Top insiders are getting an "unusual perk" that is catching the attention of both ratings agencies and the media. Reuters
reported Wednesday afternoon that a few hundred top executives at Fidelity
] are seeing returns of nearly 20 percent on private debt issued by the mutual fund firm.
focuses on the potential drag the perk has on Fidelity's operations. Yet the perk may be one of the important ways that the Johnson families keeps its top executives interests aligned with those of the firm. It also allows Fidelity to emulate the ownership structure of rivals while retaining its S-Corp status.
The junior subordinated debentures raised a flag at both Standard & Poor's and Moody's Investors Service, which evaluate Fidelity's publicly-held debt (those ratings now stand at "A2" at Moody's). Reuters
reports that it obtained financial documents of the firm that show that more than half of the $5.1 billion in subordinated debentures carried by FMR LLC consists of the junior securities. FMR LLC carries a total of $12.6 billion of debt on its balance sheet.
Moody's flagged the debt as an issue in its rating analysis due to the high interest rates carried on the debt. Analyst Dagmar Silva wrote last month that "...Fidelity's net income margins have consistently been more in line with our expectations for lower rated firms, in part due to its corporate structure."
points out that Fidelity's operating income that was 7.3 times its interest expense in 2002. In 2008 and 2009 that figure has dipped to 2.3 times to 4.3 times interest expense. It adds that Fidelity's coverage ratio of revenue to its interest payments has fallen by half since the turn of the century, dipping to 20-1 from 38-1 a decade ago.
Yet, the debt is a boon to a few hundred Fidelity top executives, however. The debt paid between 8.5 percent to 14.7 percent in 2009, Reuters
reports. Rates were even higher in earlier years, reaching as much as 19.5 percent in 2007 before falling to 13 to 16 percent in 2008.
Interest rates on the issues are two times the prime lending rate with a 200 to 300 basis point kicker, insiders told Reuters. The current prime rate is 3.25 percent.
About 600 executives purchased $63.6 million in debentures in 2010.
The Johnson family, which controls Fidelity, converted it to an S-Corp in 2007. That change limits the Boston Behemoth to just 100 shareholders. Because of that shift, the junior subordinated debt has turned into a way for key executives to be rewarded by the mutual fund firm.
Executives must sell the debt back to Fidelity when they leave the firm.
While Reuters reports that unnamed former executives call the large amount of high-interest debt a drain on Fidelity's competitiveness, the issue may be relatively less important as long as Ned Johnson or his daughter Abigail remain in control of the company. Fidelity has characterized itself as a services company relying on technology serving employers and other institutions as much as it is an asset manager. With that objective the Johnson family has seemed satisfied with lower margins as long as Fidelity continues to build wide competitive moats around its business.
Sean Hanna, Editor in Chief
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