JEFFERIES FINANCIAL GROUP INC.
Fitch Ratings has upgraded the Long-Term Issuer Default Rating (IDR) of
The Rating Outlook is Stable.
Key Rating Drivers
The upgrade reflects JFG's solid growth in its franchise and market position, full-service capabilities as an investment banking (IB) and capital markets firm, increased fee revenue from the asset management business and consistently conservative leverage and liquidity. Additionally, JFG continues to monetize its legacy merchant banking investments, which Fitch views favorably as it will reduce earnings volatility going forward. The remaining investments totaled
JFG's ratings remain constrained by the inherent earnings variability in IB, reliance on short-term secured funding and elevated operational risk associated with the securities firm business model.
JFG has been able to take advantage of the recent market dislocation and invest in its business by increasing the number of its managing directors by approximately 20% during 2023 and growing its presence outside the
Revenue volatility is an inherent constraint on the business model of securities firms, as trading and capital markets businesses are transactional and mostly cyclical. JFG's consolidated net revenues for the trailing twelve-months (TTM) ended 3Q23 (
However, revenue remains well above FY19 and prior periods as a result of the firm's improved franchise and market position. Notably, while the global fee pools for JFG's core IB products (M&A, ECM and leveraged finance) have declined by 15% since 2019, the firm's revenue has grown by 40%. During the same time period, JFG's global market position in core advisory, ECM and DCM improved from twelfth to seventh, according to industry league tables.
JFG's pre-tax ROAE was 4.6% for the TTM ended 3Q23, compared with a four-year average (2019-2022) of 12.2%, which was near the mid-point of Fitch's 'bbb' category benchmark range of 10% to 15% for securities firms with high balance sheet usage. Fitch expects a modestly improved operating environment for broker dealers and advisory firms in 2024 compared with a very challenging 2023. While market conditions could result in JFG's pre-tax ROAE remaining below 10% in 2024, Fitch believes JFG's target of low to mid-teen returns through the cycle is achievable.
JFG maintains a conservative leverage and liquidity profile, which further supports the ratings upgrade. Net adjusted leverage, defined by Fitch as tangible assets excluding securities borrowed and reverse repurchase agreements, divided by tangible common equity (TCE), was 5.3x at
Fitch expects JFG to sustain conservative leverage ratios, with most earnings growth to be achieved through less-balance-sheet-intensive IB revenues. Holding company liquidity also remained strong at
JFG mitigates the risks of its market-sensitive, primarily wholesale, short-term, secured funding profile by maintaining a strong liquidity position. Cash and equivalents as a percentage of total assets were 15.7% at
JFG demonstrated a strong ability to manage its trading risks, as evidenced by a limited number of trading loss days and generally low losses on those days. Fitch-stressed VaR, which is calculated as the 10-day, 99% high VaR multiplied by a factor of five to reflect severe market conditions, was 5.0% of TCE as of end-9M23, unchanged from FY22.
The Stable Outlook reflects Fitch's expectations for solid operating performance through the cycle given the firm's established franchise, the maintenance of a solid risk management framework, and conservative leverage and liquidity positions.
RATING SENSITIVITIES
Factors that Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade
Sustained decline in profitability as measured by four-year average ROAE below 10%, particularly if driven by trading losses taken in the capital markets business;
Alteration of the firm's risk profile, resulting in outsized performance volatility or material trading/credit losses;
Sustained increase in net leverage to over 7.5x;
Deterioration in the firm's liquidity and funding profile as evidenced by a decline in the liquid assets to short-term funding ratio below 150%;
Increased risk appetite at joint ventures (
A key person event with respect to the CEO and/or President would not necessarily result in an immediate downgrade, but would be evaluated in the context of the potential impact on the firm's strategic direction. The fact that key person risk resides with two individuals, rather than one, is a potential mitigant.
Factors that Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade
Positive rating momentum is considered limited given the sensitivity of the business model to market and funding risks. However, significant growth in the asset management business that results in a meaningful contribution to consolidated revenues in conjunction with sustained improvement in profitability as measured by four-year average ROAE to over 15%, sustained maintenance of leverage under 5.0x, and an increase in the liquid assets to short-term funding ratio to over 200% would be positive for ratings.
DEBT AND OTHER INSTRUMENT RATINGS: KEY RATING DRIVERS
The unsecured debt ratings are equalized with the Long-Term IDR and reflect the firm's largely unsecured corporate funding profile and Fitch's expectation for average recovery prospects on the debt under a stressed scenario.
The rating on JFG's cumulative convertible preferred stock is two notches down from the company's IDR. The two-notch differential reflects the subordination of the preferred stock to all senior debt and the fact that it may be converted into common shares. The preferred stock is not afforded equity credit by Fitch given that it has a fixed conversion rate and lacks a mandatory conversion feature.
A Long-Term IDR of 'BBB+' corresponds to a Short-Term IDR of 'F1' or 'F2' according to Fitch's 'Non-Bank Financial Institutions Rating Criteria,' dated
DEBT AND OTHER INSTRUMENT RATINGS: RATING SENSITIVITIES
The short-Term IDR is primarily sensitive to any change in JFG's Long-Term IDR. However, an improvement in JFG's FLC score, resulting in an upgrade of the sub-factor score to 'a', could result in an upgrade of the Short-Term IDR to 'F1'.
The unsecured debt ratings are equalized with the Long-Term IDR and are expected to move in tandem. The rating of JFG's cumulative convertible preferred stock is primarily sensitive to JFG's IDR.
ADJUSTMENTS
The Funding, Liquidity & Coverage score has been assigned below the implied score due to the following adjustment reason(s): Business model/funding convention (negative).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
ESG Considerations
The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.
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