Jefferies Financial Group Inc. quarterly report, Q3 FY2021

Jefferies Financial Group Inc. — Q3 2021 Form 10-Q

Reporting period: Quarter and nine months ended August 31, 2021. Jefferies operates investment banking and capital markets, asset management, and merchant banking businesses. Comparisons below are with the corresponding 2020 periods unless stated otherwise.

Financial performance

Metric	Q3 2021	Q3 2020	Nine months 2021	Nine months 2020
Total revenues	$2.141 billion	$1.825 billion	$7.011 billion	$4.895 billion
Net revenues	$1.939 billion	$1.616 billion	$6.376 billion	$4.150 billion
Income before taxes	$553.6 million	$412.2 million	$1.829 billion	$645.5 million
Net income	$407.9 million	$304.8 million	$1.344 billion	$460.4 million
Diluted EPS	$1.50	$1.07	$4.93	$1.57

Q3 net revenue increased 20% and net income increased 34%. For the first nine months, net revenue rose 54% and net income nearly tripled. The reported effective tax rates were 26.3% for Q3 and 26.5% year to date.
Investment Banking and Capital Markets: Q3 net revenues were $1.651 billion, up from $1.274 billion; pretax income was $590.0 million, versus $281.3 million. Investment banking revenue reached a quarterly record of $1.18 billion, led by advisory ($583.9 million) and underwriting ($596.8 million). Capital markets revenue fell to $442.3 million from $655.2 million as trading activity normalized from the prior-year period.
Asset Management: Q3 segment net revenues were $12.6 million and pretax loss was $18.6 million, compared with $118.6 million of net revenues and $87.6 million of pretax income a year earlier. Lower investment returns drove the decline. Nine-month net revenues rose to $293.9 million from $146.3 million, with pretax income of $173.9 million.
Merchant Banking: Q3 pretax income was $3.4 million, down from $70.7 million; nine-month pretax income was $170.0 million versus a $57.6 million loss. Idaho Timber’s strong first-half results supported year-to-date performance, while Q3 reflected lower lumber prices and inventory valuation charges.
Q3 net income as a share of net revenues was approximately 21%, versus 19% a year earlier; the comparable nine-month figures were approximately 21% and 11%, respectively. These are calculated ratios, not company-reported margin measures.

Financial position, cash flow and liquidity

At August 31, 2021, total assets were $58.04 billion, compared with $53.12 billion at November 30, 2020. Total equity was $10.40 billion, up from $9.44 billion.
Cash and cash equivalents were $9.48 billion; cash, cash equivalents and restricted cash totaled $10.07 billion. Parent-company liquidity was $2.35 billion, versus a stated minimum reserve target of $709.7 million.
Long-term debt was $8.67 billion and short-term borrowings were $307.3 million. Other secured financings were $4.34 billion. Jefferies Group reported $9.20 billion of cash and other liquidity sources and $13.57 billion of long-term capital, which management said exceeded cash-capital requirements. Jefferies LLC net capital was $2.06 billion, including $1.94 billion of excess net capital.
For the nine months, operating cash flow was $86.5 million, down from $1.31 billion. Investing used $256.7 million, while financing provided $575.8 million. Cash flow is affected by trading and financing balance movements and should not be read as a direct measure of earnings.
Jefferies Group reported sufficient excess liquidity to meet modeled contingent outflows. Management stated that debt covenants were met at quarter-end. The parent-company liquidity assessment and regulated-subsidiary liquidity are distinct measures.

Material changes and notable items

Investment-banking results benefited from strong M&A and underwriting markets; management described record Q3 and nine-month investment-banking revenues. It also reported a record backlog of potential future transaction revenues, while cautioning that timing is uncertain and transactions may change or be cancelled.
Q3 equities and fixed-income revenues were lower than the unusually strong prior-year quarter. Management attributed the declines to lower client activity, trading volumes, and volatility in a more normalized market environment.
Jefferies Finance recorded a $56 million one-time charge related to refinancing its debt, partly offsetting otherwise strong results. The filing also reports a $39 million prime-brokerage bad-debt expense during Q2 2021.
Idaho Timber experienced substantially lower lumber prices in Q3, reduced shipments, and inventory carrying-value adjustments. The filing does not quantify the inventory charge separately in the supplied text.
For the nine months, the company repurchased 6.5 million shares for $179.3 million at an average $27.59 per share and paid $161.3 million in dividends. The quarterly common dividend increased to $0.25 per share in Q3.
After quarter-end, the parent announced a tender offer for its $750 million 5.50% notes due 2023. Jefferies Group issued $1.0 billion of 2.625% notes due 2031 and gave notice of a planned redemption of its $750 million 5.125% notes due 2023.

Outlook, risks and contingencies

The filing provides no formal numerical earnings or revenue guidance. Management’s outlook is qualified by the inherently variable results of investment banking and markets activity and by the uncertain realization of transaction backlog.
Key risks include market, credit, liquidity and funding, operational, legal and regulatory, model, and reputational risks. VaR averaged $12.69 million per day in Q3, down from $15.77 million in Q2; trading losses exceeded the 95% one-day VaR estimate on two Q3 days. Management emphasizes that VaR does not capture all potential losses, including extreme events.
A downgrade below investment grade could trigger additional collateral demands under derivatives and other trading agreements. The filing estimates $105.7 million of additional collateral calls under specified arrangements; a separate derivatives disclosure reports $346.0 million of potential collateral return and posting associated with credit-rating contingent features.
Legal and regulatory matters are described as ordinary or not significant to consolidated financial position. The company does not expect a significant adverse effect on financial position or liquidity, though payments could materially affect results in a period. Gross unrecognized tax benefits, including interest, were $473.9 million; the company is under examination in various tax jurisdictions.
Other exposures include $1.47 billion of Berkadia-affiliate commercial paper outstanding, for which Jefferies agreed to reimburse Berkshire Hathaway for up to half of certain losses; VIE exposures and investment commitments; and market risk in less liquid or Level 3 positions. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Important facts for investors to verify

Whether investment-banking activity and the record backlog convert into completed transactions and sustainable revenues.
Whether market-making and trading revenues remain resilient as activity and volatility normalize, and how Asset Management investment returns develop.
The size and effect of Idaho Timber inventory adjustments and the $56 million Jefferies Finance refinancing charge.
Cash-flow variability, funding mix, debt refinancing and redemption outcomes, covenant headroom, and liquidity available at the parent versus regulated subsidiaries.
Potential collateral calls following a rating downgrade, the status of legal and tax matters, and the valuation sensitivity of less liquid investments and VIE exposures.
Potential dilution: the filing estimates up to 30.7 million additional common shares from outstanding awards and convertible preferred shares.