Fitch Affirms Leucadia's Long-Term IDR at 'BBB-'; Outlook Stable
The ratings of Leucadia and its main operating subsidiary, Jefferies Group LLC (Jefferies), continue to be equalized, as Fitch considers Jefferies a core subsidiary of Leucadia. This is based on Jefferies' significance relative to Leucadia's balance sheet (Jefferies accounted for 42% of Leucadia's common equity, ex-goodwill and intangibles, as of Dec. 31, 2014), the strong operational linkages between the two companies including shared leadership, and the likely role Jefferies will play in the combined company's future strategic direction.
Fitch has also affirmed Jefferies' ratings with a Stable Outlook. For more information, see the Rating Action Commentary entitled 'Fitch Affirms Jefferies' 'BBB-/F3' Long- and Short-Term IDRs; Outlook Stable' dated March 5, 2014.
KEY RATING DRIVERS - IDRs and SENIOR DEBT
The affirmation of Leucadia's rating reflects its modest balance sheet leverage, solid liquidity position, attractive debt maturity profile, and maintenance of relatively conservative operating parameters articulated by management at the time of its merger with Jefferies. Ratings are constrained by the firm's sizeable concentration in two of its largest investments, Jefferies and National Beef, which accounted for 61% of the company's total equity as of Dec. 31, 2014, variable operating performance as measured by recurring cash flow, and dividends from portfolio companies, and key man risk.
Fitch continues to assess Leucadia's strategic direction and investment approach under the new management team, which are both at early stages of their implementation. The company deployed \$1.3 billion of capital in the 12 months ending Dec. 31, 2014 in various investments including \$317.5 million in a diversified holding company (Harbinger), \$423.2 million in two oil and gas exploration and development companies, \$345.1 million in seeding various asset management initiatives (Leucadia Asset Management), and \$70.9 million in a gold/silver mining project (Golden Queen). In addition, the company has invested or identified \$700 million of investments thus far in 1Q'15, including \$300 million of rescue financing in the form of a senior secured loan provided to FXCM Inc. in January 2015 and \$400 million of seed capital commitment to Folger Hill Asset Management, a multi-manager hedge fund platform, which is expected to be funded in 1Q'15. Fitch views the combined \$2 billion in investments as significant and will monitor the performance of these investments over time.
The company continues to maintain a conservative capital and funding structure. Leverage, measured as parent company debt-to-tangible equity, was 0.21x at Dec. 31, 2014 (parent company debt includes \$125 million of 3.25% cumulative convertible preferred shares). The company has also stated a debt-to-equity operating parameter of 0.50x, which excludes the two largest assets and deferred tax assets from equity. On this basis, leverage measured 0.71x at Dec. 31, 2014, which is higher than management's stated maximum operating parameter. However, pro forma for the repayment of \$459 million of senior notes due September 2015, leverage falls to 0.50x. Fitch expects further cushion will be built from retained earnings. Given that this is a self-imposed operating parameter by Leucadia, temporary breaches of the metric do not, in and of themselves, impact the ratings.
The company's next debt maturity is not until October 2023 (excluding the September 2015 debt maturity), which is viewed positively. Furthermore, the company is not expected to issue any additional parent company debt in the near-- to intermediate-term.
As a result of the recent investment activity, liquidity has declined from all-time-high levels recorded in 2013, but is still considered solid in the context of the parent company's debt levels and holding company expenses. Liquidity, defined as cash, available-for-sale investments, and certain other investments that are easily convertible into cash measured \$2.1 billion at Dec. 31, 2014, compared to \$3.1 billion at Dec. 31, 2013. Fitch notes that liquidity is expected to be further impacted by \$700 million of investments in 1Q'15, as noted above. Still, the company is expected to maintain a sizeable liquidity cushion compared to holding company expenses, including interest expense, operating expense and dividends on common equity.
The nature of Leucadia's portfolio and the strategic focus on generating long-term investment returns versus earnings growth tends to dampen operating results and create variable overall operating cash flow. On a GAAP basis, net income was down 45% to \$204 million in 2014 from \$369 million in 2013, mainly driven by \$157.6 million of one-time charges related to discontinued operations (Lake Charles clean energy project), settlement of class action lawsuits filed against Jefferies over its merger with Leucadia, and a bad debt provision recorded at Jefferies. Excluding these charges, net income was almost flat at \$362 million.
Coverage of recurring cash flows/dividends from portfolio companies to parent company's operating and interest expense was above 1x for the 12 months ended December 2014, which is viewed as adequate when considered together with available holding company liquidity. However, the coverage falls below 1x if the dividends paid on Leucadia's common shares, which totaled \$93 million in 2014, are factored in. Fitch expects this coverage to improve in the future with the seasoning of its recent investments, particularly the low capital-intensive, cash flow-generative asset management businesses.
Key man risk continues to be a concern for both Leucadia and Jefferies, although Fitch recognizes that Jefferies has broadened and deepened its bench over the past several years.
RATING SENSITIVITIES - IDRs and SENIOR DEBT
Potential positive rating drivers for Leucadia could include demonstrated longer-term performance of the recent sizeable investments, reduced investment concentration, consistent operating performance with strong coverage of portfolio company cash flows to parent company expenses including dividends, while maintaining a conservative liquidity and leverage profile.
Ratings could be negatively affected by increased concentration of investments, sustained weakening performance at portfolio companies leading to lower cash/dividend distributions, a fundamental shift in financial policy leading to increased debt relative to parent company liquidity or cash flows from portfolio companies, and/or a less conservative leverage profile.
Fitch expects to pay particular attention to the performance of Leucadia's investments in the asset management space given the magnitude of the investments (approximately \$1 billion to date), the management team's varied track record in the asset management space, and the fact that the investments often represent stakes in funds in addition to asset managers.
Leucadia's ratings are equalized with those of Jefferies' given the ownership structure and operational and management linkages between the two companies. As a result, changes in Jefferies's ratings would influence Leucadia's credit profile as well.
Leucadia operates its business similarly to a closed-end alternative fund and serves as the holding company for Jefferies among other investments. As of Dec. 31, 2014, it had roughly \$52.6 billion in consolidated assets and \$10.3 billion in book equity. In addition to Jefferies, Leucadia's portfolio includes significant equity stakes in other private and public companies as well as Treasuries and other fixed income and equity securities.
KEY RATING DRIVERS AND SENSITIVITIES - SUBORDINATED DEBT AND OTHER HYBRID SECURITIES
The \$125 million of 3.25% cumulative convertible preferred shares issued by Leucadia are notched down twice from the company's IDR in accordance with Fitch's criteria 'Treatment and Notching of Hybrids in Nonfinancial Corporates and REIT Credit Analysis'. The two-notch differential from the IDR reflects Fitch's view of the subordinated nature of the instrument and the lack of a standard mandatory conversion feature.
Fitch has affirmed the following ratings:
Leucadia National Corp.
--Long-term IDR at 'BBB-', Outlook Stable;
--Senior unsecured debt at 'BBB-';
--Preferred Stock at 'BB'.
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