Jefferies eyes IB big league with SMBC alliance

Jefferies is a past master at turning industry dislocation to its advantage. The bank’s big growth spurt began in the US following the 2008 financial crisis, when it picked up talent from Wall Street rivals. It has been seizing opportunities ever since, including in Europe, where it has hired hundreds of bankers from rivals, leaping into action whenever they have stumbled.

In 2012, when Royal Bank of Scotland was forced to withdraw from corporate finance, Jefferies snapped up its Hoare Govett corporate broking business, a move that provided a platform for the US bank to build a dedicated UK equity capital markets and mergers and acquisitions offering. 

The firm’s growth and ambition has unsettled rivals. When in 2018 it took advantage of unrest at HSBC and hired a team of UK corporate finance specialists led by Phillip Noblet, an anonymous group of HSBC bankers sent an angry letter to their own board, suggesting that losing people to Jefferies was a sign of a franchise on the wane. While HSBC squabbled, Jefferies went from strength to strength, as Noblet and his team steered the firm into the UK investment banking mainstream.   During the pandemic it has won brokerships and gained market share in equity capital markets at a time when some rivals were pulling back. 

Then, in May 2021, as Credit Suisse battled a crisis on two fronts, Jefferies swooped again, recruiting large swathes of the bank’s financial institutions group (FIG) led by Alejandro Przygoda. Like many before them, they were lured in by Jefferies’ entrepreneurial culture.

All this positioned Jefferies well to benefit from strong tailwinds in investment banking and capital markets. The bank enjoyed a record year in 2020, and the momentum has continued. In the first half of 2021, it posted record quarterly investment banking net revenues of $1bn on the back of record advisory and debt underwriting revenues.

Now it is seizing yet another opportunity to grow by signing an alliance with SMBC Group that it hopes will launch it to the next level.

“If you look at our history, we’ve never rested on our good moments,” Brian Friedman, Jefferies’ president, told GlobalCapital. “We’ve always tried to find ways to build and we do things with a very long horizon. We think this partnership with SMBC will benefit us well through this decade into the next decade. It’s part of a next step and next generation opportunity.”

The alliance with SMBC, Japan’s third biggest bank by assets, announced on July 14, will combine SMBC’s balance sheet with Jefferies’ strength in corporate finance to enable the US bank to win further market share in leveraged finance, work with bigger public companies, and develop a broader cross-border M&A offering. In doing so, it broadens its historical mid-market focus.

 

According to the terms of the deal, SMBC will take a 5% stake in Jefferies, as well as providing a $1.65bn revolving credit facility and $250m of junior loans to Jefferies Finance (JFIN), the leveraged finance joint venture it established 17 years ago with Mass Mutual.

Friedman says the revolving credit facility is a game changer because currently all of the funding at Jefferies Finance is on a drawn basis, which means the JV has been sitting on cash to fund possible future commitments. The new deal provides Jefferies Finance with undrawn funds in addition to $1.5bn of equity capital. The JV’s funding mix also includes bonds.

Jefferies is a top 10 bookrunner in US leveraged loans and is ranked third so far this year as an underwriter on US sponsor-backed LBOs, behind Bank of America and Credit Suisse. “We’re already a meaningful participant in the leveraged finance market but we think we can grow our share further,” said Friedman.

And there is still potential to capitalise further on turbulence at Credit Suisse. “One or two of our historical competitors in leveraged finance are going through their own issues and perhaps will pull back from that market,” hinted Friedman. “We think that gives us an opportunity.”

 

The second priority of the alliance is to help Jefferies win investment banking business from the larger, publicly listed companies to which SMBC already acts as lender.

Lacking the balance sheet heft of its bigger rivals, Jefferies has until now made a virtue of out of a necessity, building out sector content so it can win market share on the quality of its ideas, research and distribution.

But it has found itself outgunned in leveraged finance and shut out of some investment banking business by not having a balance sheet.

“As an organisation we are an opportunity generator,” said Friedman. “We work with a large number of companies and a large range of private equity, venture capital and other investors. With our leading research coverage and our execution capability we bring a lot to them. But what we haven’t historically brought is a balance sheet and some of the other services that commercial banks provide. We’re hoping that through this alliance we can bring some of that.”

The big-cap initiative will start in the US healthcare sector, where Jefferies has a well-established presence in investment banking, and SMBC has lending exposure.  But Friedman says there will be opportunities for further collaboration in investment banking and sales and trading thanks to the “more active dialogue and stronger relationship” with SMBC.

 

The third priority of the alliance is to work on cross-border M&A for SMBC’s Japanese clients, using Jefferies’ investment banking presence in the US, Europe and Asia (excluding Japan). M&A bankers expect a cyclical uptick in cross-border M&A as Japanese companies expand overseas to combat sluggish growth and ageing demographics.

 

Jefferies has proved nimble in exploiting dislocation, but its expansion is part of a long term plan masterminded by Friedman and CEO Rich Handler, and the alliance with SMBC is no different.

“Five years ago, we mentioned publicly that an alliance with a global bank would be a way both to enhance our offering to clients and further grow our business. So conceptually this has been in our thinking for a long time,” said Friedman. 

The management teams know each other well, and the two firms are funding counterparties, while SMBC uses Jefferies’ research for its retail clients. “If there’s a defining and driving thought behind this, it is the potential for Jefferies and SMBC to realise together incremental opportunities that we might not separately,” explained Friedman.  

 Friedman, who has nurtured the relationship with SMBC over time through frequent visits to Japan, will oversee the alliance from the Jefferies side. Chris Kanoff, global head of investment banking, Rob Fullerton, global head of leveraged finance, and Tom Brady, President of JFIN, will take the lead with respect to leveraged finance and investment grade credit origination. John Huwiler, Jefferies’ global head of M&A, and Takumi Tanaka, head of Japan investment banking, will lead on cross-border activity.

 

For SMBC, this marks it first significant investment in a western financial firm since it participated in Barclays’ equity raising in 2008 — a position it sold in 2013.

The Japanese lender will see the most upside initially in the US, where it is ranked 20th in US syndicated loans — ten spots lower than arch-rival MUFG. 

Friedman reckons the alliance will benefit Jefferies in other geographies as well, and that includes its European business, where SMBC was ranked ninth in European syndicated loans last year, up from 16th in 2019, according to Dealogic.

Jefferies has become increasingly active in providing financing for European LBOs and the tie-up with SMBC will increase its firepower on selected deals.  In May, the bank acted as joint bookrunner and joint global co-ordinator to Apax Partners on the €780m financing package backing its acquisition of Rodenstock, while in March it provided staple financing to Nordic Capital on its $2bn acquisition of Advanz Pharma.

The push to win investment banking business from big public companies began in the UK, where Jefferies has worked on a number of high profile assignments, such as working as joint global coordinator on the Rolls Royce equity raise in 2020. This year it has advised the board of Signature Aviation, the UK aviation services company, on its acquisition by a private equity consortium for £3.5bn ($4.7bn) and in March it advised Aggreko on its sale to TDR Capital and I Squared Capital.

 

Alliances are becoming increasingly common in investment banking. In Europe, a number of second tier banks have struck joint ventures for their equity capital markets businesses. But the closest blueprint for Jefferies-SMBC is the deal struck between Morgan Stanley and MUFG at height of the financial crisis, when the Japanese bank famously wrote a cheque for $9bn for a 24% stake in Morgan Stanley to rescue the US bank from the brink of extinction.     

Since then, MUFG has provided underwriting on big M&A and ECM deals where Morgan Stanley is involved, while limiting the volatility of its investment banking business outside Japan. SMBC will hope to gain similar benefits from the alliance with Jefferies as it looks to evolve its global investment banking strategy. The success of the MUFG-Morgan Stanley alliance in Japan and the US provides a useful precedent, albeit the catalyst for that deal was crisis, not growth.

“I think it’s been encouraging that it seems to have been a successful alliance that now goes back over 10 years,” said Friedman of the MUFG alliance with Morgan Stanley.  “To some degree, that was born of a specific moment. We’ve developed this concept over a much longer period of time and we’re doing it at a time of strength for both companies, but their success is not lost on us.”

The alliance with SMBC undoubtedly moves Jefferies to another level, but Friedman says the bank will remain focused on clients, not deal size. “We’ve got the sector expertise, which means that whether the company is valued at $2.5bn or $10bn isn’t necessarily going to change what value we can add,” he said. “The issue is, historically, we were partially discounted from certain opportunities because of revolving credit facilities and other considerations. I’m not suggesting SMBC is the answer to all of our challenges. But over time we think this alliance will open up doors that historically may not have been as open to us.”

But there is a clear shift in ambition beyond the mid-market, which has been Jefferies’ perennial sweet spot. As the bank unlocks more investment banking relationships with the help of SMBC, is it time to judge Jefferies against Morgan Stanley and Goldman Sachs, rather than its mid-market rivals? Friedman bats away the suggestion. “We’re not necessarily looking to be judged against or with anyone. What we’re doing is broadening our footprint,” he said. “If you look at the leveraged finance opportunities we think come from this alliance, they are substantially in the mid-market, consistent with our historic thrust. It is simply enabling us to do more and more.”

Rivals looking down on Jefferies in the league tables would do well to take note.