Jefferies CEO Sees Turmoil Easing as MF Global Memories Fade

MF Global Offices in New York
The MF Global logo is displayed at company offices in New York. Photographer: Stephen Yang/Bloomberg

Jefferies Group Inc. Chief Executive Officer Richard Handler said turmoil around the investment bank’s shares and publicly traded debt will ease as the fallout dissipates from the collapse of MF Global Holdings Ltd.

“It is not surprising that our bonds are under pressure after the assault on our company over the past two weeks,” Handler said yesterday in an e-mail. “Some bond investors sell first and ask questions later. We expect the market to return to normal pricing once we move beyond the ripple effect of the inaccuracies others have recently disseminated and once investors digest all the information” that Jefferies disclosed.

Debt of New York-based Jefferies tumbled to distressed levels today and the stock dropped 2 percent to its lowest close since March 2009. The company came under pressure from short sellers after MF Global’s $6.3 billion bet on European debt led to an Oct. 31 bankruptcy and spurred scrutiny of similar stakes at financial firms.

Handler countered by detailing his firm’s European holdings and later cutting the positions by half. Still, the yield on some Jefferies debt hovers above 10 percent and analysts questioned whether the firm needs a more stable funding model.

“We have no need to access the debt markets at this time,” Handler, 50, said in a Nov. 15 interview at Jefferies’s headquarters in Manhattan. “By the time we might consider it again, we think yields will be back in a reasonable range.”

High Yield

The firm’s $500 million of 3.875 percent bonds due November 2015 fell 3.5 cents to 75.5 cents on the dollar at 4:17 p.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority. The debt pays 10.92 percentage points more than similar-maturity U.S. Treasuries, exceeding the 10 percentage-point spread considered distressed.

The 11.8 percent yield compares with an average of 8.8 percent for high-yield or speculative-grade issuers, according to Bank of America Merrill Lynch index data. The securities traded with yields of 4.8 percent in October, Trace data show.

Jefferies is graded Baa2 by Moody’s Investors Service and BBB by Standard & Poor’s. Similarly rated debt for U.S. issuers yields 4.5 percent, index data show.

Jefferies closed at $10.11 today and has dropped 62 percent this year. Only three of the 11 analysts tracked by Bloomberg who follow the firm recommend shares of Jefferies, which sold for as much as $27 in January.

$2 Billion in Cash

Those trends will reverse “as time goes by and people realize Jefferies is the same well-funded company it was two weeks ago,” Handler said in the interview. The average maturity of the company’s long-term debt is about nine years, and investors in thinly traded bond markets have been reacting to inaccurate reports, Handler said.

Jefferies had more than $2 billion in cash as of Aug. 31, the date of the firm’s last public financial statement, according to Brian Friedman, chairman of the executive committee. “Our cash position today is not materially different and we have a further almost $2 billion of available lines of credit,” Friedman said in an e-mail.

The firm could readily borrow more than 90 percent of the fair market value on 77 percent of its “long” inventory as of Aug. 31 because of its quality and liquidity, and Jefferies doesn’t have any unsecured overnight borrowings, Friedman wrote.

New Rules

Analysts including Jeff Harte of Sandler O’Neill & Partners LP in Chicago agree that for the present, Jefferies does have stable funding. Still, short-term financing can “dry up quickly in a stressed environment,” said Harte, who rates the stock “hold.” Shifting to more long-term financing “would improve the market’s confidence in their balance sheet,” he said. Investment banks need the trust of their counterparties, and “that confidence can be fickle and unpredictable.”

Regulators may require brokers such as Jefferies to rely on more long-term funding, which could boost costs, according to a Nov. 8 research note from Douglas Sipkin and Warren Gardiner, analysts at Ticonderoga Securities LLC.

At the end of its third quarter, 63 percent of Jefferies’s financing came from repurchase agreements, they wrote. If that fell to 40 percent and was supplanted with long-term debt, earnings would fall as much as 70 cents a share, they said. They have a “neutral” recommendation on the stock.

Jefferies plunged 18 percent during the week of the Oct. 31 collapse at MF Global, which was run by former New Jersey governor and Goldman Sachs Group Inc. co-chairman Jon Corzine. MF Global filed for bankruptcy after revealing its wrong-way bet on Europe’s most indebted nations.

Stock Slide

Jefferies slid as much as 20 percent Nov. 3 after Egan-Jones Ratings Co. downgraded the firm’s debt one level to BBB-, citing large “sovereign obligations” relative to equity and a “changed environment” for brokers following MF Global’s failure. The ratings firm said it would “prefer that Jefferies maintain a lower leverage” ratio.

The investment bank responded with six statements about its European debt holdings, detailing the specifics of its positions in bonds issued by Portugal, Ireland, Italy, Greece and Spain, and then cut the long and short positions by about $1.1 billion each as of Nov. 7 to assuage investors.

Jefferies points to customers and business partners who weren’t deterred. The company advised Oceana Therapeutics Inc. in its $300 million sale to Salix Pharmaceuticals Ltd. announced on Nov. 8, and Bank of New York Mellon Corp. selected Jefferies yesterday to provide clearing services for its futures commission merchant unit. The firm’s biggest shareholder, Leucadia National Corp., boosted its holdings by 1.5 million shares, bringing the stake to about 29 percent, according to data compiled by Bloomberg.

Profitable Company

Jefferies has been profitable since the end of 2008, with net income rising 53 percent in the third quarter to $68.3 million, overcoming what the firm called “the extremely difficult and volatile operating environment.”

The company took advantage of turmoil after the 2008 financial crisis to expand from the ranks of regional and middle-market firms to compete with the biggest U.S. investment banks. The staff has grown to more than 3,800 from about 2,270 at the end of 2008, and the balance sheet has more than doubled to $45.1 billion. In July, Jefferies completed the acquisition of Prudential Bache from Prudential Financial Inc. to expand in brokerage and clearing services for listed derivatives.

Jefferies remains dwarfed by industry leaders such as Goldman Sachs Group Inc. and Morgan Stanley, which drew on federal support during the financial crisis because regulators viewed them as essential to the stability of the system. Smaller firms such as Jefferies don’t have that support, said Brad Hintz, a Sanford C. Bernstein & Co. analyst and former chief financial officer at Lehman Brothers Holdings Inc.

“Because they don’t have a lender of last resort, they’re walking a high wire -- but without a net underneath,” Hintz said.

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