NEW YORK -- For Federated Department Stores, the purchase of 50 percent of Prudential's claim against R.H. Macy & Co. has little downside risk, according to analysts.
The Prudential loan pays interest of 12 percent a year and is secured by mortgages on 70 Macy stores. This puts it at the top of the heap of claims against the chain and the loan should be repaid in full before bank creditors, trade creditors or bond holders get anything.
Federated bought the 50 percent interest in the Prudential claim for $449.3 million and has an option to buy the rest. In addition to a cash payment of $109 million, Federated gave Prudential a three-year note for $340 million.
Interest on the note in the first year will be the London Interbank Offering Rate (LIBOR) plus 1.75 percent and, in the next two years, it will be LIBOR plus 2 percent. According to analysts, this translates to an overall interest rate of about 5 percent a year, giving Federated a 7-point spread over the interest costs on the note.
Thus, if Federated is unable to work a deal to acquire Macy's or any part of it, it should still make money on the claim.
One analyst said Federated's return on equity would be in double digits if all the interest on the Prudential loan is paid.
As to the price Federated paid for the Prudential loan, it either paid a premium or it bought the claim at a discount, depending on whether all the accrued interest is paid. In Macy's Chapter 11 proceeding, interest on the loan is being accrued but is not being paid. If the court finds that the value of the collateral exceeds the value of the loan, the interest would be paid, according to analysts.
Federated paid an 8 percent premium on the principal of the loan. However, with interest, the Prudential loan is worth 24 percent more than the principal, or a total of about $1 billion.
A Prudential spokesman said the benefit for the insurance giant is that it gets to convert a large portion of a nonperforming loan into a performing loan. Under accounting rules, Prudential must set up a reserve for the entire loan. Now it can classify part of it as "performing." In addition, Prudential gets $109 million in cash, he said.He confirmed that Federated paid 8 percent above the principal and that the interest did bring the value of the Prudential claim up by 24 percent. Explaining why Prudential agreed to sell the claim, he said the sale was a good deal for the insurance company because it was able to exchange a firm offer for the "uncertainties" of the bankruptcy proceeding results.
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