Business context and reporting period
Jefferies Financial Group Inc. is a diversified financial-services and investing company. Its principal operating businesses are Jefferies Group (investment banking and capital markets, and asset management) and Merchant Banking. This Form 10-Q covers the three months ended February 28, 2019. The comparison is to the three months ended March 31, 2018; following a fiscal-year change, both periods include Jefferies Group results for December through February, but business composition also changed. National Beef’s pre-sale results are discontinued operations in the prior period, and Berkadia and other activities were reorganized into Jefferies Group in late 2018.
Financial performance and position
Amounts below are in millions of dollars unless stated otherwise.
| Metric | Quarter ended Feb. 28, 2019 | Prior comparable quarter |
|---|---|---|
| Total revenues | $1,195.0 | $1,161.1 |
| Net revenues | $828.4 | $895.4 |
| Income from continuing operations before tax | $49.3 | $37.8 |
| Net income attributable to common shareholders | $44.8 | $124.5 |
| EPS, basic and diluted | $0.14 | $0.34 |
| Net cash used in operating activities | $784.0 | $405.3 |
- Net revenues declined 7.5%, while income from continuing operations before tax increased 30.6%. The prior quarter’s common-shareholder income included $38.5 million from discontinued operations attributable to common shareholders and a $43.9 million tax benefit from releasing valuation allowances; the current quarter had neither discontinued-operation income nor that prior-period tax benefit.
- Revenue mix shifted: principal transactions rose to $246.2 million from $145.7 million and interest income to $386.8 million from $275.2 million; investment banking fell to $285.6 million from $440.0 million. Commissions and other fees were broadly flat at $147.1 million.
- Total expenses were $806.4 million, down from $889.8 million. Compensation and benefits were $409.6 million, versus $489.7 million; compensation was 54.2% of Jefferies Group net revenues, versus 55.5%.
- Quarter-end assets were $49.0 billion, liabilities $38.9 billion, and total equity $10.0 billion. Cash and cash equivalents were $5.5 billion; cash, cash equivalents and restricted cash totaled $6.3 billion.
- Short-term borrowings were $530.5 million and long-term debt $7.7 billion, compared with $387.5 million and $7.6 billion, respectively, at November 30, 2018. Parent-company debt was about $990 million. Jefferies Group’s next scheduled note maturity was $644.8 million principal due July 2019.
- Cash flow from investing activities was positive $1.075 billion, largely reflecting investment maturities and sales; financing activities used $38.3 million. Cash and restricted cash increased $265.8 million during the quarter. Operating cash flow was negative, with substantial movements in securities financing and broker-dealer balances.
- Jefferies Group reported $1.412 billion of regulatory net capital and $1.303 billion of excess net capital. Parent-company readily convertible cash and investments were $1.502 billion, against a stated minimum liquidity reserve of $570.5 million.
Material changes and management commentary
- Management said Jefferies Group faced an extremely challenging December market environment and the U.S. government shutdown in December and January, with business returning to a more normal pace afterward.
- Jefferies Group net revenues were $685.7 million, down from $821.2 million, and pretax income was $62.6 million, down from $122.7 million. Equities improved to $174.5 million from $155.8 million; fixed income declined to $196.8 million from $213.1 million. Investment banking fell to $278.0 million from $433.8 million, principally because capital-markets activity was muted.
- Merchant Banking pretax income was $20.1 million, compared with a $49.3 million loss. The current quarter included $27.1 million of equity-method income from National Beef and a $36.0 million mark-to-market gain on Spectrum Brands. These gains and losses make segment results sensitive to investment valuations.
- Jefferies Group’s average daily one-day VaR was $9.06 million, down from $9.59 million in the prior quarter; no daily trading loss exceeded the 95% one-day VaR during this quarter. Management cautions that VaR has limitations and does not capture all tail risks.
- Management reported $5.691 billion of Jefferies Group cash and other liquidity sources at quarter-end and stated that excess liquidity covered modeled contingent outflows. This is a management liquidity measure, not cash available without restrictions throughout the consolidated group.
Outlook, risks, contingencies and unusual items
- The filing provides no quantified earnings or revenue guidance. Management emphasizes that Jefferies Group revenues are not predictable or necessarily recurring and may be materially affected by financial markets and economic conditions.
- After quarter-end, the company sold the remaining available-for-sale securities portfolio. Management expected a $545 million tax benefit in the second quarter from realizing a lodged tax effect; it said the reclassification would not change total equity, but would increase retained earnings and reduce accumulated other comprehensive income by corresponding amounts.
- In March 2019, Jefferies Group entered into a $1.0 billion promissory note with Jefferies Finance, bearing interest at LIBOR plus 5.00% and due no later than May 15, 2019.
- The company proposed acquiring the remaining HomeFed shares for two Jefferies shares per HomeFed share. The proposal remained under review by HomeFed’s independent special committee and requires specified approvals. Jefferies authorized repurchases of shares issued in the transaction if it closes.
- Market, credit, liquidity, operational, legal, regulatory and investment-valuation risks remain material. A downgrade of Jefferies Group below investment grade could trigger additional collateral demands; management estimated approximately $145 million of potential additional collateral under relevant arrangements.
- Commitments included $839 million of loan commitments, $215 million of underwriting commitments and $176.9 million of equity commitments. The disclosed $12.46 billion maximum total also includes forward-starting repos and reverse repos, most of which were expected to settle within three business days. The company also guaranteed up to half of losses under a $1.5 billion Berkadia commercial-paper surety policy; $1.47 billion was outstanding.
- The company is involved in ordinary-course legal and regulatory matters and agency reviews. It said it did not expect a significant adverse effect on consolidated financial position or liquidity, while noting payments could be significant to results in a period. Tax examinations could also affect results when resolved.
Most important facts for investors to verify
- Whether capital-markets and investment-banking activity recovered after the unusually weak December and government-shutdown period, and how much of earnings depends on volatile trading and investment marks.
- The drivers and sustainability of the $545 million second-quarter tax benefit, including its stated lack of effect on total equity.
- Funding and repayment plans for Jefferies Group’s July 2019 $644.8 million note maturity and the $1.0 billion short-term promissory note due by May 15, 2019.
- The status, approvals, share issuance and offsetting repurchase terms of the proposed HomeFed transaction.
- Available liquidity under stress, collateral sensitivity to rating changes, and the risks and timing of material commitments and guarantees.
- Comparability of reported results: the prior period includes discontinued National Beef income and a substantial tax benefit, while segment transfers and the fiscal-year change affect period-to-period interpretation.