Jefferies Financial Group Inc. — Q3 2022 Form 10-Q
Reporting period: Three and nine months ended August 31, 2022; balance-sheet comparisons are with November 30, 2021. Amounts are U.S. dollars. Jefferies operates investment banking and capital markets, asset management, and a legacy Merchant Banking portfolio it is working to reduce.
Financial performance
| Metric | Q3 2022 | Q3 2021 | Change |
|---|---|---|---|
| Total revenues | $1.84bn | $2.14bn | Down 14% |
| Net revenues | $1.52bn | $1.94bn | Down 21% |
| Income before tax | $301.9m | $553.6m | Down 45% |
| Net income | $195.9m | $407.9m | Down 52% |
| Diluted EPS | $0.78 | $1.50 | Down 48% |
Q3 net income was about 12.9% of net revenues, versus 21.0% a year earlier. The tax provision was $105.9m; the effective tax rate rose to 35.1% from 26.3%, largely because the regulatory settlement was not tax-deductible.
- Nine-month results: Net revenues were $4.63bn versus $6.38bn; income before tax was $860.7m versus $1.83bn; net income was $640.8m versus $1.34bn; diluted EPS was $2.48 versus $4.93.
- Q3 segments: Investment Banking and Capital Markets net revenues were $1.13bn and pre-tax income $166.8m. Asset Management recorded a $13.8m net-revenue loss and a $43.6m pre-tax loss. Merchant Banking net revenues were $397.8m and pre-tax income $201.1m.
- Cash flow, nine months: Operating activities provided $1.45bn; investing activities used $106.1m; financing activities used $2.63bn. Cash, cash equivalents and restricted cash decreased $1.31bn to $10.52bn.
- Balance sheet at August 31: Total assets were $55.23bn, total liabilities $44.73bn, and total equity $10.36bn. Cash and cash equivalents were $9.48bn; regulatory-segregated cash and securities were $984m.
- Debt and liquidity: Short-term borrowings were $564m and long-term debt $8.64bn, totaling approximately $9.20bn, versus $9.35bn at November 30, 2021. Parent-company liquidity was $1.72bn. Jefferies Group reported $9.30bn of cash and other liquidity sources and stated it had sufficient excess liquidity under its modeled stress scenario.
Material changes and drivers
- Investment banking and capital markets results declined amid weaker issuance and volatile markets. Q3 investment banking net revenues fell to $681.8m from $1.22bn, chiefly due to lower equity and debt underwriting; advisory revenues were $486.8m, down 16.6%.
- Capital markets net revenues were $452.1m, compared with $442.3m. Equities improved to $277.4m, while fixed income fell to $174.6m, affected by mortgage-inventory mark-to-market losses and reduced securitized-market activity.
- Asset Management’s Q3 investment return was a $19.7m loss, versus a $5.6m gain a year earlier, reflecting difficult conditions, particularly in energy and credit funds.
- Merchant Banking benefited from a $139.0m pre-tax gain on the Idaho Timber sale and stronger Vitesse Energy results; mark-to-market declines in public-company investments partly offset gains. Idaho Timber was sold in two transactions for $239.3m.
- Compensation expense fell with lower revenues. Non-compensation expense rose, including an $80m SEC/CFTC settlement, higher travel and business-development costs, and technology and market-data spending.
- Share repurchases totaled $738.6m during the first nine months; dividends paid were $211.8m. Shares outstanding at August 31 were 228.8m.
Outlook, risks and unusual items
- No quantified company-wide earnings or revenue guidance is provided. Management said the investment banking backlog was consistent with the prior quarter, but transaction execution and timing depend on market conditions; expected transactions may change, be delayed or be cancelled.
- Management described inflation, rising interest rates, market volatility and geopolitical uncertainty as pressures on underwriting and trading activity. Jefferies reported nine firmwide trading-loss days out of 64 in Q3 and one day when aggregate net trading losses exceeded its one-day 95% VaR estimate.
- The $80m combined SEC/CFTC settlement related to an industry-wide investigation into business communications on personal-texting devices. The filing also notes other regulatory reviews and legal proceedings; management did not expect them to significantly affect consolidated financial position or liquidity, though payments could materially affect results in a period.
- Jefferies LLC net capital and excess net capital declined to $1.17bn and $1.07bn from $1.88bn and $1.77bn at May 31, following an August 18 regulatory change affecting capital requirements for certain securities inventory. Management said the broker-dealer remained adequately capitalized.
- At August 31, the company reported $468.9m of gross unrecognized tax benefits, including interest; resolution of tax examinations could materially affect results in the period of resolution.
- Management expected to spin off Vitesse Energy by fiscal year-end, subject to regulatory review, and merge Jefferies Group into the parent by fiscal year-end. After quarter-end, on September 30, Jefferies sold its Oak Hill interests and recognized $175.1m in other revenue; the filing also says related Oak Hill equity commitments ended with the sale.
- Other key exposures include market, credit, liquidity, operational and regulatory risks; the filing discusses possible collateral demands following a downgrade and substantial commitments and guarantees. Management reported compliance with debt covenants and effective disclosure controls.
Investor verification priorities
- Reconcile the $80m regulatory settlement’s cash timing, tax treatment and any remaining related proceedings.
- Track investment-banking backlog conversion and underwriting volumes, and assess whether market conditions continue to pressure fixed income and advisory activity.
- Review the composition and liquidity of the $1.72bn parent-company liquidity figure, upcoming parent debt maturity of $441.7m in October 2023, and the basis for the stress-liquidity assessment.
- Verify the effect of the August regulatory capital rule change and subsequent capital levels at Jefferies LLC.
- Confirm completion and terms of the planned Vitesse Energy spin-off and Jefferies Group merger, and the accounting and cash proceeds from the Oak Hill sale.
- Assess valuation sensitivity in Level 3 positions, credit quality and aging of loans, and exposures under commitments, guarantees and potential downgrade-related collateral requirements.