Jefferies Financial Group Inc. — Q2 2020 Form 10-Q
Business context and reporting period. Jefferies is a diversified financial services company with investment banking and capital markets, asset management, and merchant banking operations. This unaudited filing covers the quarter and six months ended May 31, 2020; balance-sheet comparisons are with November 30, 2019. Results reflect the COVID-19 market shock and recovery, and prior-year results include a significant tax benefit that makes earnings comparisons unusually large.
Key financial results
Amounts below are in millions, except per-share data and percentages.
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Total revenues | $1,377.5 | $1,510.4 | $3,069.8 | $2,705.4 |
| Net revenues | $1,147.6 | $1,101.7 | $2,533.9 | $1,930.1 |
| Income before income taxes | $75.5 | $183.5 | $233.3 | $232.8 |
| Net income | $43.5 | $672.3 | $155.6 | $719.3 |
| Net income attributable to common shareholders | $44.9 | $670.8 | $157.9 | $715.6 |
| Diluted EPS | $0.16 | $2.14 | $0.53 | $2.25 |
- Q2 net revenues rose 4.2% year over year, while total revenues fell 8.8%, reflecting lower interest income and Jefferies Group interest expense. Q2 pre-tax margin on net revenues was approximately 6.6%, versus 16.7% a year earlier.
- Q2 expenses were $1,065.4 million, up from $940.3 million. Compensation and benefits were $598.5 million; management reported Jefferies Group compensation at 53.6% of its net revenues, compared with 54.8% a year earlier.
- For the first half, net revenues increased 31.3%, but net income fell sharply because Q2 2019 included a $544.6 million tax benefit from realization of a prior-period tax effect. The 2020 first-half effective tax rate was 33.3%.
Business performance and material changes
- Investment Banking and Capital Markets: Q2 net revenues were $1,028.8 million and pre-tax income was $214.5 million, versus $859.3 million and $142.6 million, respectively. Record Q2 fixed-income net revenues of $493.1 million and higher equities revenues offset lower investment banking revenues, including debt underwriting and losses tied to Jefferies Finance. First-half segment net revenues reached $2,177.7 million, with record capital-markets and advisory results.
- Asset Management: Q2 net revenues fell to $7.4 million from $44.4 million, and the segment reported a $41.6 million pre-tax loss. Lower investment returns and higher expenses weighed on results. AUM was $1.039 billion at May 31, down from $1.216 billion at November 30; $396 million of AUM was in process of liquidation after quarter-end.
- Merchant Banking: Q2 pre-tax loss was $74.7 million, compared with income of $57.5 million. First-half pre-tax loss was $128.3 million, versus income of $83.9 million. The period included write-downs of The We Company, oil-and-gas and real-estate assets, and weaker associated-company results. Positive contributions included oil hedging, Idaho Timber and FXCM.
Cash flow, balance sheet and liquidity
- Six-month operating cash flow was positive $161.0 million; investing cash flow was negative $163.4 million and financing cash flow was negative $969.4 million. Cash, cash equivalents and restricted cash ended at $7.495 billion, down from $8.480 billion at the start of the period.
- At May 31, total assets were $50.283 billion, total liabilities $40.775 billion and shareholders’ equity $9.327 billion. Short-term borrowings were $656.9 million and long-term debt was $8.020 billion.
- Parent-company liquidity was $1.636 billion, against a stated minimum liquidity target of $584.9 million. Jefferies Group reported $6.542 billion of cash and other liquidity sources and said it had sufficient excess liquidity for modeled contingent outflows. Its long-term capital of $12.1 billion exceeded cash-capital requirements.
- Jefferies LLC reported regulatory net capital of $1.508 billion and excess net capital of $1.431 billion. The filing states that applicable debt covenants were met at May 31.
- Jefferies repurchased 24.8 million common shares for $491.9 million during the first half, at an average $19.85 per share, and paid $83.4 million in dividends. The quarterly common dividend was $0.15 per share.
Outlook, risks and unusual items
- Management gave no specific numerical earnings or revenue guidance. It said Jefferies Group’s investment banking backlog remained solid and incoming business was strong, while noting investment banking revenues were below normal in Q2. The filing cautions that performance is volatile and interim results may not indicate annual results.
- Management described severe market disruption in March followed by a sharp rebound in April and May after government and central-bank interventions. Higher trading volumes and volatility boosted capital-markets activity; margin requirements remained elevated relative to pre-pandemic levels. The firm increased liquidity monitoring, extended secured-funding maturities, and accessed the Federal Reserve Primary Dealer Credit Facility, with $8 million drawn at May 31.
- COVID-19, economic uncertainty, market volatility, client activity, funding availability, credit quality, and the value of investments remain material risks. The company performed a goodwill impairment test at May 31 with no impairment, but stated future valuations remain sensitive to uncertain forecasts.
- Q2 unusual items included a $44.2 million non-cash write-down of The We Company investment, a $13.2 million oil-and-gas impairment in the DJ Basin, and $12.2 million of HomeFed write-downs cited by management. First-half real-estate write-downs included $55.6 million for the RedSky JZ Fulton joint venture; JETX Energy also recorded a $33.0 million oil-and-gas impairment in Q1. Level 3 assets recorded first-half net losses of $127.5 million, while Level 3 liabilities recorded net gains of $144.7 million.
- After quarter-end, Vitesse Energy Finance’s borrowing base was reduced from $170 million to $120 million, effective June 9, due to lower oil prices. S&P affirmed the BBB rating but changed the outlook to negative; Moody’s affirmed Baa3 with a stable outlook, and Fitch rated the company BBB with a stable outlook.
- Legal and regulatory matters are described as ordinary-course or not significant to consolidated financial position; the company says payments could nevertheless be significant to results in a particular period. The filing also discloses substantial commitments and contingent exposures, including $8.193 billion of commitments and guarantees supporting Berkadia commercial paper, derivatives, clearing activities and other arrangements.
Important facts for investors to verify
- How much of the stronger capital-markets revenue is sustainable if market volatility and trading volumes normalize, and whether the investment banking backlog converts to completed transactions.
- The valuation assumptions and potential further losses in The We Company, Level 3 positions, HomeFed real estate, and oil-and-gas assets, especially following the borrowing-base reduction.
- The pace and financial effect of the announced asset-management liquidations, including the $396 million of AUM and $78.8 million of investments described as in liquidation after quarter-end.
- Liquidity and funding resilience if COVID-19 disruption, elevated margin demands or a credit-rating downgrade intensifies; review collateral triggers and available funding capacity.
- Comparability of earnings with 2019: separate recurring operating performance from the $544.6 million prior-year tax benefit and current-period impairments and fair-value changes.
- Share-repurchase authorization and cash deployment after quarter-end, and the extent to which regulated subsidiaries can distribute capital to the parent.