Insight: Fidelity's expensive debt raises eyebrows

Fidelity Investments gives a select group of employees an unusual perk. It lets them make unsecured loans to the company at annual interest rates that have paid them nearly 20 percent in recent years.

"It was the best investment I could have made," said Ani Chitaley, a former Fidelity senior vice president. "When I left (in 2007) to start my own company, I had to give them up. That was a sad day."

The promissory notes, officially called junior subordinated debentures, have become a key but expensive source of capital for the world's second-largest mutual fund over the past decade.

The interest on the debt is tax deductible and some of the debentures also double as an equity substitute for top performers and other insiders.

Several current and former Fidelity executives, who did not want to be identified for this story, said the debenture program is a relic of the past when Fidelity's profit margin was substantially higher. And they argue the expensive debt puts the company at a competitive disadvantage.

Analysts at Moody's Investors Service have singled out the employee-held debenture debt as an area of concern.

"In our view, the debentures carry substantial coupon rates that have driven FMR's interest expense to very high levels," Moody's analyst Dagmar Silva wrote in an October 27 research note. "...Fidelity's net income margins have consistently been more in line with our expectations for lower rated firms, in part due to its corporate structure."

Fidelity spokeswoman Anne Crowley said the company uses the internal debt to make investments to grow its businesses and better serve its customers. Fidelity declined to make executives available for comment.

ADVANTAGES OF PRIVATE OWNERSHIP

"We believe our private ownership and capital structure gives us many strategic and competitive advantages that make us very comfortable with our approach," Crowley said. Read more...