Jefferies Financial Group Inc. — Q1 2020 Form 10-Q
Reporting period: Three months ended February 29, 2020; balance-sheet comparisons are to November 30, 2019. Unless noted, figures are in U.S. dollars. The filing was signed April 8, 2020.
Business context and results
Jefferies is a diversified financial services company spanning investment banking and capital markets, asset management, and merchant banking. It reorganized its reportable segments during the quarter, separating Asset Management; prior-year segment results were recast for comparison. The company says its strategy is to develop Investment Banking and Capital Markets and Asset Management while transforming Merchant Banking.
Key financial metrics
| Metric | Q1 2020 | Q1 2019 / comparison |
|---|---|---|
| Total revenues | $1,692.3 million | $1,195.0 million; up 41.6% |
| Net revenues, after Jefferies Group interest expense | $1,386.3 million | $828.4 million; up 67.3% |
| Income before income taxes | $157.8 million | $49.3 million |
| Net income | $112.0 million | $47.0 million |
| Net income attributable to common shareholders | $113.0 million | $44.8 million |
| Basic and diluted EPS | $0.37 | $0.14 |
| Operating cash flow | $(918.1) million | $(784.0) million |
| Investing cash flow | $(49.3) million | $1,074.9 million provided |
| Financing cash flow | $(316.2) million | $(38.3) million |
| Cash, cash equivalents and restricted cash at quarter-end | $7,194.0 million | $6,278.4 million at February 28, 2019 |
Q1 2020 consolidated expenses were $1,160.7 million, including $670.2 million of compensation and benefits. Income before tax was 11.4% of net revenues, compared with 5.9% in the prior-year quarter. The effective tax rate was 29.0%, versus 4.7%; the prior-year rate included a $6.7 million tax-reform benefit.
At February 29, total assets were $51.8 billion, total liabilities $42.2 billion, and total equity $9.4 billion. Cash and cash equivalents were $6.7 billion. Short-term borrowings were $623.2 million and long-term debt was $8.45 billion. Jefferies LLC reported net capital of $1.303 billion and excess net capital of $1.204 billion. Parent-company liquidity was $1.887 billion, against a stated minimum liquidity reserve of $592.5 million.
Material changes and segment performance
- Investment Banking and Capital Markets: Net revenues rose to $1,148.8 million from $658.2 million, and pre-tax income to $250.0 million from $55.1 million. Investment banking revenues were a record $577.5 million, more than double the prior-year quarter; advisory revenue was $343.2 million and underwriting revenue $248.8 million. Equities revenue was $245.6 million and fixed-income revenue $248.2 million.
- Asset Management: Net revenues fell to $20.3 million from $30.7 million, and the segment recorded a $20.9 million pre-tax loss versus $1.2 million income. Assets under management were $1.14 billion, down from $1.216 billion at November 30, 2019, primarily reflecting redemptions and market depreciation.
- Merchant Banking: The segment recorded a $53.6 million pre-tax loss versus $26.4 million income. A $55.6 million non-cash write-off of HomeFed’s RedSky JZ Fulton Mall investment and a $33.0 million non-cash JETX Energy impairment were partly offset by a $61.5 million gain on short-term hedges in other investments. The prior-year comparison included $27.1 million of National Beef equity-method income and a $36.0 million Spectrum Brands mark-to-market gain; National Beef was sold in November 2019 and Spectrum Brands shares distributed in October 2019.
Consolidated income from associated companies swung to a $67.9 million loss from $27.3 million income, driven primarily by the RedSky impairment and losses from Linkem and other real-estate associated companies.
Outlook, risks, contingencies and unusual items
- COVID-19: The pandemic and resulting market disruption arose after the February 29 quarter-end. Management said the full economic and financial impact could not yet be determined and could materially reduce results. It reported an initial adverse effect on equities, fixed income and asset management, followed by a recovery over the prior two-plus weeks and more normal operating levels in equities and fixed income. The investment-banking backlog remained solid, but management said visibility on what could be completed was limited. It planned to monitor merchant-banking investments and assess private holdings for impairment.
- Liquidity and funding: Management reported that COVID-related market volatility increased margin requirements and settlement friction, but those cash needs remained within liquidity-model assumptions and were met. Secured funding was operating efficiently, and Jefferies Group reported sufficient excess liquidity to meet modeled contingent outflows. Jefferies LLC accessed the Federal Reserve Primary Dealer Credit Facility for an immaterial operational test borrowing.
- Market risk: Average daily VaR was $7.39 million for Q1, versus $7.71 million in Q4 2019. Management expected VaR to rise significantly as the pandemic’s volatility entered the historical model and cautioned that VaR may not capture extreme or longer-horizon losses.
- Impairments and valuation: RedSky’s investment was fully written off after refinancing difficulties and a softer Brooklyn real-estate market; the appraisal indicated property value below debt outstanding. JETX’s East Eagle Ford proven properties were written down by $33.0 million, using Level 3 assumptions including a 10% discount rate. Other investment impairments totaled $20.0 million.
- Capital returns: Jefferies repurchased 14.7 million shares for $325.5 million at an average $22.21 in the quarter and paid a $0.15-per-share dividend. After quarter-end, it repurchased 8.36 million shares for $144.3 million at an average $17.26 and authorized an additional $100 million repurchase program.
- Commitments and contingencies: Disclosed commitments totaled up to $7.15 billion, including forward-starting reverse repos and repos, which largely settled within three business days. The company described ordinary-course legal and regulatory matters and did not expect them to materially affect consolidated financial position or liquidity, while noting payments could materially affect results in a period. A downgrade below investment grade could trigger additional collateral demands; the filing estimated $242.9 million for specified derivative features and $132.9 million for certain Jefferies Group arrangements.
- Guidance: The filing provides no quantified earnings or revenue guidance. Results are described as sensitive to market conditions, client activity, asset values, funding and the evolving pandemic.
Most important facts for investors to verify
- Whether pandemic-related volatility, client activity and transaction delays materially changed subsequent-quarter revenues, earnings and investment values.
- Whether HomeFed, JETX Energy, oil-and-gas assets, and other private or Level 3 holdings require further impairments.
- Whether the reported liquidity buffers, secured funding access and regulatory capital remain adequate as margin and collateral requirements change.
- The effect of share repurchases and dividends on parent-company liquidity, debt capacity and shares outstanding.
- Developments in tax examinations and uncertain tax positions; gross unrecognized tax benefits were $346.9 million at quarter-end.