Jefferies Financial Group Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended August 31, 2020; comparisons are to the periods ended August 31, 2019. Jefferies is a diversified financial services company, with investment banking and capital markets as its largest business, alongside asset management and merchant banking.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Total revenues | $1.825 billion | $1.223 billion | $4.895 billion | $3.929 billion |
| Net revenues | $1.616 billion | $857 million | $4.150 billion | $2.787 billion |
| Income before taxes | $412 million | $13 million | $646 million | $246 million |
| Net income attributable to common shareholders | $304 million | $48 million | $462 million | $764 million |
| Diluted EPS | $1.07 | $0.15 | $1.57 | $2.41 |
Q3 net revenues rose about 89% year over year, driven by record Investment Banking and Capital Markets results and higher investment returns in Asset Management. Compensation and benefits were 56.5% of net revenues, versus 52.8% a year earlier; non-compensation expenses were 21.4% of net revenues, versus 35.8%. For the first nine months, those ratios were 54.8% and 23.6%, respectively, compared with 54.2% and 33.4% in 2019.
The nine-month net income comparison is distorted by a $544.6 million tax benefit recognized in 2019 when the company sold its remaining available-for-sale portfolio and realized a previously accumulated tax benefit. The 2020 nine-month tax provision was $185.1 million, an effective rate of 28.7%; the 2019 period recorded a $522.6 million tax benefit.
Business results and material changes
- Investment Banking and Capital Markets: Q3 net revenues were $1.274 billion, versus $757 million; pretax income was $281 million, versus $86 million. Q3 investment banking revenue reached a record $589 million, including $305 million in equity underwriting. Capital markets revenue was $655 million, including record equities revenue of $319 million and fixed income revenue of $336 million. Nine-month segment net revenues were $3.452 billion, versus $2.275 billion.
- Asset Management: Q3 net revenues were $119 million, versus $20 million, mainly reflecting higher investment returns. Nine-month net revenues were $146 million, versus $95 million. Assets under management fell to $622 million from $1.216 billion at November 30, 2019, primarily due to fund liquidations and redemptions; $398 million was liquidated and returned to investors in Q3.
- Merchant Banking: Q3 pretax income was $71 million, compared with a $35 million loss. Nine-month results were a $58 million pretax loss, versus $49 million of income. The 2020 period included $67.8 million of noncash real estate write-offs, oil and gas impairments of $46.2 million, and a $44.2 million write-down of The We Company investment. Q3 also benefited from $54.5 million of unrealized increases in certain public-company investments and record Idaho Timber results.
- The company reorganized its reporting segments in fiscal Q1 2020, separating Asset Management; prior-period segment results were recast. National Beef was sold in November 2019 and Spectrum Brands shares were distributed to shareholders in October 2019.
Cash flow, balance sheet and liquidity
- For the nine months, operating activities provided $1.308 billion of cash, compared with $1.251 billion used in 2019. Investing activities used $188 million; financing activities used $222 million. Cash, cash equivalents and restricted cash ended at $9.398 billion, up from $8.480 billion at the start of the period.
- At August 31, 2020, total assets were $51.774 billion, total liabilities $42.180 billion and total equity $9.444 billion. Cash and cash equivalents were $8.427 billion; cash and securities segregated for regulatory and clearing purposes were $986 million.
- Short-term borrowings were $805 million and long-term debt was $8.420 billion. Long-term debt includes parent and subsidiary obligations; some subsidiary debt is non-recourse to the parent. The company reported $598 million of lease liabilities following adoption of the new lease standard.
- Parent-company liquidity was $1.635 billion, against a stated minimum liquidity target of $575 million. Jefferies Group reported $8.089 billion of cash and other liquidity sources and said it had sufficient excess liquidity to meet modeled contingent outflows. Jefferies LLC reported $1.613 billion of net capital and $1.532 billion of excess net capital.
- The company repurchased 32.66 million shares for $619.9 million during the nine months, at an average $18.98 per share, and paid $122.9 million in dividends. The quarterly common dividend was increased to $0.15 per share in fiscal Q1.
Outlook, risks and unusual items
Management reported a solid investment banking backlog and strong incoming new business, with improved client activity and trading conditions after the sharp market disruption in March 2020. This is commentary, not quantified earnings or revenue guidance. Management said it continued to monitor COVID-19, market conditions and the value of its investments; it reported that remote operations had continued without significant business or control-process disruptions.
- COVID-19, market volatility and economic weakness could reduce client activity and revenues, impair investments, disrupt operations, and affect oil and gas demand and prices. Advisory activity remained affected by uncertainty around completing transactions.
- Merchant Banking losses included impairments of $55.6 million for the RedSky JZ Fulton real estate venture, $6.9 million for the Brooklyn Renaissance Plaza hotel interest, $33.0 million for JETX Energy properties and $13.2 million for Vitesse Energy Finance DJ Basin properties. The We Company investment was marked down by $44.2 million.
- Market and valuation risk remains relevant: Level 3 assets rely on significant unobservable inputs. The filing also disclosed increased transfers into Level 3 associated with reduced pricing transparency.
- A downgrade below investment grade could trigger additional collateral demands. The filing estimated $135.3 million of return or additional collateral under specified derivative downgrade features and separately estimated $76 million of potential collateral calls under other arrangements.
- Commitments included $322.8 million of equity commitments, $331 million of loan commitments, and substantial forward-starting repos and reverse repos. Legal and regulatory proceedings were described as routine or not significant to consolidated financial position; payments could nevertheless materially affect results in a period.
- Moody’s affirmed a Baa3 rating with stable outlook; S&P affirmed BBB and revised its outlook to negative; Fitch rated the company BBB with stable outlook. The company reported covenant compliance. It issued $500 million of 2.75% senior notes due 2032 on October 7, 2020, after quarter-end.
Key facts investors should verify
- How much of record trading and underwriting performance is sustainable, and what the backlog and incoming business convert into.
- Whether Asset Management outflows and the decline in assets under management continue, and how much reported investment return is recurring.
- Further valuation changes or impairment risk in The We Company, real estate, oil and gas, and other investments, including Level 3 positions.
- Liquidity and funding resilience under renewed market stress, including repo financing, debt maturities, ratings outlooks and potential downgrade-related collateral calls.
- The effect of COVID-19, the Jefferies Finance loan reserves, and the 2019 one-time tax benefit when comparing future earnings.