal to purchase Fauchier Partners in December 2012.

As Legg improved, it tapped the bond markets again in January, issuing $400 million in 30-year bonds bearing an interest rate of 5.625 percent. Combined with $50 million in cash, the offering enabled Legg to repay the outstanding loan from the banking syndicate while gaining financial flexibility by extending the deadline for repayment to 2044.

Nachtwey said Legg was pleased with the response of the debt investors in secondary markets, where those notes have traded well below the coupon rate. That reaction encouraged executives to pursue the most recent deal, which includes $250 million due in 2019 with an interest rate of 2.7 percent; $250 million due in 2024 with an interest rate of 3.95 percent and a $150 million expansion of January's offering.

"In January, we're a 'de novo' issuer of 30-year debt; we need to understand how the market's going to react to it and how the market's going to trade," he said. "We weren't sure how deep the market was for 30-year debt for Legg Mason. As facts change, you change your mind."

The company will take an estimated $105 million to $110 million hit for paying off the $650 million of notes early, but Nachtwey said the penalty will be recouped in interest savings, estimated at roughly $10 million the first year. The decision to move now also is a bet that if the firm were to try to refinance closer to 2019, it would face a more expensive deal.

"By refinancing now, not only do we avoid some of that excess interest ... we also avoid refinancing the full $650 million at that point at much higher rates," Nachtwey said.

The new notes also carry standard covenants attached to an investment-grade firm, rather than the additional limits included in the 2012 offering, such as a provision that would ratchet up the coupon rate if the firm's credit rating fell and restrictions on spinning off affiliates.

"Not that anything's planned, but you never know over five years," Nachtwey said.

Legg decided not to pay down the debt further in part because of the sense that the asset-management industry is becoming more capital-intensive, Nachtwey said.

"It's better to finance [capital needs] with relatively cheap debt today than to finance it with equity, which has a much higher return expectation," he said.

The firm likely will avoid fiddling with its debt further, unless it decides to acquire another affiliate, Nachtwey said. Legg has been upfront about its desire to expand its presence in international stocks as well as other alternative investments.

Greggory Warren, an analyst at Morningstar, said Legg's decision to restructure made sense, although it initially caught investors by surprise. But he said he thinks the terms reflect the low interest rates generally, and the firm still needs to boost its performance, particularly among its affiliates focused on stock investing, to improve profitability.

"For them it's a matter of locking in lower rates for a longer period of time. I don't really view it as a reflection on the business or anything else," he said. "They've gone through two major restructures and cut a lot of costs out of the system and their profitability is not significantly higher. Part of that is they've not gotten the performance fixed.

"Time will tell over the long run," Warren said. "But if rates are going up, then it will be worth it."

nsherman@baltsun.com

Copyright © 2014, The Baltimore Sun
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