Rating agencies are weighing in on the announcement that U.S. securities firm Jefferies Group Inc. has entered into a definitive agreement to merge with Leucadia National Corp.
Under the terms of the deal announced Monday, Jefferies’ shareholders (other than Leucadia, which currently owns approximately 28.6% of the Jefferies’ outstanding shares) will receive 0.81 of a share of Leucadia common stock for each share of Jefferies common stock they hold. The merger, which is expected to close during the first quarter of 2013, is subject to customary closing conditions, including approval by both Leucadia and Jefferies shareholders.
Fitch Ratings has placed Jefferies on Rating Watch Negative, which it expects to resolve once the merger is completed in the first quarter of 2013. Assuming the transaction is completed, and absent material credit developments in the meantime, the outcome is expected to result in a one-notch downgrade, it says, noting that it believes “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, it adds. Indeed, converting to private ownership and becoming a direct subsidiary of Leucadia is expected to provide several tangible financial benefits to Jefferies, it says, including allowing it to stop paying its dividend.
At the same time, Fitch has also placed Leucadia’s rating on Rating Watch Positive, saying it expects a two notch upgrade as a result of the deal, to reflect “Leucadia’s highly liquid and lowly leveraged balance sheet, which the new management team from Jefferies has represented that it is committed to maintaining. Additionally, a wholly owned Jefferies is expected to be a source of strength to Leucadia in terms of deal flow and expertise.”
Moody’s Investors Service affirmed its ratings of Jefferies, saying it believes that the combination will not add incremental risk to Jefferies, and that, in fact, Leucadia will permanently reduce its risk profile “by instituting stricter disciplines regarding leverage, liquidity and asset concentrations.”
Moody’s also said the merger is potentially transformative to Jefferies business model and this creates execution challenges. “Jefferies senior leadership, who will run the combined firm, must implement the new investment strategy at Leucadia while maintaining effective risk controls at Jefferies,” it says. “Leucadia remains exposed to single-name event risks and losses at the Leucadia operations which could lead to concerns amongst customers and counterparties of Jefferies. Executing this merger also presents the risk that Jefferies’ senior leadership will lose some of its focus on the day to day operations of the investment bank.”
Nevertheless, Moody’s also placed Leucadia’s ratings under review for possible upgrade too, saying that its review of the rating will focus on the terms and conditions of the transaction, the company’s post close balance sheet, and the degree to which credit quality is enhanced as a result of changes in Leucadia’s investment philosophy. The review will also consider the company’s investment portfolio and the company’s ongoing ability to monetize these investments on a timely basis, it adds.