Fitch: Jefferies Reports Weaker 2Q13 Results Due to Slowdown in Fixed Income
NEW YORK -- June 18, 2013
Jefferies Group LLC (Jefferies) today reported second quarter results that are
significantly weaker than the prior quarter and below Fitch Ratings'
expectations. The decline in net revenues was primarily driven by reduced
activity in the fixed income markets. Jefferies' ratings incorporate the
inherent cyclicality of the business, and are therefore not impacted by the
quarterly slowdown in fixed income trading.
Revenues from fixed income trading were down 37% from the first quarter, which
tends to be seasonally stronger. The firm cited reduced trading flows in March
and April, resulting from more cautious investor sentiment amid uncertainty
regarding monetary policy in the U.S. Fitch notes that there was only one day
of trading losses during the quarter, excluding Knight Capital Group, Inc.
(KCG). This suggests that the underperformance was part of a sustained decline
in market activity as opposed to any material trading losses.
The investment banking business also continues to underperform relative to its
potential, given Jefferies' recent hires in this segment. Slightly higher
advisory revenues were more than offset by weaker results in debt and equity
capital markets, which was in part market-driven. While management cited a
more robust backlog for the second half of the year, the realization of this
backlog is subject to market conditions. Therefore, Fitch continues to have a
cautious outlook for the rest of 2013 as market conditions have become more
Core equity trading revenues (excluding KCG), were up 7% from the prior
quarter. Jefferies recorded a $6 million unrealized loss on the Knight Capital
Group (KCG) position, which was marked down due to the decline in KCG's stock
price. Mark-to-market gains on the KCG position have contributed approximately
$172.4 million to net revenues over the last four quarters.
Non-compensation expenses were up slightly during the quarter, mainly
resulting from nonrecurring items related to the firm's recent merger with
Leucadia National Corp. (Leucadia) and recent office moves. The compensation
ratio remained above 59%, when adjusted for acquisition-related accounting.
The high compensation rate is viewed as a rating constraint and Fitch would
expect the compensation ratio to trend back down as recent hires achieve
run-rate revenue production.
Firm-wide average Value at Risk (VaR) declined to $8.7 million from $9.3
million quarter-over-quarter (including KCG), largely reflecting reduced
volatility in the dataset and an increase in the diversification benefit.
Jefferies' uses a one year look-back period, which currently reflects a more
benign market environment over the past year. One of the main weaknesses of
the VaR metric is that it tends to under-represent market risk during periods
of low market volatility. Fitch believes that the current VaR levels are
unusually low and expects some increase in future periods.
Leverage (net assets divided by tangible equity) declined modestly to 9.9x at
May 31, 2013 from 10.4x at prior quarter end, as tangible equity increased
slightly and the size of the balance sheet remained flat. Fitch expects that
over time, when market conditions improve, the firm may manage its leverage
levels to somewhat less conservative levels.
Jefferies continued to increase its liquidity buffer, which included $3.4
billion in cash & equivalents. The firm also had $1.8 billion of other
liquidity sources, a portion of which Fitch does not view as highly liquid,
particularly in a stress scenario. Cash & equivalents represent roughly 9% of
total assets, which is somewhat lower than comparable measures at higher-rated
peers. Fitch notes that Jefferies has no unsecured short-term debt and minimal
long-term debt maturities over the next 12 months.
Jefferies, a Delaware-incorporated holding company, is a well-established
full-service investment banking and institutional securities firm primarily
serving middle-market clients and investors. Its primary broker/dealer
operating subsidiary, Jefferies LLC, holds the vast majority of the firm's
consolidated assets and is regulated by the SEC. At May 31, 2013, Jefferies
had U.S. GAAP total assets of $38.9 billion and shareholders' equity of $5.2
billion (including non-controlling interests and $1.7 billion of goodwill from
the recent merger). Fitch considers Jefferies to be a core subsidiary of
Leucadia based on Jefferies' significance relative to Leucadia's equity and
the likely role it will play in the combined company's future strategic
Additional information is available at 'www.fitchratings.com'.
Applicable Criteria and Related Research:
--'Fitch Equalizes Jefferies' and Leucadia's L-T IDRs at 'BBB-' After Merger;
Outlook Stable', March 7, 2013;
--'2013 Outlook: U.S. Securities Firms', Nov. 9, 2012.
Applicable Criteria and Related Research:
2013 Outlook: U.S. Securities Firms
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Ilya Ivashkov, CFA
Fitch Ratings, Inc.
One State Street Plaza
New York, NY 10004
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