Legg Mason Inc. F3Q09 (Qtr End 12/31/08) Earnings Call Transcript

Jan.28.09 | About: Legg Mason (LM)

Legg Mason Inc. (NYSE:LM)

F3Q09 (Qtr End 12/31/08) Earnings Call

January 28, 2009 8:30 am ET

Executives

Tim Munoz - SVP and Head of Corporate Marketing and Communications

Mark Fetting - Chairman and CEO

Charles Daley - SVP, CFO

Barry Bilson - SVP, Finance

Analysts

Jeff Hopson - Stifel Nicolaus

William Katz - Buckingham Research

Dan Fannon - Jeffries & Co.

Roger Freeman - Barclays Capital

Marc Irizarry - Goldman Sachs

Craig Siegenthaler - Credit Suisse

Douglas Sipkin

Hojoon Lee - Morgan Stanley

Matt Snowling - FBR

Robert Lee - KBW

Cynthia Mayer - Bank of America

Roger Smith - Fox-Pitt Kelton

Operator

Good day, ladies and gentlemen and welcome to the Legg Mason Quarterly Conference Call. (Operator Instructions.)

I would now like to introduce your host for today's presentation, Mr. Tim Munoz. Mr. Munoz, you may begin, Sir.

Tim Munoz

Thank you, good morning. On behalf of Legg Mason, I would like to welcome you to our conference call to discuss operating results for the fiscal 2009 third quarter ended December 31, 2008.

This presentation may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are not statements of facts or guarantees of future performance, and they are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statements.

For a discussion of these risks and uncertainties, please see the sections "Risk Factors" and “Management's Discussion and Analysis of Financial Condition and Results of Operations” in the company's Annual Report on Form 10-K for the fiscal year ended March 31, 2008 and in the company's Quarterly Reports on Form 10-Q.

This morning's call will include remarks from the following speakers: Mr. Mark Fetting, Chairman and Chief Executive Officer; Mr. C. J. Daley, Chief Financial Officer; and Mr. Barry Bilson, Senior Vice President of Finance, who will discuss Legg Mason's financial results. In addition, following a review of the company's quarter, we will then open the call to Q&A.

Now I'd like to turn this call over to Mr. Mark Fetting.

Mark Fetting

Thank you, Tim, and good morning, everyone. On behalf of the management team and my fellow employees, I would like to make some opening comments. Details will then follow with Barry covering the operating results and CJ hitting balance sheet issues.

We will do all of our remarks in a shorter time this morning, so that we can take more of your questions. I assume most of you have seen the release; assets of almost $700 billion, revenues of $720 million and a GAAP loss of $1.5 billion. Our assets and revenue levels continue to reflect a substantial franchise in a great business going through very turbulent times.

As you may have seen, I described our operating results as bitter, reflecting necessary actions to move us forward. Upon reflection, you could also call them bittersweet. Let's take a look.

There are four significant charges that drove the $1.5 billion loss: the sale of Axon, $3.63 a share, the additional SIV support which has been an ongoing issue for us at $1.07 a share. Both of those items are nothing new; it's consistent with what we previously announced in our mission of reducing SIV exposure.

There's also, and significantly, a goodwill and other intangible asset impairment charge of $6.03, which is about 60% plus or so of the total loss - CJ will cover that in detail - tied to a subsidiary; it, too, would not be a total surprise, although the number is certainly big. And then finally, we have net charges of about $0.16 a share, related to a sublease that involves a major investment bank and here again, we'll cover that later.

Now, analytically, when you breakout the realized loss on the Axon sale from our cash income as adjusted page in our results, you'll see that we made an operating cash income of $72 million. Taken against net revenues of approximately $518 million, that's net of the distribution expenses that flow through both revenue and expenses for the most part, you get a profit margin of almost 14%.

This cash profit margin has been and will continue to be a key metric for us to focus on for improvement, albeit in current conditions, it will continue to be tough sledding. You will also see a balance sheet of $2.2 billion in available cash to cover our full $1.8 billion off balance sheet exposure for our remaining SIV situation, and that's after an expected tax refund and also excludes our working capital needs. So we believe, particularly with the sale of Axon, that the balance sheet remains strong and our cash position ample.

Now, we also have to take these results in the context of the current market, and particularly the quarter just ended. The December quarter was the worst quarter in the equity markets since the crash of '87. Just for those following the S&P, the S&P was down 22.6% in '08, versus 23.2% in the December quarter of '87. Indeed, 2008 was the worst, second worst year in S&P history, outdone only by 1931.

The economic fundamentals continue to be daunting and are probably going to get worse before they get better. Unemployment at 7% plus is clearly a challenge, but many are predicting it to reach 9% to 10%, and also Ben Graham's Mr. Market is not letting up, so that January of '09 current month, S&P is down about 7.5%.

We have seen continued unprecedented volatility and losses in all global markets. Since the 29th, the S&P has had 18 days where the index has gained or lost 5% or more. That's more than half of the 35 in total over the last 50 years. Investor confidence remains extremely low and, in fact, continues to go back and forth in severe fear emotions.

We take part in the government actions that are underway and are likely to continue at an increased pace, as Congress and the Obama administration work through the various initiatives being considered.

We also note that the TED, so-called TED over credit spread has narrowed from its high of 463 basis points at October 10th to 106 on the 27th of this month. So that's still maybe twice the level normal of 50 basis points, which I guess is around the 20 year average. So that's a significant improvement.

There is no doubt that investment grade credit situation is improving. Riskier assets not as much, these are encouraging because. as we all know, as the credit markets really get back to normal that will bode well for the markets overall.

So, bittersweet indeed. We've made progress. We've got a lot more work to do, and these challenging times will continue to give us a hurdle to work against. What I'd like to make sure as we keep together a focus on three key measures; to track our performance, cash earnings and cash earnings margin, our balance sheet strength and our strategic growth initiatives.

Let me talk quickly about the strategic initiatives to give you an update.

As we said before, the key priority there is to focus on the profit margin. Our model does have a self-correcting mechanism and so there is considerable benefit coming off of the revenue share range. About 75% of our expenses are variable. To give you an update specifically on the LM or Legg Mason corporate side, when we last spoke, I advised that we had charged the -- I had charged the management team to go and get us $120 million of expense saves, the run rate of which would be achieved 3/31.

I'm pleased to report today we are well ahead of schedule. You will see in these results, as of 12/31, cost saves of a $108 million. We have achieved $135 million of saves that will be reflected in the 3/31 run rate. So we're ahead of schedule and we're not going to stop there. So that's an update on the profit margin initiatives.

Second is to enhance our affiliate and Legg Mason collaboration. Here, the number one mission, of course, is performance, performance, performance and I work more closely with some key affiliates on this important measure. There's also continued good support going on between Western and Legg Mason in getting the SIV issues behind us and building our liquidity business.

We were able to help in the quarter for now to meet some unexpected redemptions in such a way that, just for a couple of weeks, the parent was able to provide some funds, and repay clearly. It worked out very well, and I'll talk about it some more. And then finally, in Japan we had some significant institutional wins across several of our managers.

The third initiative is to accelerate global growth and product development. We continue to look at innovative ways to expand our multi-channel open architecture distribution strategy. We announced the creation of an innovation initiative to develop a new suite of products and to also restructure our existing fund line up.

I'd like to emphasize one product in particular that we are going to launch. It is an all weather fund that will be managed by Permal, whose expertise in asset allocation is, we believe, unsurpassed. They will allocate the assets that we raise among Legg Mason affiliates and other investments as appropriate.

Let me now turn to some quick updates on a couple of other metrics. In terms of flows, as you will see, the flows picked up on the equity side. We had about $17 billion versus about $9 billion in the prior quarter. It's important to point out that Permal was a portion of that. In fact, the other managers were about their same level.

In the fixed income side, where we went from $42 billion from $12 billion, that's a significant pick up. Most of that was Western. In this case, what we saw was the kind of outcome of what we had talked about before, in terms of clients rebalancing and also specifically in the areas of core-core plus domestic to a certain extent and some global mandates out of our London desk.

On the liquidity side, there was a pickup in outflows. That really reflects one sovereign wealth client, for the most part, adjusting as you have seen others do in terms of shifting funds to their internal needs.

Quickly, I'd like to also highlight our individual manager AUM's and make a couple of comments. We did this last quarter and a number of analysts thought it was well received. So, Western ends the quarter with $512 billion under management, about 12% decline from the prior quarter; Permal is $23 billion, about 35% from the prior quarter; ClearBridge at $50 billion, down 27%, pretty consistent with market in terms of that S&P number; Royce at $20 billion, down 28%, all market for the most part; Capital Management, Legg Mason Capital Management, $15 billion, down and about two-thirds of that is market; Brandywine and related entities $37 billion, down about 14%; Batterymarch at $17 billion. PCM ended the quarter at $3 billion, down from $5 billion.

As I did before, I listed those affiliates in order of their contribution. We continue to have diversified contribution across our affiliates, clearly Western in terms of AUM, and also, contribution has increased, and we work closely with Western on a number of funds, as we've talked about.

Some quick hits relative to this. Western has actually performed well with global sovereign mandates, inflation-linked and muni bonds, the Core and Core Plus remain challenged. Private capital management has restructured, with Bruce Sherman now singularly focused on investments as the Chief Investment Officer, and Greg Powers taking the reins as CEO. We're working together with Greg and Bruce and the team to move forward there.

And then on Permal, we actually had Isaac Souede at our Board meeting on Monday night. As you all know, in that business, there was a surge in October for redemptions; Permal, unlike many, was able to meet those redemptions. They did introduce a 95 day notice period, which has helped stabilize the situation considerably. It is important to note that Permal had no exposure on Madoff.

Overall performance: we hope you saw that Charlie Dreifus was named the Morningstar Manager of the Year and Equity Manager, and we're delighted that Hersh Cohen and Scott Glasser were among the other nominees as a finalist.

Our long-term performance on the funds remained solid at 71% of equity funds being the Lipper average, and 68% of our fixed income funds. Here again, we know we've got some work in certain areas in the short and medium term, and we're on track to get that moving favorably.

So let me now turn it over to Barry.

Barry Bilson

Thanks Mark. Good morning, everyone. I will try and move efficiently, because I'm sure there are a number of questions. We tried to relay through in the release the principal vagaries or the unusual items in the quarter. There certainly are other things. I'll touch on them briefly, but the ones identified, summing up to a $1,535 million or $10.89 a share, are the principal drivers.

When you look at the P&L, I'm not going to roll through each and every line. Most of them are fairly explanatory, but it's important when we look at this. Certainly these markets have deteriorated quicker than they are ambitious at cost reduction program. But if you'll look carefully, we've tallied it, and we think this quarter does prove it through, the variable structure of our cost base, that, on a sequential basis, you've got revenue off of that 25%. On a year-over-year base, you're off about 40%.

Concurrently, when you get the expenses normalized, get the impairment out of the equation, you're looking at operating expenses down 28% sequentially, 39% year-over-year, and that's aligning distribution contra revenue, the distribution and service expense.

So, you've got revenues dropping 25%, operating expenses dropping 28% sequentially. Year-over-year, you've got revenue down 40%, and you've got expenses down 39%. So, while certainly the bottom line isn't . . . and we certainly acknowledge has been eroded substantially. We have been able to compensate and work our expenses to be dramatically variable with the revenue.

Okay. I will touch on now very briefly the unusual items in the quarter. The intangible write-off is principally goodwill. There are some identifiable intangibles that are included in there as well but, that's probably less than 10% of the total. I'm going to defer it to C. J. to really frame up that non-cash charge, and exactly the 'whats' and 'whys' and it's sitting on its own line.

The SIV stuff, both on the Axon side, and the other supports that are in place, geographically is in the other non-operating, as it has been all along; and on the sublease default, that stands out pretty painfully, that $36 million gross hit is in the occupancy line. On the realization rate, you're looking at a realization rate for this quarter that has moved substantially, down to a 33.0 basis point level versus last quarter at 36.7. Last year it's 37.8. It is reflective of nothing more or less than the erosion on the equity AUM.

Obviously, there are the higher fee-business for us, and if you'll look at their relative proportion of the total, they drop to a level such that they are driving almost 3.5-4 basis points of variation. They are now at about 23% of the total, or the average AUM versus last quarter at just shy of 27.

Now, a question that's going to come up is fee waivers. While, certainly the liquidity business looks like it could, if there is continued narrowing especially in the government side, be challenged relative for full realization of fees. We are overwhelmingly institutional, which already starts with a lower fee structure, lower expense ratios and, therefore, more breathing room in that regard. At least in this quarter, there are no additional fee waivers that you're looking at in order to accommodate a positive yield. We can't promise what tomorrow will be, but there is nothing that's spiking or deteriorating this yield in any dramatic fashion.

I do point out that the ending AUM, and this is a cautionary note because we're all struggling to figure exactly what our model should be and what the environment will be, the ending AUM is 6% lower than the average. So, depending on where the market goes from here, we're already starting the March quarter with a challenge in that regard.

The relationship of distribution expenses to the related revenues is identical. Mark's already made the reference to the cost saves that are running larger and ahead of schedule. There's also reference in the release, that it was in excess of $50 million this quarter. You will note that we did not make an additional disclosure with respect to restructure costs, because of the fact as many others I've noted had some recapture of prior bonus monies in prior quarters, that was equal or even greater than the corporate restructure, we netted the two together.

Additionally, because of the revenue share model, the corporate restructure item would not look of that magnitude, as others would quote a more traditional model. There are reductions in quotes that have occurred outside of corporate. Mark made reference to the corporate side and a couple of hundred people. It does go beyond that, but it ends up being a trade off between normal compensation expense and restructure, so we didn't stay get or try and do that as an add-back because that just that would be inappropriate accounting.

Let's move briskly to the other non-operating on the SIV front. You've got the numbers in the release. If you back off and look at the disclosures at the point of the disposition of Axon, you'll see that for the balance of the month of December there was approximately $45 million of additional gross markdown, which throws off about $30 million net or about $0.22 a share. Some include that in their model, a few do not, but the end of quarter number obviously changed from December's, 11 points.

The other thing in that category and many in the space have had variances this quarter, is the deferred compensation plans that are funded and corporate investment securities. CJ is going to talk about the portfolio on the Balance Sheet a little bit, but just to get the framing on the deferred compensation side, the mark-to-markets again have an equal offset in the comp and benefits. So no bottom line impact, just a swing between non-operating and operating, about a $40,000 item this quarter, $23 million last quarter, so an uptick of about 17.

On the investment side, the marks last quarter were about $15 million, this quarter $35 million, or about $20 million gross. If you roll that through to the bottom line, and we didn't isolate because it is a part of the business that we run and the investments we make, it was about $0.09 a share. That is just to give that framing.

The other thing that appears that some folks may be surprised by, is the net interest profit. Certainly, there have been anxieties of how their balance sheet over time, or cash position, or debt position, et cetera, but here we sit with substantial cash in an environment with deterioration in short-term rates and it eroded our income in a meaningful way.

On the expense side, with the change in our terms, that was basically identical, so it was about a $12 million deterioration, sequentially they were about $0.06 a share. From a standpoint of guidance for next quarter, we would envision that number would be similar all else equal, maybe a drop of a $1 million or $2 million.

Finally, on the tax rate side, the numbers get very large, it throws all strange differences very-very quickly. Indicated last quarter if we were projecting a loss for the quarter that it would not be an inappropriate level to assume about a 35% tax rate. We came through at a 34.2, which is reflective of geography, both country and state, and the ability to deduct on a current basis any of these operating losses from any of the corporations that we are dealing with.

If you look at that versus the 35 rate on a loss, you're getting almost the delta method in sense of share. Our normalized kind of rate, when we return to the positive numbers and again the cash numbers when you adjust out the non-cash items and the impairment, while positive, the GAAP reporting on the tax side of life was a loss. If it is a profit, the rate of around 37.5 is probably the bogey versus this quarter at 34.2, it gets you a pretty substantial variation of almost $75 million or $0.53 a share.

So just be careful, whereas you roll your models at what's your presumption or expectation is for pre-tax profits and what rates you use. Because of the large impairment hit this quarter, it certainly makes the optic on that rate look a little peculiar. I know that was brisk, but at least I think I've gotten your hands when I need to, and we can certainly follow on behind, but at this point probably it would be good to flip it over to CJ.

Charles Daley

Thanks, Barry. Good morning, everyone. I will update you on our balance sheet liquidity and then a condensed review of our process surrounding the valuation of our goodwill and intangibles. Our balance sheet remains strong; however, when you see our balance sheet, you will notice several items of variances, primarily as a result of the impairment charge and the sale of Axon Securities in December.

Our cash position at December 31 is $2.4 billion, of which $825 million remains restricted for SIV support. Cash is down from $3.1 billion at September, primarily as a result of the realized loss on the sale of Axon in December.

An important measure of our balance sheet strength is our ability to support our SIVs. At December 31, of our $2.4 billion of cash, $1.8 billion is available for support of SIVs, and on a pro forma basis, after taking into account the expected tax refund, our net operating and the net operating loss carry back, we have $2.2 billion of cash, which Mark referenced to support SIVs.

So our exposure to supported SIVs, which was reduced as a result of the sale of Axon, is now $1.4 billion. That equates to cash coverage to our supported SIVs of 157%. That's up from 93% pre the sale of Axon, a decent improvement. And even after including the $400 million of SIVs that we have not supported but remain in our funds, our cash coverage is now at 122%.

So as we stated on the call with disposition of Axon, the sale of Axon has strengthened our ability to meet the challenges of our SIV exposure and we remain confident that the actions we took early to raise capital continue to provide us the flexibility to meet our SIV challenges.

Investment and securities which Barry referenced were $1.1 billion at September 30th, and included positions in Axon that we had acquired and put on our balance sheet and have subsequently sold. Investment securities at December 31 declined to $517 million.

That $517 million is represented by $150 million of remaining SIV that are on our balance sheet, and $361 million of seed capital and assets held in deferred comp plans. Barry mentioned that we recorded P&L charges related to those investments of $76 million, which are in our other income and expense line on the P&L.

Intangibles and goodwill declined $1.2 billion to $5.3 billion as a result of the write-down of goodwill in our Wealth division. As we disclose, we review all of our goodwill and intangibles on a quarterly basis. We determine current values of our intangibles and goodwill on a discounted cash flow basis and compare those values to the carrying values on our books.

Valuations of these assets relied heavily on the use of a number of assumptions, including market returns and net client flow projections. Projected future cash flows are then discounted utilizing a risk adjusted rate. As a result of the severe market conditions in the December quarter, including significant declines in equity markets and net out flows, our assumptions are revised to reflect current levels of AUM and lower growth expectation.

We utilize services of the big four accounting valuation groups to review our assumptions, so that we would have the comfort of knowing that we are neither too aggressive nor too conservative in our assumptions and projections. The change in assumptions particularly impacted the value of our Wealth division, which is supported primarily by cash flows from PCM and Permal.

As you know, PCM assets have declined significantly and Permal experienced significant redemptions from fund of hedge fund products. The result of both, significantly lower markets and AUM's, as well as our revised projected future cash flows, led to a shortfall in the carrying value of our Wealth division.

We then revalued all the assets in that division, which led to the determination that the previous carrying value of goodwill need to be reduced to $200 million which is a reduction in carrying value of $1.2 billion. The remaining goodwill in our books of $1.1 billion primarily resides in our Managed Investments division, and is supported by fund contracts principally managed by ClearBridge, Capital Management and Royce.

In addition, we have indefinite life contracts of $3.9 billion, represented primarily by mutual fund contracts in the US, Europe and our funded hedge fund business. While we have no current expectation of additional write-offs, we could have additional exposure to future impairments if actual results adversely deviate materially from our assumptions. Our debt levels remained unchanged during the quarter at $3.5 billion, which includes $1.1 billion of convertible equity units.

Finally, two important measures of our financial strength or our ability to generate EBITDA, and our ability to service our debt levels. At December 31, EBITDA, which is a measure on a trailing 12 months, was $1.13 billion, down from $1.23 billion at September. Our leverage ratio, which measures debt to EBITDA and for our bank covenants has a maximum ratio of three times, was 2.1 times in December, that's up from 1.9 times at September.

With that, I'll turn it back to the operator for Q&A.

Question and Answer Session

Operator

(Operator Instructions) Our first question or comment comes from Jeff Hopson from Stifel Nicolaus. Your line is open.

Jeff Hopson - Stifel Nicolaus

Okay, thank you very much. You may have given this, but in terms of Permal, is there a pipeline of funds waiting with that 90 days, and what would you think has the behavior, so to speak, at the margin change in terms of what those clients are trying to do?

Mark Fetting

Yeah, Jeff, this is Mark. Clearly, October leading to kind of mid-November redemption was the surge. Things have stabilized significantly since then. As you may know, Permal's performance overall compared quite favorably, and so their performance story on a relative basis is a strong one. It, of course, is in the context of a market concern that continues to be difficult.

The fact that there was no Madoff exposure, and has never been, is a very important fact that's helped, but I think if Isaac were responding, he would want to point out that it's less a redemption issue now and more of an acknowledgment that sales going forward for the near term will be tougher than normal.

Jeff Hopson - Stifel Nicolaus

Okay, great. Thank you.

Operator

Our next question or comment comes from the line of William Katz from Buckingham Research. Your line is open, Sir.

William Katz - Buckingham Research

Okay, thank you. I do have two questions. The first one, I just want to be clear . . . The identified cost savings that you've raised the guidance on, was any of that in the quarter that just ended in December?

Mark Fetting

Yes. Let me give the preface, and then C.J will be more specific, Bill, if you need it. There's $108 million of run-rate in the quarter ended December. There will be, and we have high confidence, 135 by 331. We're not going to stop there, but some of the other things may take a little longer to actually see. So we don't want to get ahead of ourselves, but C. J., anything more specific?

C.J. Daley

I mean, I think that's basically it. On a run-rate basis, we'll be at 135, so I think the message is that in the December quarter, you didn't see a full quarter's of run-rate on a normalized basis, because we still have a portion of that to realize in the March quarter.

Barry Bilson

And Bill, just so there's no reconciliation confusion later, when you look at the narrative, and I tried to touch on it briefly, probably not clearly, when you're looking at the narrative in the release, looking at this quarter versus last quarter, there is a reference that there are declines in the corporate cost base of approximately $50 million, reflecting the impact. That is a reflection of the profitability enhancement process, but it is, in addition, reflective of some of the 'Recovery' of prior period bonus monies.

And, again, I made the reference; we didn't identify and say, 'a corporate reduction enforced expense', because, in the big picture, that was negated or slightly more than negated. So, the short answer to your question is, broadly speaking, and obviously some of these things are tailoring in, you were looking at a cost base this quarter, ex-the unusual items if you will. It is not dramatically different than what you should be starting with for the December quarter.

William Katz - Buckingham Research

Extra sub-lease charge?

Barry Bilson

Correct.

William Katz - Buckingham Research

Okay, my second question is broader than that. As we think about the fixed income business, clearly Wamco is losing share. Just wondering what comp does the market have that we are reaching potentially Nedar in the business here, or is this just now a wasting asset?

Mark Fetting

Well, that's obviously a broad question. It encompasses the fixed income business overall. I guess where I would approach that is certainly the asset class fixed income. If you look at any kind of multi-year work in an environment with more folks approaching retirement, et cetera is a favored asset class for growth.

In the near-term, the market conditions have certainly been severe, but the improvement has to be noted. There is 10 spread coming in, the investment grade, markets operating less and less through government support and more and more on their own, and then kind of everybody is, therefore, moving into the riskier asset classes and hoping to see some improvements there.

We've seen some definite improvement in terms of bids that have come in on some of our exposure; while we may or may not pursue them, it's encouraging to see them come in. All of that, I think, bodes well for the fixed income improvements. And clearly, the fiscal and monetary policies on a global scale are going to be targeted there as well.

Within Western specifically, Bill, what you have there is, as you know, when credit is not rewarded, Western tends to under perform. When credit is rewarded, it tends to do quite well, and while their numbers right now are a bit, it's a longer kind of under performance because this market condition has been more protracted.

Jim and Ken and Steve and I were out there last week, encouraged that it could be near term. No one is willing to call exactly when you can see some improvements, and then they will get some benefit from that with both existing clients and potentially new ones. In the meantime, they do continue to win business on global sovereign, on the inflation length and on the muni area.

William Katz - Buckingham Research

Okay, thank you.

Operator

Okay. Our next question or comment comes from the line of Dan Fannon from Jeffries. Your line is open sir.

Dan Fannon - Jeffries & Co.

Good morning, guys. $77 billion in outflows is a substantial number. Can you give us a sense of the institutional pipeline across-the-board and the conversations in terms of Western, how they're going with their current customers and how we should think about those metrics going forward in terms of new mandates?

Mark Fetting

Well, particularly if you look at it on a kind of a calendar year basis of '08, the rebalancing issue was considerable, and we looked at some data that said maybe as much as 80% of the 12 month outflow was tied to the rebalancing piece. To the extent that's kind of paused a bit very recently it has been reported, it does gives an opportunity for you to get in front of clients and work through.

Western specifically, on the quarter and quarter plus, there continue to be some performance issues that are challenging. That would be in the domestic area and the global area out of the London desk, but I would say specifically their pipeline of opportunities is still a reasonable one. They're therefore getting the . . . their win rate is not what you would normally want to see or we have normally been able to achieve, but we hope to pick up with the performance side.

On our other equity managers, I would say it's really across-the-board. Batterymarch has been out getting some business, as has Brandywine on their equity side, and ClearBridge is less of an institutional manager, so it wouldn't be quite as relevant.

Dan Fannon - Jeffries & Co.

Okay, and then you mentioned briefly to answer your last question about bids improving on some of your stuff. Does that, just to clarify, was that implying that on some of the SIV assets you have seen more interest in those in recent months or recent weeks?

Mark Fetting

Yeah. And I would have to put that in the context of a desert situation. In most of '08, we were getting nothing to kind of certainly some trickles of water that make it better and we'll see how much further it goes, but the trend is moving in the right direction.

Dan Fannon - Jeffries & Co.

Thank you.

Operator

Our next question or comment comes from the line of Roger Freeman from Barclays Capital. Your line is open.

Roger Freeman - Barclays Capital

Hi. Good morning. I've got two questions. The first is around the flows. Maybe you can attack it this way. If you calculate outflows were about 9% across the entire AUM base, if you exclude some of those more unusual things, like the sovereign withdrawal, any redemptions from Bill Miller's fund and Permal. What would you say the outflow across everything else would have been, either on a dollar basis or on a percentage basis?

Mark Fetting

Well, I can't be that specific, but I can tell you that when you start to do that, you're down to really kind of Western, which is, of course, our largest asset, largest manager in AUM and, as a result, that percentage is not as troublesome as the one that you said in aggregate.

Roger Freeman - Barclays Capital

All right, fair enough. My other question is around the comp expense, and I was a little confused on a couple of comments you made. I think you said there was some true up related to accruals earlier in the year that helped benefit the comp expense, but I'm more interested in how much of the reduction in comp expense is tied to managers really delivering on those contracted margins for the quarter, and did they all deliver on their contractual requirements?

Mark Fetting

Yes, they all delivered on their contractual requirements, and CJ or Barry can hit how to position the metric.

Charles Daley

I can, but most of that was 75% plus of our expenses being variable, that same kind of metric then rolls right against the comps side. So, it would not be inappropriate to assume that something of that kind of magnitude was really being driven by the affiliates.

Roger Freeman - Barclays Capital

Okay, thanks.

Operator

Our next question or comment comes from the line of Marc Irizarry from Goldman Sachs. Your line is open.

Marc Irizarry - Goldman Sachs

Great. It's Marc Irizarry, Goldman Sachs. Good morning. In terms of the margin, the core margin here, we calculate that we're coming out about 26%. How should we think about the margin going forward with what looks like another 5% or so off the cost base already, where do you see that margin and the core margin trending this year?

Mark Fetting

Well, that's the key metric, both that and on a cash basis. I've charged the management team to really stay focused on, as it relates to our ability to take costs out, both at the affiliate level because of the self-correcting piece, and the corporate level. You can assume that we're going to continue to make progress as it relates to how this market continues to hammer all of us in the business. That will be the swing factor. If the markets went up and AUM's come back up, revenues will come back up and that will help us to the extent they drive it further down, it will effectively stall things, I suspect.

Marc Irizarry - Goldman Sachs

And then just, if we just think about Barry's 28% decline sequentially that you called out in the cost base here in your cost structure. What sort of controllable, from your perspective when you're looking at the potential cost saves going forward, and how should we think about the buckets where the saves are going to come from, from here on in?

Barry Bilson

The buckets are very clear in my mind, Mark, and the controllable is the key, is the operative term. There is what was $600 million on a run rate; it is going to get chopped by 135 by 331 and more going forward. That's a controllable. There are certain affiliates that are not on a revenue share. We've been talking and working with each and every one of them to make sure not just comp, but other expenses are reviewed and taken back where appropriate. And then finally, as we say, those affiliates on a revenue share, it's just making sure they stay within -- that they are able to operate the business within that revenue share, such that the self-correcting piece is delivered. So those are three areas of controllables, and we're working on each and every one of them.

Marc Irizarry - Goldman Sachs

Okay, and then just in terms of Western, is there any place where you're notably on watch with consultants or you mentioned that sort of investors, or maybe a little bit frozen in terms of RFPs at this point in time, or do you think there's another sort of shoe to drop in terms of the flows and fixed income?

Mark Fetting

In fact, here again, in the conversations I had last week, we are on the recommended list of all of the major consultants. It was noted by a third party firm that does analysis on this, that's reflective of Western's strong client service, because the performance and the market conditions are challenging, but they've continued to be, as I say, they are continuing to get the right path.

Marc Irizarry - Goldman Sachs

Okay, great. Thank you.

Operator

Our next question or comment comes from the line of Craig Siegenthaler from Credit Suisse. Your line is open, Sir.

Craig Siegenthaler - Credit Suisse

Thanks, it's Craig Siegenthaler, Credit Suisse. Just want to get my arms around the compensation expense. I believe there are a few unusual items you've pointed out, really one of them, but I'm just wondering what is really the add back to expenses we should think about in terms of if there's any deferred compensation. Also, the SIV, you pointed out, but I don't know if you ever could define that number and also any unusually low bonus accruals?

Barry Bilson

Yeah, Craig, real quick and I think I've thrown them out and probably too quickly. So if we've got to go further, we could take it off line in the midst. But the comp that you're looking at here is an appropriate level to be viewing on this revenue base, that while there was some restructured costs, there was also some recovery of prior quarters' bonus net-net-net, probably a plus of a few $5 million. So, I don't think you need to get too hung up on that one.

Relative to the SIV side, there is a level of compensation adjust that is in this quarter, was in last quarter and will be in the foreseeable quarters. So, you really don't need to be modifying there. The deferred compensation piece is one that you do need to factor through. It does move and can move pretty substantially this quarter; remember, you've got the income or expense in non-operating with an identical amount in comp and benefits. That number this quarter was $40 million. That number last quarter was $23 million, so depending on what you would presume, assume environments for gain or loss would alter your comp line, but it has no impact on your pre-tax.

Craig Siegenthaler - Credit Suisse

So about 240 of, because it sounds like 240 a comp was kind of the core number? 195 plus the 5, plus the 40, gets to about 240?

Barry Bilson

That will work.

Craig Siegenthaler - Credit Suisse

Got it. Okay, and just one other specific question. I was wondering if you could disclose the actual level of net outflows or organic deterioration at both Western and Permal?

Mark Fetting

We really don't do that, so direction in it, let's see what, I can help you. You see the fixed income, the $62 billion and most of that was Western in the fixed income, and then the liquidity business is all Western. On Permal, they have both equity and fixed income and one way of looking at that is their redemption rate; I guess the industry was about 20% on a run rate basis and Permal was actually inline with that.

Craig Siegenthaler - Credit Suisse

Does all of Permal fit in the wealth management bucket?

Mark Fetting

Yes.

Craig Siegenthaler - Credit Suisse

Okay, so that then might be another good approximation?

Mark Fetting

Yes.

Craig Siegenthaler - Credit Suisse

Got it. All right, great. Thanks all for taking my questions.

Operator

Our next question or comment comes from the line of Douglas Sipkin from Wells Fargo. Your line is open, Sir.

Douglas Sipkin

Good morning. I just have two questions. One and a follow-up. Can you talk about how potentially Permal's sort of redemption policy may or may not have been different than some of the competitors and, if it was, what can you do to potentially highlight that, given that just from the surface, it appears like it was a little bit more investor friendly redemption model?

Mark Fetting

Yeah. It was a monthly window and the way they've taken the first step towards addressing that is the 95 day notice period, and that has, that plus just the market is soft, settling down there, and for those non-Madoff firms has pretty much taken them back to a stabilized situation.

Douglas Sipkin

And was that policy, that monthly any different than other competing firms?

Mark Fetting

There were others, but there were not as many, so yeah.

Barry Bilson

And, Doug, they have maintained a monthly redemption, but what they have now instituted was instead of a 20 day notification, a 90 day notification, but it was more lenient than any of their competitors.

Douglas Sipkin

And I guess what I'm trying to get at, it just seems like, given that a lot of these alternative managers have frozen redemption and you have not, and again, seeing that, that seems like it's a much more investor friendly model. I mean, is there any way that you can sort of capitalize on that from a branding standpoint, given the carnage in the sector? I guess it looks like Permal will be an end game winner because of the relative performance. Is there some more of additive things that you can do to enhance that this is the most investor friendly, or one of the more investor friendly, models, despite what happened in the marketplace?

Mark Fetting

I think from a risk Management standpoint they are unlikely to pursue that. Isaac has pointed out that this October/November, the clients were treating them like an ATM. That certainly wasn't helping Jim Hodge and Bob Kaplan and the investment team, but one thing to think about, embedded in those outflows was a lot of structured product where the sponsor itself was fueling that. That business they are less likely to pursue. They are going forward, focused, will probably be more on institutional and kind of sophisticated retail as opposed to pure retail. It's in my mind, they are very focused on quality business, quality clients, and delivering those results and probably therefore getting a better outcome.

Douglas Sipkin

Okay, great and I just got a follow-up, just so I make sure I heard it correctly, investment losses in the quarter accounted to about $0.09; is that correct?

Charles Daley

That's correct, Doug.

Douglas Sipkin

And then also the cost, I think you guess at 108 run rate was embedded in that December expense number; correct?

Charles Daley

A slug of it, but not completely.

Douglas Sipkin

Okay, great. Thank you.

Mark Fetting

Thank you.

Operator

Our next question or comment comes from the line of Hojoon Lee from Morgan Stanley. Your line is open.

Hojoon Lee - Morgan Stanley

Thank you. A question on your plans to reorganize your mutual funds. What specifically do you plan to do and how do you see this either driving growth or leading the cost saves, if any?

Mark Fetting

Well, as you may recall when we first did the Citi transaction, we made considerable progress taking in aggregate something that was in excess of 200 number down to about 160. Since that time, and in these market conditions, where certain asset levels could take a long time to recover, regardless of who the firm is. We're taking another look and it's really an opportunity to put best managers against best mandates on as efficient a platform as possible.

We do see some opportunities of repositioning and going out in the market with something that's kind of bigger and better. It will take sometime, because, as you know, you've got to go through the fund boards to do that, but we are very encouraged and our team that is leading that initiative has made some good progress.

Now, you should also keep open to us launching some new products on a very selective basis, and then I mentioned this all-weather fund with Permal and some of our other Managers, as well as potentially other investments. We think this has some very encouraging possibilities.

Hojoon Lee - Morgan Stanley

Great, thanks. And just a few follow-up questions on Permal. One, I think you referred to industry redemption rates of 20%. Was that for the full year that you're referring to, or a fourth quarter number that's annualized?

Mark Fetting

I think annualized, I'm sure the fourth quarter is part of that.

Charles Daley

And clearly the preponderance, Hojoon. The early part of the year in the alternative space and fund-to-fund space was positive. It was as you head into that fourth quarter that things really degraded.

Hojoon Lee - Morgan Stanley

Okay, and then just in terms of the 95 day notice period, was this introduced in November or December?

Mark Fetting

It was essentially introduced some time late October, early November, both with clients meetings and distribution partner notifications.

Hojoon Lee - Morgan Stanley

Okay, great. And you mentioned that you were, or Permal is targeting more institutional business, and just for us to get a sense, should we expect lower management or performance fees on assets that you gather from this channel?

Mark Fetting

Not necessarily. One of the interesting issues is on the manager side of this. The managers themselves, as you can imagine, covet inflows and quality partners, and so there's a bit of a trade-off going on that acknowledges, look going forward. As Isaac likes to point out, they went through this in '98. The industry itself dates back to '49, Permal itself in the late 60's. They are going to get through this, but you're into a bit of a correction period here, which should play to the strength of the quality firms and Permal we think is certainly one of the best.

Hojoon Lee - Morgan Stanley

Great, thank you.

Operator

(Operator Instructions.) Our next question or comment comes from the line of Matt Snowling from FBR. Your line is open.

Matt Snowling - FBR

Good morning.

Mark Fetting

Good morning, Matt.

Matt Snowling - FBR

Last quarter, you reported having about a billion dollars of CSA's expiring in March. Is that still the case or can you update us on that?

Mark Fetting

Yeah, they are. They do expire. It's the same. We are working with the Commission to get those extended, as at least one other in the industry has done, and at this point, we're relatively confident that we can accomplish that.

Matt Snowling - FBR

Okay. And real quick, $500 million bank line looks like it matures this quarter. What are your plans on that?

Mark Fetting

I'm not familiar with what you're talking about. Our bank, our revolver --

Matt Snowling - FBR

Revolver, I am sorry.

Mark Fetting

That expires in 2010, November.

Matt Snowling - FBR

I had the wrong date. Okay, thank you.

Operator

Our next question or comment comes from the line of Robert Lee from KBW. Your line is open.

Robert Lee - KBW

Thanks, good morning, everyone.

Mark Fetting

Good morning, Robert.

Robert Lee - KBW

Maybe going back to, I guess to beat a dead horse, but going back to the fixed income business. The delta change in outflows was so dramatic, is it possible to get any kind of insight as we look to this current quarter, next couple quarters, in terms of your look at the pipeline, whether you have been notified of redemptions, you have January activity? I mean, should we be expecting that it's going to go back to the run rate, or closer to the run rate it had been at, or are we at some kind of new level for awhile? Maybe some color on that would be helpful.

Mark Fetting

Yeah. Western has been working, as you would imagine, on a bottom's up basis across all of their accounts, and they would expect some near term continuation of these out flows. I don't think anyone that I've seen has predicted the exact level; however, once you get past this near term with a hope for some improved performance and potentially some market benefit, it probably abates.

Robert Lee - KBW

Okay, and also going to the revenue share, understanding how that's worked to your benefit with making so much of your expense base variable, but as some of the affiliates have come under pressure and understanding that they've taken steps to reduce their own expenses, are you starting to get to the point in some places where the revenue sharing has to alter more of the margin compression, if you will, or reduce revenue. It flows through to you, because they just have to keep their infrastructure at a certain level to maintain their long-term?

Mark Fetting

Most of the firms were not at that level or near it. In a couple of situations I mentioned last time, private capital management, we certainly made some adjustments, but they continue to be a profitable entity. And I think that shouldn't be a big issue, but to the extent there's further erosion in our smaller affiliates it could be, but we're going to continue to work together to keep it minimal.

Robert Lee - KBW

Okay, great. Thank you very much.

Operator

Our next question or comment comes from the line of Cynthia Mayer from Bank of America. Your line is open.

Cynthia Mayer - Bank of America

Hi, good morning. Most of my questions have been answered, but I'm wondering if you could speak really quickly on what impact, if any, you think combining that Smith Barney and Morgan Stanley brokerage forces might have, because you still have distribution agreements with Smith Barney; right? But Morgan Stanley has its own product?

Mark Fetting

Yes. Cynthia, we've been fortunate to work closely on the Smith Barney side, and also have a developing relationship on the Morgan Stanley side, actually because of some pre-existing work that had been done by the Citi team. So, we look forward to working with the combined entity, and because with Charlie Johnston effectively being the Operating President, and his team and their systems at the moment seeming like they're going to be embraced. We think there is a good opportunity for us to continue to have a good relationship. But to be clear and fair to them, they are still sorting out some other issues and so we're going to get more clarity on that as we go along.

Cynthia Mayer - Bank of America

Do you know, formally, what will happen to your distribution agreement?

Mark Fetting

Yeah. The distribution agreement as you know, this so-called exclusivity is scheduled to expire on February and that will work through. The broader distribution agreement, and how specifically we do that remains to be seen. There are two parts to that, both retail and institutional. On the institutional side, on the money funds, we have already extended that so that it's later in '09 and we got time to work through things.

Cynthia Mayer - Bank of America

Okay, thank you.

Operator

Our next question or comment comes from the line of Mr. Roger Smith from Fox-Pitt Kelton. Your line is open.

Roger Smith - Fox-Pitt Kelton

I just want to talk about the liquidity or money-market business here a second. Can you give us an idea of what's going on with the fee waivers that might be happening in the industry and how you might be handling those?

Mark Fetting

Yes. Certainly there's a lot going on in the liquidity business. What we have done, like most of the firms, is so long as the inflows to treasury funds continue at a strong rate, we've essentially started to rationalize access, so that we don't get too exposed to that situation. Most of the other firms have been doing that as well, and then in terms of our current fee waiver, I would not call what we're doing now all that different than what we've done from time to time and we just have to play it through.

You should expect that to the extent investors become less concerned, because the credit markets themselves start to turn back, etc., and a recognition of getting virtually zero or very low interest rates isn't going to help anybody . . . That you've got to assume that a lot of that surge in the treasury swings back out, and we're pretty well positioned competitively for all of those options.

Roger Smith - Fox-Pitt Kelton

Okay, so for the most part you're not seeing a lot of fee waivers. There's only some maybe normal stuff that's going on in the treasury side. Can I just go over then to the fixed income business again? I know there's been a lot of questions on it, but I think my belief was that investors would get the, or the performance at Western would rebound once the credit markets improved. And it's sort of surprising then if the message that's been out there with the investors. Why are they giving up now? Why would they, after hanging in there for so many quarters, give it away?

Mark Fetting

Well, that goes back to, a good part of this, is driven by rebalancing, and to the extent some are rebalancing away, it is the folks who have not been working with Western as long as most of their longstanding clients, and so that's really the top line. Obviously, there's special circumstances that go on here and there but that's the top line.

Roger Smith - Fox-Pitt Kelton

Okay, so then should I really be assuming that more of this is a rebalancing activity that you are seeing back into equities on the institutional side?

Mark Fetting

The rebalancing as I said and I think you've heard from other reports. The rebalancing has paused a bit.

Roger Smith - Fox-Pitt Kelton

Yes.

Mark Fetting

So we're going to need to see where it goes and there has been some rebalancing into fixed income. Some people have been going into some distress that and we have an offering on that and even some appetite for high yields.

Roger Smith - Fox-Pitt Kelton

Great, thanks a lot.

Mark Fetting

Welcome.

Operator

Ladies and gentlemen, this concludes the allotted time schedule for the Q&A session. I'd like to turn the conference back over to the panel.

Mark Fetting

Well, thank you very much. This has been a longer call, but we had quite a number of moving parts here. So I appreciate everyone and their time. As we look at things, you've got to work through things sequentially. From a market condition standpoint, you have to assume that the global recession remains severe and in '09 certainly, we'll continue to probably pick up speed. A key metric to watch is housing. Some reported recently potentially some leveling off there that would be very-very important.

From a policy standpoint, the global coordination of fiscal and monetary policy is a definite plus. And so then you get down to those of us in the asset management, and Legg Mason in particular. We at Legg Mason are very clear eyed about what we've got to focus on. We've got to improve our performance where appropriate, continue to reduce our exposure to issues like SIV. We've got to deliver cash earnings on an improving basis assuming there will be some market improvement eventually.

And then finally, we as a management team have spent more time this last quarter on the exciting opportunities of growing the business and we want to continue to report to you progress that we make against that. I want to thank everyone for their interest and support of Legg Mason and I look forward to talking to you next quarter.

Operator

Ladies and Gentlemen, thank you for participating in today's conference. This concludes the program. You may now disconnect. Everyone have a wonderful day.

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