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Franklin Resources, Inc. -- Moody's affirms Franklin Resources' ratings, upgrades Legg Mason following acquisition

·16 min read

Rating Action: Moody's affirms Franklin Resources' ratings, upgrades Legg Mason following acquisition

Global Credit Research - 03 Aug 2020

New York, August 03, 2020 -- Moody's Investors Service, ("Moody's") has affirmed Franklin Resources, Inc.'s ("Franklin", NYSE: BEN) A2 senior unsecured debt rating following the conclusion of its acquisition of Legg Mason. Concurrently, Moody's upgraded Legg Mason's senior unsecured and junior subordinate debt ratings one-notch to A3 and Baa1, respectively. This concludes the review of Legg Mason's debt ratings which was initiated on 19 February 2020, when the transaction was announced. Legg Mason's legacy debts will remain outstanding as obligations of the merger subsidiary but will not be guaranteed by its new owner, Franklin. Acquisition consideration included approximately $4.5 billion of cash and the assumption of $2.0 billion of Legg Mason's senior and junior subordinated notes.

The following rating actions were taken:

Franklin Resources Inc.

-- Senior Unsecured (Domestic) rating affirmed at A2

The outlook is stable.

Legg Mason, Inc.

-- Senior Unsecured (Domestic) rating upgraded to A3 from Baa1

-- Junior Subordinate (Domestic) rating upgraded to Baa1 from Baa2

The outlook was changed to stable from ratings under review .

RATINGS RATIONALE

For Franklin, the acquisition of Legg Mason will diversify its revenue sources and enhance its scale, while supplementing its distribution organization with distinctive strengths. However, it also poses significant integration challenges, and leaves in place investment performance challenges that have eroded Franklin's competitiveness on a standalone basis.

Franklin continues to experience severe net outflows of assets under management (AUM) and declining revenue. Legg Mason's revenue trend also has been weak, with organic growth of AUM at some of its affiliates offsetting losses among others. While the combined capabilities of the two firms are substantial, establishing the right mix of products and personnel to reignite distribution will take time. To that end, Franklin has announced new leadership in its global distribution organization, which draws upon senior figures from both companies.

For Legg Mason, whose leverage remains high following a series of acquisitions in recent years, the financial resources of Franklin will improve its financial profile and help support its affiliates' product development efforts with seed capital investments. Certain expense synergies and the anticipated refinancing of Legg Mason's junior subordinated notes once they become callable next year will lift its financial profile.

The combined firms, with $1.4 trillion of AUM and $8.3 billion of revenue in the trailing twelve months, will be a competitive force. Certain strengths that Legg Mason brings to Franklin, notably its success in building a separate managed account platform and otherwise diversifying its commingled product set away from traditional mutual funds, as well as its institutional sales capabilities, may help Franklin reach new sources of demand. Both firms have significant global footprints, with overlapping presences in 18 countries. The augmentation of its share in these markets should improve Franklin's ability to increase its penetration. But, Legg Mason adds significant complexity to the organization in terms of the number of brands and marketing initiatives that will need to be worked into a coherent whole, globally.

In its outlooks for the asset management sector, Moody's has noted that all asset managers face a rising risk from economic uncertainty stemming from the coronavirus pandemic, which has caused an extraordinary confluence of economic weakness and elevated market valuations, low interest rates and weakening global credit quality. All of these factors could contribute volatility to the firm's financial performance.

A key credit strength of the combined firm will be its cash generation, of approximately $1.5 billion per year, supported by $270 million of net deal synergies and $500 million of tax assets that will be significantly monetized over the next few years. At 30 June 2020, Franklin and Legg Mason had combined balance sheet liquidity of approximately $8.4 billion of cash and investments in liquid assets before operational, regulatory and fund requirements, to fund the $4.5 billion cash consideration at close.

Giving effect to the proposed transaction, Franklin will have a consolidated, adjusted financial leverage ratio of 1.6x EBITDA, approximately one half a turn higher than its pre-deal level, based on Moody's adjustments and assumptions, which include the transition tax liability on non-US earnings as well as operating lease liabilities. The assumed debt and use of cash to close the transaction will put modest downward pressure on the group's financial flexibility in the near term.

In forming our view of Franklin's financial flexibility, we have considered that Franklin's creditors are structurally subordinated to claims on the Legg Mason subsidiary's cash flows. However, this circumstance does not weigh on Franklin's rating outcome. The one-notch upgrade to Legg Mason's ratings reflects the implied support the subsidiary will receive from Franklin. However, their senior ratings are not aligned because Franklin has decided not to formally guarantee Legg Mason's debts.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

Moody's said factors that could cause upward pressure on Franklin's ratings include: 1) scale exceeding $9 billion, 2) improved AUM sales and positive organic growth, 3) market penetration of new products and new channels, and 4) reduction of leverage, as calculated by Moody's, to 1.0x. The following factors could result in a ratings downgrade: 1) scale remaining below $3.5 billion, 2) weak investment performance, or negative organic growth despite improved performance, 3) persistently weak or negative trend of revenues and margins, and 4) leverage rising to 2.0x.

Moody's said factors that could cause upward pressure on Legg Mason's ratings include: 1) an upgrade of Franklin Resources' rating. 2) a significant improvement in Legg Mason's financial profile, including reduced leverage or improved margins, or 3) the agreement by Franklin to provide a guarantee of its debt. The following factors could result in a ratings downgrade: 1) a downgrade of Franklin Resources' rating, 2) a deterioration of Legg Mason's financial profile, including rising leverage and weaker margins.

Headquartered in San Mateo, California, Franklin Resources, Inc. is a holding company that, along with its various subsidiaries, operates as the global investment organization Franklin Templeton Investments, providing diversified investment management services to retail, institutional and high-net-worth clients. Franklin offers its sponsored investment products and services globally, with offices in more than 30 countries.

The principal methodology used in these ratings was Asset Managers Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1186105. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of these methodologies.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Neal M. Epstein, CFA VP - Senior Credit Officer Financial Institutions Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Robert M. Callagy Senior Vice President Financial Institutions Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

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