Nov 12 - Fitch Ratings has placed Jefferies Group, Inc.'s (Jefferies) long-term Issuer Default Rating (IDR) and short-term IDR on Rating Watch Negative. A full list of rating actions follows at the end of this press release.
Today's action follows Jefferies' announcement that it has entered into a definitive agreement to merge with Leucadia National Corp. (Leucadia; 'BB'/Rating Watch Positive). Fitch expects to resolve the Rating Watch Negative once the merger is completed in the first quarter of 2013. Assuming the transaction is completed, and absent material credit developments in the interim, the outcome is expected to result in a one-notch downgrade of Jefferies' long-term IDR to 'BBB-' and short-term IDR to 'F3'.
The expected one-notch downgrade reflects Fitch's view that after the proposed merger, Jefferies would become much more exposed to the market risk inherent in the other subsidiaries' investments at Leucadia. Conversely, becoming a privately-owned company may help insulate Jefferies from external market pressures similar to those experienced in November 2011 Fitch believes that management's interest would generally be aligned between Leucadia and Jefferies.
Under Fitch's criteria 'Rating FI Subsidiaries and Holding Companies', Jefferies would be considered a core subsidiary based on its significance relative to Leucadia's equity and the likely role it will play in the combined company's future strategic direction. Key executive management will be shared by both firms although each will retain a separate Board of Directors. Fitch believes that management has discretion to move capital between Jefferies and Leucadia, although that is not expected under normal market conditions.
Fitch would not expect Jefferies' core business strategies and operations to be materially impacted by the proposed ownership change, although management's ability to balance time demands between Jefferies and Leucadia would be an important consideration. Fitch's rating view also incorporates an assumption that Jefferies would continue to maintain its current liquidity, leverage and enhanced funding profile post-transaction.
Converting to private ownership and becoming a direct subsidiary of Leucadia is expected to provide several tangible financial benefits to Jefferies. For example, it would allow Jefferies to terminate the dividends on its common stock, which total approximately $60 million per year. Furthermore, Jefferies would no longer be required to make minority interest distributions to Jefferies High Yield Holdings, which have totaled $110 million over the last three fiscal years. Finally, Leucadia also will have the ability to limit Jefferies' Federal income tax distributions by utilizing the $4.7 billion of net operating losses available at Leucadia.
Post-merger, Jefferies' and Leucadia's long-term IDRs are expected to be equalized at 'BBB-'. Given the ratings linkage, material changes in either entities' credit profile will have an impact on their ratings. The 'BBB-' rating would reflect the proposed operating parameters articulated by Jefferies and Leucadia management, including:
--Maintaining Leucadia's debt-to-equity ratio below 0.5x, assuming Leucadia's two largest investments are fully impaired and the DTA is excluded from the calculation;
--Maintaining Leucadia's ratio of minimum liquid assets to parent company debt below 1.0x;
--Maintaining Leucadia's minimum cash and equivalents of at least 10% of book value (excluding Jefferies); and
--Limiting Leucadia's single largest investment to 20% of book value with all other investments limited to 10% of book value (both excluding Jefferies).
Rating Drivers and Sensitivities
Positive rating drivers over the longer-term would include Leucadia's demonstrated commitment to a conservative liquidity profile, limited investment concentrations and reduced leverage at the parent company as well as maintenance or improvement of Jefferies' current credit profile. The interaction between Jefferies and Leucadia will play an important role in the longer-term value and risk profile of the combined franchise, in Fitch's view.
Jefferies' and Leucadia's ratings could be negatively impacted by an increase in leverage, a less conservative liquidity or funding profile or more aggressive growth strategy at either entity. Ratings would also be negatively impacted if Fitch perceives the risks taken in Leucadia's investment portfolio as increasing materially from current levels. Fitch will continue to assess the ability of Jefferies' management team to run both companies effectively. Furthermore, unanticipated departure of key executives at either Jefferies or Leucadia could result in negative actions.
Jefferies, a Delaware-incorporated holding company, is a well-established full service investment bank and institutional securities firm primarily serving middle-market clients and investors. Its primary broker/dealer operating subsidiary, Jefferies & Company, Inc., holds the vast majority of the firm's consolidated assets and is regulated by the SEC. At Aug. 31, 2012, Jefferies had U.S. GAAP total assets of $34.4 billion and shareholders' equity of $3.4 billion (including non-controlling interests).
Fitch has placed the following ratings for Jefferies Group, Inc. on Rating Watch Negative:
--Long-term IDR 'BBB';
--Short-term IDR 'F2';
--Senior unsecured debt 'BBB';
--Short-term debt 'F2';
--Subordinated debt 'BB+'.