JEF - Jefferies Group

[Munger]

Could you tell me where you find the information about sudden shrinking of Jef balance sheet at quarter end (four quarters in a row)?

 

The conference call replay is still available on the JEF website, which I cited on my original post and several subsequent posts.  Note the other very relevant questions that analysts struggled to get answered.  I'm surprised some of those who have expressed bullish opinions on this company haven't even listened to the most recent conference call.

[Grenville]

Unfortunately I've never seen a transcript from the AGM.  From my recollection, Tweedy Brown asked: "it seems like Jefferies trades at high P/E... is it fair to say that you think earnings will grow?" and the Leucadia guys (with charactersitic loquaciousness) replied: "I think that's fair."

 

Thanks!

[Munger]

Will be interesting to see the actual securities.  The company is def in panic mode given the bond spreads so kudos to management for trying to be proactive but why not just give this info to Egan when he first asked and simultaneously release to the market?

 

Further -- the info does nothing the address questions re the business model.

 

As management noted on the conference call -- hedges work until they don't and inventory turns until it doesn't.

 

First, the U.S. Treasury hedges used to offset the interest rate risk in our high grade inventory increased in value significantly due to a flight to quality which resulted in significant losses. Second, we incurred significant write downs in the value of some of our long inventory positions including high yield, distress and some mortgage inventory.

 

Maybe as a little more color, Rich, on FIC. Even if it's just roughly, what was maybe the

percentage of impacts of secondary trading versus prop and then inventory marks, even if it's just generally speaking? I mean, was one disproportionately impactful than any other?

 

No direct answer.

 

But management at least again admits hedges work until they don't and inventory turns until it doesn't: :

Once August hit, the events that I mentioned, we carry inventory to facilitate trading with our clients, and effectively, the market for most of those assets classes just went a little bit haywire in August.

 

We had markdowns in high yield. We had markdowns in mortgages. We had that the spread widening in the corporate high grade business and clearly we operate generally on a pretty hedged basis with treasuries and that generally works unless you're in a period of extreme volatility in which case it didn't work.

 

What good is a hedge if it doesn't work when you need it most?

 

And then just one last for me on the comp ratio, I mean clearly jumped up in the quarter. Revenues were down. For the nine months, it's about 60%. I mean, if we assume – I hope not – but sort ofstatic level of revenues going forward, is the 3Q absolute number of comp, kind of sticky?

 

No direct answer.

 

Okay. So even though it's happened a few quarters in a row, it's really just about when clients

are looking to transact?  (question re the shrinking balance sheet at quarter end)

 

Look, we clearly like to make sure we know what's on our balance sheet, and it's tough

enough to get down, and so we put pressure on everybody on a regular basis to have a clean balance sheet. And quarter-end's a good period of time to measure it by so we clearly go through. But that being said, we see opportunities throughout the quarter, and we take advantage of it.

 

Huh?

 

Here is the relevance of the question and the lack of an answer -- is the company fully disclosing to owners the leverage required to generate the reported returns.

 

And I think this observation by Millennium is informed and very relevant:

 

Ex improved by Bache, ROE for the quarter looked around 3% to 4%, 5%. Jefferies looks like it has cost of capital 12%. So back of the envelope math looks like the assets got up to around $59 billion during the quarter.

 

 

As I've stated, I have no position in JEF or LUK.  I'm just tired of the complete BS that emanates from investment banks and their management teams.  I believe JEF is going to provide quite a bit more entertainment over the next 12-18 months as they scramble to make this growth strategy work.

 

And if you want exposure to an investment bank -- why not buy GS...superior franchise, cheaper valuation.

 

 

[txlaw]

I suggest everyone who is interested read the actual conference call in its entirety -- not just the Munger paraphrased version -- and read the actual SEC filings to determine whether Munger's interpretation of the conference call (and Jefferies' disclosure) is valid.

 

 

 

[bmichaud]

For ease of discussion, here are the last two CCs in PDF.

JEF_2011_Q3_CC.pdf

JEF_2011_Q2_CC.pdf

[Munger]

Txlaw -- those are the exact questions and answers.

 

Even better -- I would encourage all to listen to the conference call so they can hear management hem and haw through the q&a.

 

And Txlaw -- why don't you answer the following for us based on your "reading" of the SEC filings and the transcript with direct, specific answers -- feel free to cut and paste exactly from management comments and SEC filings.  (this should be interesting given the BAC experience)  Reality will show you can't provide anything more than vague rhetoric offered by management.

 

 

What good is a hedge if it doesn't work when you need it most?

 

What good is citing high inventory turnover when the inventory doesn't turn during periods of stress?

 

Even if it's just roughly, what was maybe the percentage of impacts of secondary trading versus prop and then inventory marks, even if it's just generally speaking? I mean, was one disproportionately impactful than any other?

 

And then just one last for me on the comp ratio, I mean clearly jumped up in the quarter. Revenues were down. For the nine months, it's about 60%. I mean, if we assume – I hope not – but sort ofstatic level of revenues going forward, is the 3Q absolute number of comp, kind of sticky?

 

Okay. So even though it's happened a few quarters in a row, it's really just about when clients

are looking to transact?

 

How did the convert market collapse but JEF avoid losses?

 

[txlaw]

Txlaw -- those are the exact questions and answers.

 

Even better -- I would encourage all to listen to the conference call so they can hear management hem and haw through the q&a.

 

And Txlaw -- why don't you answer the following for us based on your "reading" of the SEC filings and the transcript with direct, specific answers -- feel free to cut and paste exactly from management comments and SEC filings.  (this should be interesting given the BAC experience)  Reality will show you can't provide anything more than vague rhetoric offered by management.

 

 

What good is a hedge if it doesn't work when you need it most?

 

What good is citing high inventory turnover when the inventory doesn't turn during periods of stress?

 

Even if it's just roughly, what was maybe the percentage of impacts of secondary trading versus prop and then inventory marks, even if it's just generally speaking? I mean, was one disproportionately impactful than any other?

 

And then just one last for me on the comp ratio, I mean clearly jumped up in the quarter. Revenues were down. For the nine months, it's about 60%. I mean, if we assume – I hope not – but sort ofstatic level of revenues going forward, is the 3Q absolute number of comp, kind of sticky?

 

Okay. So even though it's happened a few quarters in a row, it's really just about when clients

are looking to transact?

 

How did the convert market collapse but JEF avoid losses?

 

How is "No direct answer" the exact answer given in the CC?

 

Reality will be understood by those who actually read the filings and the available CC transcripts.  Thanks Ben for attaching them.

 

I already know how I interpret the CCs and quarterly filings.  I'd like to hear from folks who do not have a dog in the fight (I now own JEF) whether they agree with your (Munger's) interpretation.

[mevsemt]

http://www.bloomberg.com/news/2011-11-07/jefferies-bears-in-retreat-after-firm-boosts-european-disclosure-options.html?cmpid=yhoo

[fuluvu]

JEF reduces Sovereign Debt  in a single days!

Jefferies Reduces Gross Holdings Of Sovereign Debt Of Portugal, Italy, Ireland, Greece, And Spain By 49.5% In Today's Trading In Europe

[rijk]

Jefferies Cuts Holdings Of European Sovereign Debt

Last update: 11/7/2011 9:42:16 AM

DOW JONES NEWSWIRES

Jefferies Group Inc. (JEF) reduced its gross holdings of Portugal, Italy, Ireland, Greece and Spain sovereign securities by 49.5% since the close of business Friday, a move it said resulted in no meaningful profit or loss.

"We undertook this reduction in our holdings solely to demonstrate the liquid nature of this market-making trading book," said Chairman and Chief Executive Richard Handler and Executive Committee Chairman Brian Friedman in a joint statement. "We will now resume our normal market-making activities and serve our clients around the world."

Shares were up 7.3% at $12.95 in early trading and are off 52% this year.

The investment bank was dogged last week by questions about its European exposure. Jefferies disclosed on Friday a $2.4 billion long position and a $2.3 billion short position to European nations including Italy, Spain, Ireland, Portugal, and Greece. Its net cash exposure to the region at the time was $91 million.

The company said Monday its trading positions in the sovereign securities were reduced by about $1.1 billion long and $1.1 billion short.

Jefferies' current net exposure to these sovereign securities is currently $59 million, or 1.7% of shareholder equity.

[Grenville]

I spent the weekend reading the 10-K, was hoping someone here could shed light on who the European bank is that supports the commodity business.

 

Here's the info from the K: p.121 of the 2010 10-K

"JFP maintains a credit intermediation facility with a highly rated European bank (the "Bank"), which allows JFP customers that require a counterparty with a high credit rating for commodity index transactions to transact with the Bank.  The Bank simultaneously enters into offsetting transactions with JFP and receive fees from JFP for providing credit support."

[Grenville]

Nice commentary on Jefferies on Bloomberg. Recent quotes from Handler and Friedman.

 

http://www.bloomberg.com/news/2011-11-17/jefferies-ceo-sees-turmoil-easing-as-mf-global-comparison-fades.html

[oddballstocks]

So I saw Jef is dropping like a rock again this morning.  I've read through this thread and the business seems decent, they unloaded their European Sovereigns eliminating that risk.  So what I'm trying to understand is what is the bear case here?  Why is this stock being punished?

 

It seems like this is a classic panic play, I don't mind speculating on this, but I can't get my head around why it's so hated if they've worked to cut/eliminate exposure.

[nkp007]

Anyone looking at the debt? Yielding above 10%.

 

 

[scorpioncapital]

The debt is an amazing deal. 10% for 10 years. If you leverage up 50% that's 15% return. If debt is yielding this, the stock could yield even better!

[link01]

So I saw Jef is dropping like a rock again this morning.  I've read through this thread and the business seems decent, they unloaded their European Sovereigns eliminating that risk.  So what I'm trying to understand is what is the bear case here?  Why is this stock being punished?

 

It seems like this is a classic panic play, I don't mind speculating on this, but I can't get my head around why it's so hated if they've worked to cut/eliminate exposure.

 

couple of things makes jef's risk standout vs the other majors ibanks: they arent a bank holding co , & they're not TBTF (too big to fail). so there's more uncertaintly/vulnerability from that side of things. also, while they cut their euro sovereign debt in half, its the other remaining half that the market is worried & skeptical about.

 

plus, in highly stressed global market the new watchword for net HEDGED exposure has become: gross is the new NET! fear has undermined trust.

 

from naked capitalism:

 

1. Can the institution with CDS exposure afford to collateralize all of their exposures? This was a big factor in why MF Global moved so quickly to bankruptcy – as MF and their exposures got downgraded, MF ran out of available assets to post against their CDS. This is probably why they violated their segregated accounts. This is also what drove AIG to needing a bailout – they lacked sufficient funds to post against their very large exposures. Thus, the problem is not the mechanics of CDS and collateralization, but the fact there is no real limit on how much exposure an institution can take on in CDS relative to assets available for collateral posting.

2. What is the credit worthiness of the various counterparties? Gross exposure may be netted down via CDS hedges, but what if the counterparties run into an MF Global or AIG situation? If a counterparty is unable to honor its hedge (either through collateral posting or outright), then the value of the hedge is greatly diminished and more likely to yield something like ten cents on the dollar (a typical ISDA auction level for unsecured CDS debt). This is the issue that ZeroHedge has been harping on with Morgan Stanley and Jeffries – i.e. “gross is the new net”. Since the various gross exposures to various European sovereigns is quite large, a legitimate question can be asked about how secure these hedges (and the resulting netting) will be in the event of significant country or institution downgrades. >>

 

http://www.nakedcapitalism.com/2011/11/on-the-dubious-defenses-of-the-netting-of-4-trillion-of-us-bank-cds-to-the-eurozone.html

 

http://ftalphaville.ft.com/blog/2011/10/27/713826/how-gross-and-net-cds-notionals-really-work/

 

 

[Grenville]

So I saw Jef is dropping like a rock again this morning.  I've read through this thread and the business seems decent, they unloaded their European Sovereigns eliminating that risk.  So what I'm trying to understand is what is the bear case here?  Why is this stock being punished?

 

It seems like this is a classic panic play, I don't mind speculating on this, but I can't get my head around why it's so hated if they've worked to cut/eliminate exposure.

 

couple of things makes jef's risk standout vs the other majors ibanks: they arent a bank holding co , & they're not TBTF (too big to fail). so there's more uncertaintly/vulnerability from that side of things. also, while they cut their euro sovereign debt in half, its the other remaining half that the market is worried & skeptical about.

 

plus, in highly stressed global market the new watchword for net HEDGED exposure has become: gross is the new NET! fear has undermined trust.

 

from naked capitalism:

 

1. Can the institution with CDS exposure afford to collateralize all of their exposures? This was a big factor in why MF Global moved so quickly to bankruptcy – as MF and their exposures got downgraded, MF ran out of available assets to post against their CDS. This is probably why they violated their segregated accounts. This is also what drove AIG to needing a bailout – they lacked sufficient funds to post against their very large exposures. Thus, the problem is not the mechanics of CDS and collateralization, but the fact there is no real limit on how much exposure an institution can take on in CDS relative to assets available for collateral posting.

2. What is the credit worthiness of the various counterparties? Gross exposure may be netted down via CDS hedges, but what if the counterparties run into an MF Global or AIG situation? If a counterparty is unable to honor its hedge (either through collateral posting or outright), then the value of the hedge is greatly diminished and more likely to yield something like ten cents on the dollar (a typical ISDA auction level for unsecured CDS debt). This is the issue that ZeroHedge has been harping on with Morgan Stanley and Jeffries – i.e. “gross is the new net”. Since the various gross exposures to various European sovereigns is quite large, a legitimate question can be asked about how secure these hedges (and the resulting netting) will be in the event of significant country or institution downgrades. >>

 

http://www.nakedcapitalism.com/2011/11/on-the-dubious-defenses-of-the-netting-of-4-trillion-of-us-bank-cds-to-the-eurozone.html

 

http://ftalphaville.ft.com/blog/2011/10/27/713826/how-gross-and-net-cds-notionals-really-work/

 

I would encourage anyone interested in JEF to look at their disclosure for derivatives. According to the Q3 10Q, their CDS exposure is to Indexes. Also a large % of their derivatives are exchange traded versus OTC based on fair value data estimating. They seem to run a clean ship based on their ability to lower their exposure to sovereigns as shown last week.

 

You also have LUK owning 29% of the equity at Jefferies and 50% of JEF high yield platform. Then you have Handler & Friedman who own 8.3% of the equity as well.

[BargainValueHunter]

The debt is an amazing deal. 10% for 10 years. If you leverage up 50% that's 15% return. If debt is yielding this, the stock could yield even better!

 

It seems like it would be a good deal here to borrow @ 4% - 5% and just load up on the bonds.

 

If they aren't safe I can't see why.

 

Sometimes Mr. Market just puts the ball on a tee for you. 8)

[oddballstocks]

Just took a look at the bonds

 

I see the 3/12 has about a 14% YTM, might not be a bad place to put some cash for four months.

[BargainValueHunter]

The debt is an amazing deal. 10% for 10 years. If you leverage up 50% that's 15% return. If debt is yielding this, the stock could yield even better!

 

It seems like it would be a good deal here to borrow @ 4% - 5% and just load up on the bonds.

 

If they aren't safe I can't see why.

 

Sometimes Mr. Market just puts the ball on a tee for you. 8)

 

http://online.wsj.com/article/SB10001424052970204517204577044460022840008.html

 

In other words, even if the Jefferies business is challenged over the next year or so, it is unlikely to crack. That may not be enough to entice investors into the stock, which is likely to remain volatile as the European crisis unfolds. But it does argue in favor of the firm's debt.

 

Jefferies' 5.125% senior unsecured bonds due April 2018, for example, were trading Thursday below 80 cents on the dollar for a yield of more than 9.5%, according to MarketAxess. Meanwhile, its 5.875% debt due June 2014 was trading at about 85 for a yield of nearly 13%.

 

Those distressed prices could end up proving lucrative if the concern around Jefferies' European exposure really is being driven by fear rather than fundamentals.

[link01]

I would encourage anyone interested in JEF to look at their disclosure for derivatives. According to the Q3 10Q, their CDS exposure is to Indexes. Also a large % of their derivatives are exchange traded versus OTC based on fair value data estimating. They seem to run a clean ship based on their ability to lower their exposure to sovereigns as shown last week.

 

You also have LUK owning 29% of the equity at Jefferies and 50% of JEF high yield platform. Then you have Handler & Friedman who own 8.3% of the equity as well.

 

you make some very good points here. however, in this environment those hedges are fraught with more than normal risk, no matter how well structured & tested for historical asset/spread relationships.  investors need more than ever to have their eyes WIDE open. jef is still a leveraged business, after all, dependant on the markets for its funding & exposed to counterparty risks etc.

 

FTalpha really has some insightful articles about some of the risks:

 

http://ftalphaville.ft.com/blog/2011/11/04/726571/the-jefferies-issue/

 

http://ftalphaville.ft.com/blog/2011/11/03/725391/jefferies-we-have-to-explain-this-again/

 

http://ftalphaville.ft.com/blog/2011/11/07/730881/jefferies-2bn-toldjaso/

 

http://ftalphaville.ft.com/blog/2011/11/04/728711/jefferies-for-the-love-of-a-greek-god-how-many-times-must-we-explain-this/#comments

 

but perhaps the biggest unknown, unquantifiable risk comes courtesy of zerohedge (useful for its news aggregating abilities tho its extreme anarchist slant on that news needs to be hugely discounted). anyways, it seems jef & its bigger brother ibanks are being sued for fraud for underwriting & peddling MF Global bonds right before they went poof:

 

http://www.zerohedge.com/news/final-straw-jefferies-and-six-other-banks-sued-fraudulent-mf-global-bond-issuance

 

personally, i think INTL is the best managed ibank by far, with JEF being a distant 2nd, tho i wont get interested in it again until 16 or so

 

 

[Grenville]

I would encourage anyone interested in JEF to look at their disclosure for derivatives. According to the Q3 10Q, their CDS exposure is to Indexes. Also a large % of their derivatives are exchange traded versus OTC based on fair value data estimating. They seem to run a clean ship based on their ability to lower their exposure to sovereigns as shown last week.

 

You also have LUK owning 29% of the equity at Jefferies and 50% of JEF high yield platform. Then you have Handler & Friedman who own 8.3% of the equity as well.

 

you make some very good points here. however, in this environment those hedges are fraught with more than normal risk, no matter how well structured & tested for historical asset/spread relationships.  investors need more than ever to have their eyes WIDE open. jef is still a leveraged business, after all, dependant on the markets for its funding & exposed to counterparty risks etc.

 

FTalpha really has some insightful articles about some of the risks:

 

http://ftalphaville.ft.com/blog/2011/11/04/726571/the-jefferies-issue/

 

http://ftalphaville.ft.com/blog/2011/11/03/725391/jefferies-we-have-to-explain-this-again/

 

http://ftalphaville.ft.com/blog/2011/11/07/730881/jefferies-2bn-toldjaso/

 

http://ftalphaville.ft.com/blog/2011/11/04/728711/jefferies-for-the-love-of-a-greek-god-how-many-times-must-we-explain-this/#comments

 

but perhaps the biggest unknown, unquantifiable risk comes courtesy of zerohedge (useful for its news aggregating abilities tho its extreme anarchist slant on that news needs to be hugely discounted). anyways, it seems jef & its bigger brother ibanks are being sued for fraud for underwriting & peddling MF Global bonds right before they went poof:

 

http://www.zerohedge.com/news/final-straw-jefferies-and-six-other-banks-sued-fraudulent-mf-global-bond-issuance

 

personally, i think INTL is the best managed ibank by far, with JEF being a distant 2nd, tho i wont get interested in it again until 16 or so

 

Thanks for all the linked articles.

 

I agree that times must be much tougher when sizing up counter parties. According to the filings JEF isn't taking large gross exposures via CDS and netting them out neatly like a lot of the major commercial banks. A large percentage of their derivative exposure is through central clearing houses. Also their ability to reduce their sovereign exposure in a stressed market is telling about the structure of their hedges.

 

In terms of liquidity:

1. JEF has raised equity and debt in a prudent manner, maturities are spread out

a. 4.2bln of debt

b. 3.5bln of stockholder's equity

2. They have financial instruments that can be pledged as collateral

3. Cash & uncommitted lines of credit

a. 2bln of cash

b. 1.7bln of bank lines unused

 

They do not have the ultimate backstop with the FED as a bank holding company, but they also don't have the regulation risk that comes with it.

 

In terms of the MF Global Bonds, that doesn't come across very well if you tout working in the best interest of both clients and customers. Some of the fraud and the using of customer funds couldn't have been known by JEF so I find it hard to see them at risk for that. In terms of ultimate exposure, it depends on how long the litigation last and the ultimate outcome which could be years in the future when hopefully normal markets return.

 

Lastly, there is risk of the unknown since we only get a glimpse of what's going on in the black box when you see the financial filings. It really is a bet on the management and on their track record. The one thing that gives me confidence is that the Leucadia guys have worked with Handler for a long time both on the board since 2008 and through the High Yield platform (since 2000) that is run by Handler. I'm also aware that Leucadia hasn't always sized up their partners given what happened at Fortescue and the litigation there but sometimes its a matter of time before true intentions appear.

 

I haven't looked at INTL, but LUK owns shares.

[rijk]

i am not a legal expert but there are several references to proprietary trading risks in the 10-K (which is referenced in the prospectus), see page 17

 

regards

rijk

 

http://www.sec.gov/Archives/edgar/data/1401106/000119312511145663/d10k.htm

 

Principal transactions incurred through our normal business activities arise when we act as principal in connection with our market making activities or when we facilitate client business. Principal transactions also include proprietary positions that we take in fixed income and related interest rate products, equities, foreign exchange and commodities to monetize our views on future movements in market prices and volatilities in commodities, securities and other instruments and products, which may be affected by, among other things, changes in credit spreads, potential rating changes, and possibility of issuer default. These future movements and events can differ substantially from our expectations (as well as, among other things, any instrument correlations or market conditions that we believed to be existent) and therefore result in substantial losses. For example, in 2010, concerns were raised about certain European countries, including Italy, Spain, Belgium, Portugal and Ireland, regarding perceived weaknesses in their economic and fiscal condition, and the extent to which such weaknesses might affect other economies as well as financial institutions such as ours, which did business with these countries or invested in securities issued by them. For a discussion of these risks, see “Item 7A. Quantitative and Qualitative Disclosures About Market Risk”. Changes in regulatory and tax rules can also change the expected profitability or outcome of these trades, and in the worst case result in losses. These changes can even be applied retroactively. Additionally, regulatory, liquidity and other capital restrictions may also force us to exit certain positions prematurely, or in adverse market conditions, resulting in significant losses.

 

Historically, our trading activities have largely been limited to effecting client transactions as a broker, involving minimal principal exposure of generally short duration. As we implement our new strategic plan, we expect to increase our principal trading activities significantly, in connection with facilitating our clients’ transactions, our market-making and our proprietary activities and investing, and as a result, our exposure to market risk and trading losses will increase. Although we expect to increasingly recognize trading income as part of our ongoing activity for our clients and to continue monetizing our market views with unhedged principal transactions, there can be no assurance that we can increase the level of this activity or that it will be profitable. Because of the market risk and issuer risk that we face, we may incur significant losses at any time with respect to any of our principal transactions, including those executed for client facilitation and market making, proprietary activities, or asset-liability management; and particularly in the event of severe market stress.

 

[stahleyp]

 

you make some very good points here. however, in this environment those hedges are fraught with more than normal risk, no matter how well structured & tested for historical asset/spread relationships.  investors need more than ever to have their eyes WIDE open. jef is still a leveraged business, after all, dependant on the markets for its funding & exposed to counterparty risks etc.

 

 

 

I think it's best to keep your eyes wide open when no one else is. I think almost everyone has their eyes open now.

[link01]

Historically, our trading activities have largely been limited to effecting client transactions as a broker, involving minimal principal exposure of generally short duration. As we implement our new strategic plan, we expect to increase our principal trading activities significantly, in connection with facilitating our clients’ transactions, our market-making and our proprietary activities and investing, and as a result, our exposure to market risk and trading losses will increase. Although we expect to increasingly recognize trading income as part of our ongoing activity for our clients and to continue monetizing our market views with unhedged principal transactions, there can be no assurance that we can increase the level of this activity or that it will be profitable. Because of the market risk and issuer risk that we face, we may incur significant losses at any time with respect to any of our principal transactions, including those executed for client facilitation and market making, proprietary activities, or asset-liability management; and particularly in the event of severe market stress.

 

this is exactly the kind of thing i am not a fan of....at all.  "... we expect to increase our principal trading activities significantly, in connection with facilitating our clients’ transactions, our market-making and our proprietary activities and investing,...". facilitate client transactions etc? isnt that the height of rank disengenuousness? more like SUPPLEMENT, it seems to me. really, i just dont see how thats not a conflict of interest with their own clients all too often.