Legg Mason, Inc. F4Q08 (Qtr. End 03/31/08) Earnings Call Transcript

May. 6.08 | About: Legg Mason (LM)

Legg Mason, Inc. (NYSE:LM)

Q4 FY08 Earnings Call

May 6, 2008, 10:00 AM ET

Executives

Timothy F. Munoz - Sr. VP, Head of Corporate Marketing and Communications

Mark R. Fetting - President and CEO

F. Barry Bilson - Sr. VP

Charles J. Daley, Jr. - Sr. VP, CFO and Treasurer

Analysts

William Katz - Buckingham Research

Prashant Bhatia - Citigroup

Robert Lee - Keefe, Bruyette & Woods

Michael Hecht - Banc of America Securities

Marc Irizarry - Goldman Sachs

Roger Smith - Fox-Pitt Kelton

Craig Siegenthaler - Credit Suisse

Christopher Spahr - Deutsche Bank Securities

Operator

Good day, ladies and gentlemen and thank you for standing by. Welcome to the Legg Mason Quarterly Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions]. As a reminder, today's conference is being recorded.

I will now turn the presentation over to your host, Mr. Tim Munoz, Senior Vice President at Legg Mason. Mr. Munoz you may begin.

Timothy F. Munoz - Senior Vice President, Head of Corporate Marketing and Communications

Thank you and good morning. On behalf of Legg Mason, I would like to welcome you all to our conference call to discuss operating results for the fiscal 2008 fourth quarter and fiscal year ended March 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 are subject to risks, uncertainties and other factors that may cause actual results to differ materially from those discussed in the statement. For a discussion of these risks and uncertainties, please see 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, 2007, as well as management's discussion and analysis of financial conditions and results of operations in the company's quarterly reports on Form 10-Q.

This morning's call will include remarks from the following speakers, Mr. Mark Fetting, President 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 to the following review of the company's quarter, we will then open the call up to questions and answers.

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

Mark R. Fetting - President and Chief Executive Officer

Thank you, Tim and thank you all for joining us today. As many of you may know from this morning's release, we are reporting difficult results in a difficult environment. In fact, this is Legg Mason's first quarterly loss since listing as a public company. As Chief Executive Officer and a shareholder, I can assure you, all of us at Legg Mason are disappointed in these results and determined to deliver improvements in the areas we influence.

For the first time in more than a year, however, I have to say we are gratified to see some daylight on the horizon. The various fed actions have effectively halted contingent in the markets, financials and other leading indicators have rallied since mid-March, credit spread most importantly in areas we have a significant interest in, have come in, creating an appetite and attraction for risk investors in the bond markets.

Indeed as Warren Buffett said at his recent annual meeting, the idea of financial panic that has been pretty much... has pretty much been taken care of. And even with the current headlines of this deal on or off, or this issue coming up, I think the fundamentals are encouraging. We are also gratified to see some recent indicators of performance improvement at some Legg Mason managers.

I am an avid hiker and a long-time mountain climber. While not in their league, I enjoy reading about the great guys pursuing our world's most challenging peaks. You learn that these experts emphasize the importance of completing the entire expedition, not just a summit. For success is measured by meeting your full objectives of a safe, healthy and satisfying climb.

It appears that in the credit crisis, we are at or near the summit with the worst of the elevation behind us. Yet we also believe the next phase of our expedition continue to be very demanding and not prone to quick fixes. With that context established, I would like to cover three topics in my remaining remarks.

Our financial results, our managerial and distribution updates and comments on our today announced capital raise. In terms of financial results, knowing that you more often... more likely do not have to call us, seen our release of this morning, I'll hit the highlights. The fiscal fourth quarter ending 3/31 ended with assets at $950 billion, a decline of about 5% against the prior quarter, which actually compares reasonably well with other managers when you consider that we have a heavier compensation [ph] of fixed than equity, given the turbulence of the markets.

Our operating revenues for the quarter were $1.1 billion, 6% below prior year and 10% below the prior quarter. Our GAAP earnings per share was a loss of a $1.81. Importantly this included non-cash charges of $2.06 for previously-announced liquidity support and an impairment charge of $0.66 against pre-existing management contracts acquired.

The adjusted earnings per share was $1.25, approximately 20% off prior year and prior quarter. For the fiscal year, our operating revenues totaled $4.6 billion which was 7% above the prior year and indeed is record revenues for the company. Our GAAP earnings per share is $1.86. This too was significantly affected by the non-cash charges for the full year of $2.18 per liquidity funds support and the same $0.66 impairment charge. Adjusted for these our adjusted cash earnings per share were $6.09, 4% above the prior year. Adjusted cash income totaled $877 million for the year, the highest ever and shows the true cash generating power of our franchise and our business model.

Let me now turn to manager update and some comments on our distribution activity. Performance for the quarter was truly below our expectations in some key managers and also quite good on others. In aggregate, the impact of performance and other issues led to and have a significant impact on our flow and hence we saw increased outflows for the quarter.

It should be mentioned that long-term mutual fund flows throughout the industry were down. Equity fund flows in the industry were negative and fixed income were modestly positive plus or minus in various categories. I have spent the quarter making it a point to meet with all of the managers and their investment teams; we had candid discussions of their focus on investment performance. I can assure you for those where there is an underperformance issue they are immensely aware of it and focus on improving these records. And for those who are enjoying long-term and short-term strong records, they are committed to continuing it.

Western Asset; assets there grew year-over-year and quarter-over-quarter. Western remains one of the largest and most respected fixed income managers in the world. As spreads have narrowed and risk appetite returns to sectors like corporate and mortgages, this bodes very well for Western. And in fact, we've seen an improvement in the month of April in their core and core plus areas that is quite meaningful and a very strong consistent and both short and long-term out performance in the muni area, where most recently Barron's Joe Deane and David Fare were featured.

At Legg Mason Capital Management, management is focused on performance with an emphasis on bolstering its research team and optimizing interaction with portfolio managers. Its valuation-driven philosophy and process remains intact and consistent with Bill Millers letter to Value Trust shareholders for the quarter, where he described the Bear Stearns events of mid-March is an inflexion point. Value Trust has shown some meaningful improvement against its benchmark.

ClearBridge Advisors; the operating leadership team of CIO Hersh Cohen and Chief Operating Officer, Terrence Murphy have done a great job leading the unit, and the investment teams have converged nicely through these markets to share ideas and perspective.

The appreciation front that is run by Hersh and Scott Glasser has had outstanding performance and meaningful improvements have occurred in fundamental value and also the capital fund.

Private Capital Management; Bruce Sherman and Greg Powers are focused laser-like on performing and improving our performance to their historic levels. Recent outlaws have made it difficult, given some of the small and mid-cap positions that they hold in the portfolio. While assets have declined, the current level does allow the team to more nimbly focus on areas of traditional strength; financials, tech et cetera.

Permal said in a recent client update performance has been quite normal in a very abnormal environment and this is a real testimony to the fact that they delivered relatively very strong performance at a very turbulent time in the hedge fund and fund to hedge fund business. In fact, assets have grown from both slow and reflecting positive performance; a testimony to their rigorous management... manager selection, a disciplined process of risk mitigation and diversification.

Quickly, at Batterymarch global emerging market equities in Asia, ex Japan have done very nicely. At Brandywine, its global fixed income team was awarded a major Japanese pension fund award. At Royce, five funds were awarded 2007 Lipper Award and Chuck Royce just yesterday sent me a note saying that all of its funds with ten-year records are five-star rarely achieved by any fund family.

Legg Mason International Equities; the Japanese equity team based in Singapore has registered top decile performance in the one, three and five-year periods. So, during April we have seen some encouraging improvements and some key products. While admittedly a short timeframe combined with a fundamental inflexion that may be occurring in the markets, we are hopeful about this trend.

Long-term performance remains strong. 85% of our long-term mutual fund assets are beating the Lipper category for the trailing ten-year period. We remain confident in our managers and realize that in order to outperform there will be periods of underperformance. All our active managers are focused and they are actively pursuing investments that do not hug the benchmark.

Let me quickly comment also on some distribution updates. Our U.S. distribution teams remain focused on gaining traction across multiple distribution channels in the increasingly open-architecture world they compete. They are focused on the national and regional broker-dealer channel, the independent intermediaries in our RI channel and the institutional fund in insurance channels.

Our International Business Group led by new hired Ron Dewhurst, is formulating the strategy to accelerate... of accelerated growth to a build-and-buy approach. We have been making good progress in the Asian markets where the combination of product performance and distribution traction is very encouraging.

Let me now shift if I can to the capital raised. We announced this morning, capital raise of the mandatory convert was approximately a $1 billion. We believe companies with strong cash balances and ready access to capital will best manage to these markets. Having recently raised capital, you may ask why more and why now. Let me be clear, we seek more not because we have to, but because we choose to, to proactively get through this market from a position of strength. Now is the time for an extra margin of safety that may or may not be deployed against some of our exposures, yet can always be deployed for other corporate purposes.

We looked at private and public offerings. That was clear that public provided more favorable terms to the permanent shareholders. More specific reasons to raise the capital will include the ability to provide additional support to the money front if needed, to fortify our balance sheet and enhance financial flexibility, to take advantage of receptive capital markets, and to pursue our ability to make acquisitions. We continue to focus in the international area, an area of significant opportunity and as we commented before, the international equity space in particular represents a gap at our business.

We do not have any immediate use at present, but we think it's prudent to position the balance sheet for possible, but unexpected deterioration of the credit markets if that happens, or if markets do not improve over the long-term. Relative to our considerably reduced SIB exposure, ample capital and cash availability also fosters smart distribution as opposed to the succumbing to fire sales strategies or approaches. This also allows for real-time action if needed without delay in the capital raised.

Another interesting observation is that it would enable us to support the NAVs at the money market space, should its attractiveness inflows reverse themselves and move back into long-term fixed income and equity investments. Not that we are predicting that, but here again the contingency is a prudent... gives us prudent optionality.

This capital raise that we did in January, you should know we partially used... we put about $400 million to work in March and we have a debt repayment scheduled for July 1 of $425 [ph] million. This is in addition to our existing cash. As shareholders ourselves, we acknowledge that the cost of this raise is modestly dilutive. We do believe however, this is the right short-term decision for better long-term results to enhance the shareholder value of Legg Mason.

With that I am now going to turn it to Barry, who will give us a financial review and then Barry will turn it to CJ, to focus specifically on the capital raise and our liquidity support. Barry?

F. Barry Bilson - Senior Vice President

Thanks Mark. Good morning everyone. I will give you the reductive [ph] on the points that I suspect are of concern or confusion relative to your models and expectation. Certainly I want to make sure we leave as much time as possible for Q&A, and we apologize coming out of the block that I clearly am not in the office. Mark are myself are on the East Coast, CJ Daley our CFO and Peter Bain, Senior Executive VP are on the West Coast on the Roche Circuit for the next two days.

I'll try and cycle back, if I can. But please be patient, it could be a first day before I can really clear the slate of back-up of calls. Let me try and zero in. Certainly everyone did a somewhat different approach to incorporating into their estimates, the impact for the prior announced hit, when the mark-to-markets or some of the SIV activity, some did not.

It appears to me trying to normalize going through that the consensus sitting up here of $0.26 loss, actually... yes if in fact, everyone adjusted the same with we take it up to $0.84. Certainly, we exceeded that. Couple of areas that I think are driving in; one is the impact of our mark-to-markets when the SIV activity is greater than the previously announced. We announced at the beginning of March was about 500 gross or $2.06. You are looking at a number of about 525.17 that is driving an impact of 206, $0.10 higher than expected that is the final marks at the end of the quarter, principally related to some of the paper that we actually purchased on to our balance sheet.

Other these are little math exercises; one is the share count for EPS calculation. When you turn a loss, you must revert to use your basic shares outstanding not dilutive. So that impacts up after you for dividing by a smaller number you get a larger end result. That is trimming off probably depending on what rate you were presuming on the tax front, probably close to $0.05 a share. The other dynamic of uniqueness or pokiness is the tax rate, the impact of permanent differences when you have a very small and in this case a loss GAAP number and the geography relative to some of the expenses that are recorded.

He is giving you a tax rate and since again, you are calculating off of a minus number, it's about 2.25, 2.5 percentage points different than what you would have expected and that's also driving off of about $0.06. So you have got $0.10 there, you have the additional SIB impact of $0.10 and certainly the item you had not previously seen was the impairment charge that we took for the quarter, that there was no prior communication because quite candidly, there is an analysis based on after the end of each quarter... we do at each quarter we do it each quarter, requirement is not as frequent to assess all the intangibles on your balance sheet. It was determined that the appropriate valuation of some separate account contracts that were acquired at this point at seven years ago were higher than appropriate.

Certainly I'd suspect most have concluded, it does relate to private capital management who have got so many hits and some performance challenges. Their business is larger than it was at the point of acquisition, but the accounting when you identify intangibles you must monitor the pre-existing contracts for their life. Based upon the historical turnovers, they were lifed at 18 years which was shorter than the historical but, certainly far longer than what, most in the business would have experienced.

Truing that up to the remaining estimated value resulted in this $151 million charge, which nets one through to about $0.60 to $0.66 per share. There are no other intangibles or the balance sheet. We'd certainly review them rigorously, that we have any foreseeable expectation of having any kind of a mark down on, again a non-cash charge but an erosion of a previously recorded asset level. And again probably the lighting was the biggest issue there, but hindsight it's always 20-20. That will result in an impact on the P&L going forward, of an easing in that intangible expenses of about $4 million a quarter.

Right, couple of other biggies relative to metrics; we are typically looking at realization rate very, very similar year-over-year and sequential quarter, 37 basis point ex-performance fees versus 37 spot, either there about last quarter. The distribution expense relative to fund revenues is right in line again at the 42, 42.5 level that it's been tracking for several quarters. Tax rate we talked about I'd envision that next quarter you would be back at a level of by around a level of 37.5 of the Cop and Benny [ph] image is the other one that you'll recall last quarter there was certainly some adjustment on incentive compensation that gave a little bit of a funny uptick. If you normalize that through, it's as reported at 42.8 but if you normalize through after recoveries for just standalone comp, it would be at about 48 spot 7.

The operating expenses, non-comp, non-distribution and non-write off on the intangible assets is pretty much in line with prior guidance at a $149 million versus $152 million last quarter, $147 million a year ago. So pretty much in line. The other dynamic clearly that is lower than I suspect we one would have was modeling through, is the performance fees. Lowest level probably you'd seen in several years that $3 million remember the backdrop is a number of managers with a number of products have some level performance fees, some is quite literally a fee that's just driven off with the performances as opposed to the home run kicker.

Historically, expectation was 40%, 50% of that is actually driven from Permal who on virtually all of their products had a very respectable to good trailing 12 basis, almost a universal better than benchmark performance. But if in fact you're beating your benchmark but you're not above your previous high order mark, your minus is smaller than the index minus, you're not going to drive all of our performances fee.

Don't forget the last quarter there was those calendar year measurement period. Performance fees of about $24 million expectation hope as market behaves as often we deliver the results that that would be there again, but not until the December quarter. As mentioned in the last quarter's call, and what these markets do will impact that number, certainly would hope that it would grow from this current quarter's number. But you're going to be obligate [ph] that a bit just relative to what the industries are doing. And you've rolled that map through and that are probably trimmed about $0.10 as well.

As I sort of look at the numbers of the one-off items versus the recurring items and your models and forecast, it appear to be about a $0.20 delta between the two which is roughly $0.10 on performances fees, $0.06 after the tax rate and $0.04 after the reversion to using basic shares, as opposed to diluted shares in the EPS calc for the quarter.

I am sure there are some specific questions beyond, there is some little pluses and minuses alike in the operating expenses, but net-net pretty much indicative. Communication technology certainly could see easing back a bit from this quarter, but other expenses moving up some. The geography on the mark-to-markets is again in that other non-operating income of $525 million embedded in that for the SIVs is about $570 million and the balance is the mark-to-markets or in seed investments and funded deferred compensation plans.

I hope, I have hit the high points for you. Certainly if not, you'll come back and sit in the Q&A point and at this juncture, let me turn it over to CJ, to update you on the offering in the liquidity space.

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

Thanks Barry. Good morning. As Mark and Barry mentioned, I'm going to review the structure of the capital raise we may intend to issue and also give you an update on our exposure to structured investment vehicles.

We will be issuing a mandatory convertible security, a mandatory convertible security consist of two parts. The first is a three year forward contract and the second is a 13 year debt instrument that is remarketed in to 2 to 10 year debt at the end of year three.

The mandatory is a cost efficient alternative to common stock. Legg Mason retains a stock appreciation percentage which is determined during marketing. In exchange for that, we will pay an enhance yield that is tax deductible over our common dividend yields.

Prior to year four, when the forward contract converts to equity, we will only book interest expense for the payment stream and a diluted share count will be impacted on a treasury basis only to the extent that it is in the money. When the security matures at the end of year three, all the underlying shares will be included in EPS. The purpose of the rating agencies they will subscribe 75% to 100% equity credit to their security because it mandatorily converts into common stock at the end of year three.

So in summary, we plan to issue three-year equity at a conversion premium that pays tax-deductible interest and enhanced yield and two to ten-year term debt at the end of year three that we intend to use to retire existing debt on our balance sheet.

Next on to SIVs; as you know, we have taken deliberate and measured steps to support our money fundedness. As difficult as it is, we had addressed our issues on a facts and circumstances basis, which we believe strikes the right balance between our shareholders interest and those interest of our fund shareholders. Ultimately, we recognize that fundamentally both interests are aligned in the long-term.

Since October 31, 2007, our actions have reduced the SIV holdings in our money fund business from 6% to 2%. At October 31, we reported 6.0% exposure to SIVs on our liquidity AUMs of $167 billion. As of March 28th, at our last reported SIV exposure we had 2.0% exposure on liquidity assets under management of a $176 billion. Of that 2%, approximately a quarter of that is in bank-sponsored SIV.

Our support to the money fund business has taken the form of primarily three types, the objective of which is to support the fund while keeping the security off of our balance sheet. The firms to support are one letters of credit, which basically provides support to the value of security while it remains in the fund.

Second is total return swaps which removes securities from the fund, but on to another counterparty's balance sheet and where necessary, we have purchased some securities. This support ultimately exposes our P&L to the market values of the securities supported. During the quarter we put in place support of $550 million which in conjunction with the support placed in the December quarter, resulted in non-cash charges of... on a net income basis, $291 million or $2.06 per share. Non-cash net charges for the fiscal year totaled $314 million or $2.18 per-share.

We think about our exposure and how it relates to our cash needs by assessing the needed liquidity to support the arrangements in place today plus remaining exposure to SIV and our money funds. The total exposure therefore is approximately based on the numbers I indicated earlier; $4.5 billion. After reducing that $4.5 billion to account for the fact that several banks have spot... have announced support for their SIV and taking them on to their balance sheet, we have approximately $2.9 billion of exposure.

With the capital rates initiated today, Legg Mason will have enough cash to support approximately 93% of our gross exposure to non-bank sponsored SIVs. In closing, we are taking measured and deliberate steps to reduce our exposure to SIV taking great care to only remove securities from the fund onto our balance sheet when absolutely necessary. Our actions to date have been effective in supporting the fund and limiting our shareholders exposure. We remain committed to be thoughtful, deliberate and prudent in utilizing shareholder capital.

With that operator, I'll turn the call over to Q&A.

Question And Answer

Operator

Thank you sir. [Operator Instructions]. Our first question or comment comes from the line of William Katz with Buckingham Research. Your line is open.

William Katz - Buckingham Research

Yes, thank you very much. Markus I guess the question is you let off the conversation by saying that the business has turned better in through since March 31st and sounds like the same credit spread analysis you are looking at and when it was improved but just sort of two basic questions, if that's occurring, why the capital raise at all? I just... I don't see the optionality of it doing it now. And then secondly, are there businesses here that might be saleable that you could actually sell rather than continue to look down the FVRs [ph], that's my first question.

Mark R. Fetting - President and Chief Executive Officer

Thanks Bill. I think those are two separate issues. And going to your first question, in terms of the kind of potential and early indication of some performance improvements, I think that as you know is the leading indicator as I have always said is the starting engine and to the extent in some areas where there is some improvement, and it is sustained, and it's too early to say that for sure but if it is, then metrics might close, et cetera, should follow, that will take some time. The capital raise is really targeted to a series of issues that to me are separate. First and foremost is... as CJ has detail, the reduced exposure that we have but still there and in this kind of an environment it is because we've done so many, we believe, successful approaches to supporting the money funds on an efficient basis, it's clear to us that as things improve, fundamentally there year wise they have capital to kind of work through it for the remaining piece over a reasonable period of time. As to exactly when and if we have to do it remains to be seen.

So for those who would say why raise this capital, it's really because we do have that remaining exposure and ample capital from a kind of extra margin of safety should facilitate our further reduction of it. If we do not use it, which is certainly a possibility, we have other means, other opportunities in terms of our core building wise strategy to deploy it in both acquisitions and also supporting the growth of our existing managers. We think our businesses are all performing well and like our business model.

William Katz - Buckingham Research

Okay. Next question I have is just the equity attrition just continues to accelerate, not withstanding a bad backdrop and you have some pretty high profile managers that just continue to under-perform not withstanding a little bit of a recovery. And what steps can you take to help learn some of the attrition and then maybe within the attrition, is there any lumpy account losses or is it just really across the border?

Mark R. Fetting - President and Chief Executive Officer

Well I think on the equity front as we've talked, there's the kind of principal managers underlying that would be capital management, PCM and ClearBridge, and if I tried to convey having met with all of the teams there I think they are doing all that should and needs to be done and in some cases you've seen improvement. ClearBridge being an excellent example in terms of the improved performances, depreciation, et cetera, and you do see some impact, still outflows for sure but some impact. Capital management is interesting because I think it's build... has extended the team and expanded the product offering. They are while still very focused on improving the situation, both in performance and flows in their core products; they are pursuing some other opportunities as an example. Bill just got awarded a Financial Services mandate from a sovereign wealth government and fund. And that's an indication of some opportunity that they would want to pursue. So no one is at all doing anything other than just focused on turning where it needs to be turned and continuing to grow the business. And I think that is the best strategy. I would... coupled out with also a very strong emphasis on client service and staying close and that's what gives us confidence that these managers do have what it takes to deliver long-term results, they do have periods in all of their histories of having extended out performance and have turned it and we think that should happen here as well.

William Katz - Buckingham Research

Okay. Thank you.

Operator

Thank you sir. Our next question or comment is from the line of Prashant Bhatia with Citigroup. Your line is open.

Prashant Bhatia - Citigroup

Hi, just on the [technical difficulty] split that you are doing with Western, you've limited a little here, is it fair to think about the amount the Western owes the Legg Mason shareholder to be roughly in the $200 million range? And if that's accurate over what time period do you think that will be recovered?

Mark R. Fetting - President and Chief Executive Officer

I don't think obviously we can be that specific that we've indicated that we worked with Western on this and I am not aware that we have given any details on that. Barry?

F. Barry Bilson - Senior Vice President

Yes there, Prashant certainly the agreement is in facts and circumstances market environment, the retention, et cetera, will come to play. But you will recall back I guess last quarter indicated there was an agreement of recovery over the next fiscal year, the more recent 8-K indicated years because candidly it would be inappropriate to cut their nose off and display their face, i.e., squeeze everything out immediately. There's certainly every expectation at this point that there would be recovery and from a standpoint of your modeling, I believe, we indicated in the last quarter's call that you could be looking at something in order of magnitude of about $20 million a quarter. But again that's subject to some variability, but that's, I think, what you are looking for.

Prashant Bhatia - Citigroup

Okay, that's helpful. And then second, any update on the leadership back at ClearBridge and I guess what are you looking for in terms of replacing someone in the timeframe there?

Mark R. Fetting - President and Chief Executive Officer

We have an active search underway, it's made good progress meeting with both internal and external candidates and I think we are on track. In the meantime as I mentioned I am very appreciative of the progress the teams have made and confident that we will have that result in a reasonable timeframe.

Prashant Bhatia - Citigroup

Okay, thank you.

Operator

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

Robert Lee - Keefe, Bruyette & Woods

Thank you, good morning. A quick question on effect of flows. It looks like... could we get a little bit more color on institutional flows, I mean it look like that was anything that's where the real kind of acceleration and outflows was in the institutional business. Should... I am assuming lot of that was Western, but can you give maybe just a little bit more feel if you know how much of that was maybe coming from Legg Mason capital management? And any comments you may have on kind of the pipeline on business activity, RFP activity, would be helpful?

Mark R. Fetting - President and Chief Executive Officer

You are correct to kind of point out the pick up on the institutional side and it does as you get to know our managers and the composition of institutional versus retail or what I call kind of individual businesses they have. The more one becomes more vulnerable for some short-time pressure, it could impact flows. So the short answer is yes, if there's probably been some pickup as you would expect with Western in that number, but other equity managers are part of it. It has been our experience that retaining out that with institutional clients across our managers has been better because of the relationships we have, the understanding they have around the philosophy process that we have and generally being alpha managers.

As the performance... underperformance extends, it does become a little more problematic, and that's kind of a general overview. As you know, we don't break that out individually. Relative to pipeline, here again I think for our leading institutional managers such as Western, you would expect that with the performance issues, there would be some impact, and that's certainly been the case. Having said that they continue to be active in the markets, winning mandates and it's too soon to predict, I think, how quickly that can kind of turn back up to their normal level that they've been making good progress when you consider the... both the market challenges, and some of their individual issues.

Robert Lee - Keefe, Bruyette & Woods

Okay, thanks. And a question for Barry. Could you kind of repeat your comments around the more of a muni [ph] question around it. How should we think of kind of a normalized kind of a comp level and also in terms of down the road, we assume there's some recovery from Western, would that manifest itself in the context of lower comp expense since there's a little bit of fundability in the revenue share there?

Mark R. Fetting - President and Chief Executive Officer

Yes the first part Rob, where I would begin from standpoint of a modeling is at a 49% type level, and actually it could be plus or minus a tiny bit but that's a fairly consistent level that it's been running in guesses as you know with the revenue shares. There is a dramatic fundability along the lines. But back to sort of the point of query that Prashant hit previously rose, that benchmark comp ratio is your starting point and assuming there is not a dramatic meaningful tremendous additional mark on the SIV holdings or support and again we'll see how that plays through, then you could see and should expect to see some easy old narrative [ph] in order magnitude of about $20 million a quarter. If you rolled up that math through, that's going to give you a couple of percentage points against net revenue, i.e., the total revenue less the distribution expense. Probably you should mention since I overlooked it before just because I know there's a bit of noise around this whole SIV front and what markets are doing, absolutely markets have improved.

But they are a bit sploggy [ph], it is not universal, one day their subprime improves, next day it deteriorates, one day all they improves, next day it deteriorates. One day monitor line [ph] wrap paper improves; the next day it deteriorates. But on balance if... we... just at the end of the quarter or we reported a marking at the end of April, there would be for the month of April from current evaluation methods, we think are prudent and inappropriate and may be some would argue conservative, I think prudent and appropriate, an additional $30 million as of the end of April which was a good credit month relative to the past several. So we are not out of the woods but cautiously optimistic it's leveling also.

Robert Lee - Keefe, Bruyette & Woods

Okay, thank you.

Mark R. Fetting - President and Chief Executive Officer

Yes, thank you.

Operator

Thank you. Our next question or comment is from the line of Michael Hecht with Banc of America Securities, your line is open.

Michael Hecht - Banc of America Securities

Hey guys, good morning.

Mark R. Fetting - President and Chief Executive Officer

Good morning.

Michael Hecht - Banc of America Securities

Can we come back to the equity outflows of $17 billion, can we just get a little bit more attribution, I understand you guys don't want to give specific numbers but just looking for any concentrations across the different managers, Legg Mason Capital Management, ClearBridge versus Private Capital and it's really kind of across the board, I mean in other words you are seeing softer trends in Royce and Batterymarch and Brandywine and then as part of that I am also trying to get a sense of where the assets for some of the managers particularly like ClearBridge and Private Capital entered the quarter?

Mark R. Fetting - President and Chief Executive Officer

Well Mike, I think we don't give that specific detail on the manager assets but relative to the out-flows, I was trying to be helpful in terms of acknowledging that the three principal contributors would be who you would expect, which would be Capital Management, ClearBridge and PCM.

In Capital Management, there is... you can get more visibility through your own sources on the fund side and then on the institutional side but those have been contributing. On Clear Bride, you have visibility on the fund side and then the retailers [ph] side less so, there have... both are in outflows but the... there's been some improvement in the rate of outflow relative to the fund side at ClearBridge in light of some of those performance improvements. And then PCM I think we have been keeping you current, so that's about it, best I can do and hope it helps.

Michael Hecht - Banc of America Securities

Well, any... just any color on the change that you have seen at some of the other managers that might... we might have expected to act as offsets like Royce and Batterymarch and Brandywine, I mean, just kind of seeing the same softness we are seeing across the industry?

Mark R. Fetting - President and Chief Executive Officer

I think that's the Mark Twain... my demise [ph] was exaggerated or whatever the quote is. I mean Chuck has long said that the small cap surge would give way to large cap and sometimes I think you see that happening and sometimes it returns. So kind of there have been periods of actually decent inflows at Royce, yet the rate of growth hasn't been quite the same but it's difficult to kind of predict that one as concluded yet. But all... if you look at Brandywine, you look at Batterymarch, you look at Royce, very solid situation, a good performance and decent growth.

Michael Hecht - Banc of America Securities

Okay. And then just the second question, the... any color on outlook for acquisition whether you guys continue to look for international equity manager, what the pricing environment looks like and whether this capital raise suggests you are closer to something than not?

Mark R. Fetting - President and Chief Executive Officer

Yes, as I said we don't have anything imminent and no immediate use. We do remain active in looking in a very targeted and kind of wanting to as we spoke in more publicly in kind of our general goal here than we have on any other situation, it would be helpful to get further resolution on the SIV stuff and this raise helps us have that optionality because there is a combination of events that could allow us to move much more quickly, and we would be poised to do so.

Michael Hecht - Banc of America Securities

Okay, thanks.

Operator

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

Marc Irizarry - Goldman Sachs

Great, thank you. Just a question on your balance sheet SIV exposure, can you give us to date or as of the quarter what your balance sheet exposure is?

Mark R. Fetting - President and Chief Executive Officer

CJ, why don't you handle that?

F. Barry Bilson - Senior Vice President

Yes, on the balance sheet we have about 150 million of securities and then we have exposure to... through a total return swap of about 890 million.

Marc Irizarry - Goldman Sachs

Great, and then if you could just, I think Barry mentioned there was a 500, there's obviously a $525 million in other loss if you will, and then Barry, did you say that the SIV portion of that, the support, was $517 million?

F. Barry Bilson - Senior Vice President

That's correct Marc.

Mark R. Fetting - President and Chief Executive Officer

And you are saying what type's the rest of it?

Marc Irizarry - Goldman Sachs

Yes, not only that, but also if you just look at the level of your investments, it seems like the... was there anything in that line item that was marked up or maybe if you can give us little more color what the balance sheet investments are there?

Mark R. Fetting - President and Chief Executive Officer

All right and let me make sure I am understanding the question. If you look at the P&L, you are seeing other non-operating income of a negative 525. You are trying to get a sense on that. But also sounds like you have a question beyond that.

Marc Irizarry - Goldman Sachs

The question is if you net out the impact from the support of the SIVs --

Mark R. Fetting - President and Chief Executive Officer

Right.

Marc Irizarry - Goldman Sachs

Seems like the other income, the decline and... or loss there was pretty moderate, relative to the overall asset loss. So I am just curious if there are any investments that were marked-up or if the, what the investments are that generated that $8 million or so cost?

F. Barry Bilson - Senior Vice President

Yes, and I think you've seen this sort of across the board and I guess part of what you are saying Mark is the sort of mark-to-market investments sort of like [ph] didn't look as bad as some others and I think that's probably true. But that is a composite of two major pieces. One is the... are these funded deferred compensation plans that we have. Certainly Western Asset being one of their larger or the largest subsidiary with a vintage plan got substantial assets as to our number of the other managers, would they balance between spread cash bonds and equities. The impact this quarter was not as great as it was last quarter. Additionally we have seed moneys in a number of different products and I have got the number here if you really need it but I am thinking it nearly 150 million or something, but you're talking literally dozens of different products that we have seed money in. They have been... that faired up fairly well.

Obviously there's also a miscellaneous other pieces of other non-operating but you are talking 100s of millions not... I am sorry; there are hundreds of thousands, not millions. So it's roughly a 50-50 split between these funded for comp plans and seed investments. They run the gamut between the fund the funds investments, fixed income investments, equity investments.

Marc Irizarry - Goldman Sachs

Okay, great. Thanks. And then Mark a question for you. Can you give a little bit of color around maybe the gross sales trends in the quarter and how they have been tracking so far in April versus the redemption rates for equities?

Mark R. Fetting - President and Chief Executive Officer

Yes, I mean that... this would obviously be general but it's a good question, we have seen in areas where there's been sustained underperformance, a sales falloff more of an issue than a redemption ratio pick-up. And so the outflow is more a function of that sale... that lost opportunity on the sales and necessarily a surge in redemption. We've seen the flip side and in fact keep urging that distribution focus to delivery has been more. But if you take a thing like community product where Joe Deane and his team are delivering really strong performance, we see a pick up in gross sales and a good traction in channels. I think that goes back to this where our model will really prove itself is when we have this combination of performance and distribution traction kind of aligning the expertise of the manager and Legg Mason to really deliver market share gains and that's kind of an overview Marc.

Marc Irizarry - Goldman Sachs

That's helpful. And then just one more, you mentioned this sovereign wealth financial specialty mandate that Bill won [ph], when is that funding?

Mark R. Fetting - President and Chief Executive Officer

I don't really know; I suspect it hasn't funded yet but that's just as far as I can take that one.

Marc Irizarry - Goldman Sachs

Great, thank you.

Operator

Thank you. [Operator Instructions]. Our next question or comment comes from the line of Roger Smith with Fox-Pitt Kelton. Your line is open.

Roger Smith - Fox-Pitt Kelton

Great, thanks a lot, I just want to go over the impairment charge here in the quarter and I just want to make sure I understand it. You said there's $5 million that's going to impact the cash earnings number on a quarterly basis that that's the number that we should be thinking about?

Mark R. Fetting - President and Chief Executive Officer

Yes well that was Raj [ph] as a result of this $151 million mark down. The quarter-to-quarter impact or our quarter-to-quarter expense will then reduce by up to $4-$5 million.

Roger Smith - Fox-Pitt Kelton

Okay. And then based... does that charge determine based on where we were at the end of December 31st or I am sorry at the end of March 31st or is there some kind for further impairment that can potentially happen with further outflows here and how should we sort think about the markets and flows in relation to the future cash charge impacts?

Mark R. Fetting - President and Chief Executive Officer

I remember cap [ph], you keep drilling into the word cash in the midst up here are you meaning adjustments against the cash earnings?

Roger Smith - Fox-Pitt Kelton

Yes that's right. The adjustments...

Mark R. Fetting - President and Chief Executive Officer

All right that's good enough I'm with you Raj, I just want to make sure we weren't mixed in apples and oranges in the midst that all the intangible amortization whether it's just the normalcies or any kind of an acceleration or an adjustment against the balance sheet is still a non-cash. We do evaluate all the intangibles for quarter. Certainly there is always the possibility if you end up with a dramatic erosion disproportionate to the market that is other contemporary. But my comment earlier was there is no current foreseeable or expected adjustment against any of the other intangibles as of their evaluation at the end of March that the analytics of substantiation of the balances is on across the board is very, very solid. So, could there be a charge? Always. Is there... but there is no current expectation and certainly the magnitude of this really is much more related to a bad estimation of an expected lifing despite the fact that I didn't the historic of the point of acquisition was about a 2% or 3% per annum turned over so we're shorten from there but obviously inappropriately set too long a life. Does that help?

Roger Smith - Fox-Pitt Kelton

Yes, no it does. And then just quickly on the capital raise. I know that we don't know what the premium conversion price would but if ...could we put maybe a hypothetical around so I understand what the dilution in the near-term would be. So if I just said let's say the premium was an $80 conversion price, do I count shares in here in ensuing three year period?

Mark R. Fetting - President and Chief Executive Officer

CJ you want to answer that.

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

Sure yeah, for the first three years, shares are only included in diluted EPS to the extent that we're in the money. So it's on a treasury stock basis. So the only dilution would be the impact of the interest spread.

Roger Smith - Fox-Pitt Kelton

Okay, thanks very much.

Operator

Thank you. Our next question or comment is from the line of Douglas Sipkin with Wachovia. Your line is open.

Mark R. Fetting - President and Chief Executive Officer

Douglas?

Operator

Looks like he has removed himself from the queue. Our next question or comment comes from the line of Craig please excuse me mispronunciation Siegenthaler with Credit Suisse. Your line is open.

Craig Siegenthaler - Credit Suisse

You almost got it its Craig Siegenthaler from Credit Suisse, Good morning

Mark R. Fetting - President and Chief Executive Officer

Good morning Craig.

Craig Siegenthaler - Credit Suisse

As we watch the March you know a lot of it is stressed in high grade assets in related fixed income markets improved in the June quarter. Could we see a potentially positive adjustment in your other income line item which would be your June quarter. So could that go from very negative, because we saw some non-cash impairment charges to possibly positive as the markets may be improving from these assets.

Mark R. Fetting - President and Chief Executive Officer

I'll let CJ or Barry speak to exactly where it lines up in albeit that's clearly our expectation and why we are providing and building this optionality is that we want to be smart investors in working through these final stages of SIV reduction. And if we can do that in the right timeframe and in the right way, there is that opportunity. In the meantime, the marks themselves will be a function of the fair valuation process that are a function of the actual prices that are out there. Well, Barry noted that the April chart would be something in the neighborhood of $30 million, but that's way off what it was obviously in March. I mean significant improvement. And so you could see the possibility of these of these fundamentals continue to improve that it moves positive, but CJ or Barry, you want to hit the... where it hits.

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

Yes Craig the geography is just what you said. All the impact of the marks, whether they are marked downs or mark ups and certainly, we hope we will see those and the time will tell, would be in that line item other non-operating income, which I think was your question right?

Craig Siegenthaler - Credit Suisse

Yes.

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

Yes.

Craig Siegenthaler - Credit Suisse

And then on the Barclays torrid tran swap [ph], I think that's roughly 890 million of notional. I believe in a all day KOs [ph] as to run off in March and it looks like you still have notional of 890 prior comments, I think a few question facts. I am wondering that 50% that did not roll off, is that now in default or is there some other issue with that? I believe that's asset backed commercial paper that may not be assessed.

Mark R. Fetting - President and Chief Executive Officer

CJ, you want to do that?

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

Yes that paper related to... it was a bank sponsored, there was a bank sponsor that had initially indicated their support for it and then took away the support. So it is... I don't know if it's in technical default, but it certainly is non-performing.

Craig Siegenthaler - Credit Suisse

That must be a Whistle Jack. Is that all Whistle Jack or is that a mix of some other stuff?

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

It was half, half of the $890 was Whistle Jack and the other half was safe sponsored by Dresdner.

Craig Siegenthaler - Credit Suisse

Got it. Okay, yeah thank you very much for taking my questions.

Operator

Thank you, sir. Our next question or comment is from the line of Chris Spahr with Deutsche Bank. Your line is open.

Christopher Spahr - Deutsche Bank Securities

Good morning. It looks like your international or say your non-U.S client AUM held up a little bit better than U.S. client AUM. Is that... did you have some positive flows within Wamco [ph] during the quarter from the non-U.S. clients?

Mark R. Fetting - President and Chief Executive Officer

Well if you expand our entire international operations the answer is definitely yes. It moves kind of territory to territory as I mentioned in the kind of Asian markets we've had some particular good traction both on the institutional side with some managers as well as through some of our offshore fund. We have mentioned the examples like the Brandywine. And there is also an element of liquidity business that has kind of international clients in it. So in aggregate that is obviously an important thing for us and we are encouraged and with Ron Dewhurste coming on board alongside the good work our managers are doing in their institutional businesses and in some cases we are collaborating such as China we are really looking quite strategically on a number of fronts with a greater collaboration between manager and Legg Mason to go after that in a strategic way.

Christopher Spahr - Deutsche Bank Securities

And Barry can you just work the math a little bit better for me on the performance fees, are us just looking at a like link... I understand a link quarter decline from seasonality perspective. But year-on-year versus water marks and how we should think about the per mall [ph]or performance fees going forward?

F. Barry Bilson - Senior Vice President

Yesand Chris this as you would guess is the most difficult number to pick; one, you've obviously got the market dynamic to deal with and then two, you have the underlying managers performance to factor in as well. You will tend to see a greater persistency, lack of volatility and relatively modest portion of our revenue driven in performance fees. With that said, I still haven't answered your question. You will recall and I made the comment earlier that you have those December measurement periods but they run the gamut between both equity and fixed income products, both domestic currency and global currency, so it gets tough to bench here... I cannot give you a singular benchmark to utilize against additionally even if you did you would see there are underlying performance.

I think if we are in normal markets where we are talking about the 8% kind our equity markets, 4% kind of bond markets, a number of across the board... its not just the primary [ph] issue, keep in mind I made the reference based on 40%-50%, that there mean... therefore means there is another 50%-60% that's driven by other managers on both the equity and the bond side that we literally are talking probably 2-3 dozen products across 8 or 10 different mangers. But your benchmark staring point I think in prior calls, right, wrong or indifferent I told you they a decent staring point would be 25- 30 million a quarter. Certainly this quarter was nowhere near that magnitude. But I think if you want to be conservative the owner save that 20-25 range and then if you have one balance a more favorable than one market you can migrate that in North, 20% if you've got an unfavorable you discount at that and if you have a very choppy unfavorable market even more so keep the mind most of the products, most of the managers with this performance fees are dealing with high water marks. So if you end up going backwards you've got some free ground on the positive to make up before you start moving in the positive space again.

Christopher Spahr - Deutsche Bank Securities

And would the first quarter be one of those quarters where you kind of took a step back so you have those the hurdles that you are referring to?

F. Barry Bilson - Senior Vice President

Yes and again they would be individual product manager be a specific. But yes there certainly are pieces they are underwater so I would discount offer that 20 25 level by looking at June at this juncture.

Christopher Spahr - Deutsche Bank Securities

Thank you

Mark R. Fetting - President and Chief Executive Officer

Yes.

Operator

Thank you. Our final question for today is a follow up from the line of William Katz. Your line is open once again sir.

William Katz - Buckingham Research

Okay, great thank you. Just try to come back to equity raise for a second. So I presume the write off so far or a write-down excuse me has been in the ballpark of 20% to 25% of the assets. So if you're sitting at 93% coverage it would imply that if you really wrote-down 25% that you would be able to have north of a billion dollars of capital that you would not have to use at the end of the day. I'm just very curious if you were to get to that case what... how should we think about the repatriation of that capital?

Mark R. Fetting - President and Chief Executive Officer

Well.

William Katz - Buckingham Research

If my method is right, I am doing this obviously.

Mark R. Fetting - President and Chief Executive Officer

Obviously everybody is going to work the numbers a little differently. But directionally that's a reasonable approach and the... what we have tried to do is you can see is methodically work the number down to its lowest level and then work off of that haircut to ultimate disposition that time is certainly tends to be kind of a 6 to 12 month timeframe and we got the benefit of time and the ample capital. As we've worked through it there are various approaches that we could take that would prevent it from having to come on to our balance sheet but would get the disposition and those things were working quite creatively with various parties. But it's too soon to say exactly how, when and what the ultimate resolution is but directionally that's right though.

William Katz - Buckingham Research

Okay and then CJ real quickly you said after you had three do you improve the entire share count or there would be a treasury stock offset as well?

Charles J. Daley, Jr. - Senior Vice President, Chief Financial Officer and Treasurer

After year of three it all mandatorily converts in to equity. So you would include all of the shares.

William Katz - Buckingham Research

Okay, thank you.

Operator

Thank you. I'd like to turn the conference back over to you for your closing remarks.

Mark R. Fetting - President and Chief Executive Officer

Thank you and thank you all for your questions and your interest in Legg Mason. I'd like to summarize with our commitments from the Legg Mason management team we commit to a rigorous review of our business model to improve effectiveness and efficiency across the board. You should know that we are looking as we should in these times that are discretionary expenses. We have done things like we have been able to sublease some space where we had excess capacity. We kind of pruned compensation where it makes sense without really altering our ability to provide good rewards for our colleagues. We also as a management team commit to continue proactive solutions to our challenges and to also accelerate pursuit of our growth opportunities.

From our managers I hope it's clear to you that from the time that I spend with them and the updates that I provided and your own following of their work that there is a clear focus on improving performance without the issuance, sustaining good performance was being delivered both from an investing standpoint and a client service standpoint. From the Legg Mason partners that we work with I just want to thank them. I want to thank the capital markets team that's helping us with the raise. Citi, Merrill, Goldman and JP Morgan as their book runners. I particularly want to thank KKR who has been a very valued and supportive partner since coming on board and has been terrific. And I would like to thank our distribution partners that we're increasingly working with on multiple fronts as we expand our opportunities in this open market architecture world not just in the U.S. but globally and that cuts across managers doing interesting things with various distribution parties.

To our clients, we are solely focused as an asset manager on delivering consistently strong performance that is our mission. To my colleagues at Legg Mason, I thank you all for the hard work that you've been delivering, these are not easy times and you've been superb. Finally to our shareholders, let me conclude with a summary, we are disappointed in this results. We are determined to deliver improvements. We are encouraged by the market some of the fundamental improvements that we've seen we're not out of the woods yet by any stretch and we're gratified to see some performance upticks in some key areas of our managers. We remain in our long term success knowing it will take some time in these markets and against our specific challengers.

And with that, I want to thank you all on behalf of Legg Mason for the call today. Thank you.

Operator

Ladies and gentlemen, this does conclude the conference for today. We again thank you for your participation. You may all disconnect at this time. Good day.

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