Why Battered Jefferies Could Survive

Why Battered Jefferies Could Survive


When Jefferies Group CEO Rich Handler sat down for his Thanksgiving dinner yesterday, he had several things to be thankful for – and two especially.

First, his investment bank -- despite its exposure to the MF Global debacle -- is still alive and independent as of this morning. And Jefferies may have minimal exposure to sovereign debt issued by Greece, Italy, and other troubled EU member nations, and may have a sound capital base, as Handler forcefully declared in a characteristically blunt but uncharacteristically open letter to its shareholders and clients. (He pronounced the whispering about Jefferies’ potential problems “malicious lies.”)

But what Handler didn’t mention in that letter is the unpalatable truth that when confidence and liquidity dry up simultaneously, nothing else may matter. If its counterparties don’t believe Jefferies will survive, it won’t. Or, at best, a big financial institution with a fortress-like balance sheet – think Royal Bank of Canada – will take advantage of the rumors and uncertainty to swoop in and make an acquisition offer. That might be an offer that the Jefferies board – with a duty to prevent the stock from further battering this year – can’t refuse. (The stock has dropped 24 percent since the MF Global scandal struck.)

Still, in recent days, Handler and Jefferies have acquired some much-needed supporters. Known for its sharp elbows and aggressive approach, Jefferies has never been much loved by its peers on Wall Street. And when it became the country’s largest surviving investment bank in 2008, there was a lot of rolling of eyes and wrinkling of noses at other firms. But Handler’s arguments, as outlined in that six-page letter, are striking a responsive chord with the likes of Oppenheimer & Co. analyst Chris Kotowski. He delivered a stinging indictment of efforts by rating agency Egan-Jones to sound the alarm about the finances of Jefferies, which, like all banks that depend on trading, market-making, and investment banking, is suffering from sluggish revenues and declines in profitability. Kotowski called the agency’s calculations “grotesquely wrong” and suggested that Egan-Jones should do more fact checking and proofreading before issuing reports on the companies whose debt it monitors.

That’s not all. While Gimme Credit Kathleen Shanley analyst didn’t take on Egan-Jones directly – or downplay the magnitude of the challenges that Jefferies still faces, she issued a report earlier this week that deals in a matter-of-fact manner with the critical points under contention. Jefferies hasn’t been relying on unsecured commercial paper for its funding; it only needs to deal with $50 million in maturing debt next year, she points out. True, it still needs to rely on the repo market to finance its inventory, and even the words “repo market” are enough to give investors conniptions on post-crisis Wall Street. But Shanley concludes that while shareholders may worry about how well Jefferies will succeed in generating profits in this kind of toxic market environment, the firm’s bonds offer “above-average potential;” she upgraded her rating to a “buy.”

True, such endorsements aren’t the equivalent of a ticker-tape parade. But in an environment where sentiment and confidence are likely to continue to play a crucial role in deciding which financial institutions survive, these “yes” votes arrived at a strategically crucial moment. So let’s hope that Handler remembered Kotowski and Shanley while reciting his litany of things for which he should be  grateful this year.