Fitch: Jefferies Core Performance Improves on Fixed Income Activity
NEW YORK -- December 19, 2012
Jefferies Group Inc. (Jefferies) today reported higher core earnings
(excluding extraordinary items) than the prior quarter and significantly
better than the challenging fourth quarter of 2011 (4Q'11). Results were
driven by improved volumes in both fixed income and equities trading, with
fixed income being the larger driver, as equity volumes remain weak relative
to historical levels. Activity in the high-yield market has helped sustain the
firm's momentum in the fixed income business over the last four quarters.
These results are consistent with Fitch's expectations and are considered to
be credit neutral.
Full-year core net revenues were up 12% year-over-year and surpassed prior
periods, while core net income was down approximately 10% (both measures
exclude recent gains from Knight Capital Group [Knight]). Margins were lower
in 2012, primarily due to an increase in compensation expense, as Jefferies
added to headcount and maintained a slightly higher compensation ratio. Fitch
would expect the compensation ratio to trend back down as recent hires achieve
run-rate revenue production and the amortization of certain compensation
expenses from recent acquisitions runs off.
Jefferies' 4Q'12 results were supported by debt capital markets (DCM)
revenues, which were up 66% from the linked quarter and 18% year-over-year.
While DCM revenues have been fairly volatile over the past several quarters,
they generally continue to trend higher as improving market conditions have
led to improved volumes.
Despite the improvement in the capital markets business, overall investment
banking revenues were up by a more modest 9%. This was primarily the result of
weak advisory fees, which were at the lowest level since 2Q'10. Mergers and
acquisitions (M&A) activity remains sluggish as many clients are averse to the
uncertain macroeconomic and market conditions.
Jefferies' opportunistic investment in Knight boosted fourth-quarter net
income, but to a lesser extent than in the prior quarter. The unrealized gain
added approximately $50 million to the reported equities trading revenue and
represented $7 million of the $72 million in net income for the quarter.
Reported earnings for the past two quarters include approximately $26 million
of mark-to-market gains from the company's investment in Knight, which Fitch
views as non-recurring.
Value at Risk (VaR) continues to be elevated as a result of its position in
Knight, and comprised approximately 37% of the firm-wide average VaR during
the fourth quarter. Jefferies continues to be Knight's largest shareholder,
with an ownership stake of approximately 44%. VaR is likely to remain elevated
until Jefferies reduces its investment in Knight, which Fitch views as
relatively large and opportunistic.
The balance sheet increased modestly during the fourth quarter while leverage
stayed roughly the same, close to historically low levels. Fitch-calculated
leverage has ranged between 9x and 10x over the last four quarters. Fitch
expects that over time, as market conditions stabilize, the firm may manage
its leverage modestly higher. Jefferies continues to maintain a solid
liquidity buffer, with over $4 billion in cash and unencumbered collateral.
Jefferies' ratings were placed on Rating Watch Negative on Nov. 12, 2012 in
connection with the company's planned merger with Leucadia National Corp.
Market reaction to the transaction has been positive with most of the firm's
bonds trading up since the announcement. For more information, please see the
press release titled 'Fitch Places Jefferies' 'BBB' L-T IDR on Rating Watch
Negative on Proposed Merger with Leucadia,' available at
Jefferies, a Delaware-incorporated holding company, is a well-established
full-service investment bank and institutional securities firm primarily
serving middle-market clients and investors. Its primary broker/dealer
operating subsidiary, Jefferies & Company, Inc., holds the vast majority of
the firm's consolidated assets and is regulated by the SEC. At Nov. 30, 2012,
Jefferies had U.S. GAAP total assets of $36.3 billion and shareholders' equity
of $3.4 billion (including non-controlling interests).
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Fitch Places Jefferies' 'BBB' L-T IDR on Rating Watch Negative on Proposed
Merger with Leucadia', Nov. 12, 2012;
--'2013 Outlook: U.S. Securities Firms', Nov. 9, 2012;
--'Fitch Affirms Jefferies' 'BBB/F2' Long- and Short-Term IDRs; Outlook
Stable', Dec. 15, 2011.
Applicable Criteria and Related Research:
2013 Outlook: U.S. Securities Firms
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One State Street Plaza
New York, NY 10004
Ilya Ivashkov, CFA
Brian Bertsch, +1-212-908-0549 (New York)
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