Fitch: Another Weak Quarter for Jefferies, but Capital and Liquidity Remain Strong

NEW YORK--()--Jefferies Group LLC (Jefferies) today reported a fiscal first quarter 2016 (1Q16) loss of $166.8 million driven by market volatility which translated into significant mark downs on two large equities positions including KCG Holdings Inc. (KCG) and $38 million of mark downs on two loan positions at Jefferies Finance LLC (JFIN), the firm's 50% commercial finance joint venture with Massachusetts Mutual Life Insurance Company, according to Fitch Ratings. Investment banking, an area of recent strength, was also challenged by delayed transactions.

The latest results have no immediate rating impact on Jefferies' 'BBB-/F3' ratings or Stable Outlook, given the company's maintenance of a conservative balance sheet, strong capital, solid liquidity and reduced risk levels. Fitch recognizes that Jefferies 1Q16 results are, in part, symptomatic of a continued difficult market environment affecting the industry as a whole, and views the company's steps to de-risk the balance sheet and maintain a conservative financial profile as appropriate responses. Jefferies also noted in its press release that business conditions and results improved in the first half of March.

Jefferies' quarterly net revenues of $299 million were down 42% from the prior quarter and 49% from the prior year, largely driven by a significant decline in equities sales and trading. Equities sales and trading revenues were $1.7 million, down from $203.5 million in 1Q15. The material decline in equities revenue was largely driven by two listed equity positions (one of which was disclosed as being KCG), which combined for $67 million of unrealized loss and $15 million of realized loss in the quarter.

Jefferies' 50% equity stake in JFIN, which flows through equity revenues, produced an after tax loss of $22 million in the quarter, stemming from $38 million of mark downs on two loans that JFIN held at quarter-end. Fitch expects Jefferies to carefully manage the credit, market and liquidity risk associated with JFIN going forward, particularly given the recent volatile market conditions and competitive underwriting environment.

Fixed income revenues improved to $56.8 million from $9.4 million the prior quarter, although 4Q15 was itself a weak quarter. Investment banking had net revenues of $230.9 million, down 38% on a linked-quarter basis and 15% from the prior year, mostly driven by a decline in equity capital markets revenue. Performance in the asset management segment improved, but is a small contributor to overall performance. Lower revenues combined with higher compensation expenses typically paid during the first quarter, drove a net loss of $166.8 million for 1Q16, compared to net income of $20 million in 4Q15.

Excluding losses attributable JFIN and to the two large equity positions would have produced more manageable results in the quarter, with revenues up 10% from the prior quarter and down 14% from the prior year on this basis. That said, Fitch views the JFIN structure and large equity positions, such as those associated with rescue financings, as integral elements of Jefferies' overall business model, making such 'core' metrics less relevant.

In 1Q16, Jefferies continued to improve its risk and capital, reducing its balance sheet further to $35.2 billion, down $3.4 billion from 2015 year-end and $8.6 billion from the year ago period. Jefferies' reported firm-wide value at risk (VaR) for the quarter was $8.4 million, down 16% from $9.7 million in 4Q15. Jefferies-calculated adjusted leverage, defined as assets excluding securities borrowed, reverse repurchase agreements, cash and goodwill and intangibles divided by tangible equity, was estimated at 8.6x at Feb. 29, 2016, down from 8.8x at Nov. 30, 2015. Fitch views Jefferies' balance sheet, leverage and VaR levels as increasingly conservative, although it is expected that over time Jefferies will redeploy capital and risk capacity.

Jefferies-calculated liquidity, which includes cash, cash equivalents, high-quality government securities and reverse repurchase agreements collateralized by high-quality government securities, decreased to 12.9% of total tangible assets (from 13.9% of total tangible assets at 4Q15) but remains strong. A dip in first quarter liquidity is typical as the firm pays bonuses in the quarter, resulting in lower cash balances. The company repaid $350 million of debt maturing in March 2016 with cash on hand and has paid down a net $784 million of debt over the last year.

Jefferies, a Delaware-incorporated holding company, is a full-service investment banking and institutional securities firm primarily serving middle-market clients and investors. Its primary broker/dealer operating subsidiary, Jefferies LLC, holds the vast majority of the firm's consolidated assets and is regulated by the SEC. At Feb. 29, 2016, Jefferies had U.S. GAAP total assets of $35.2 billion and shareholders' equity of $5.3 billion (including non-controlling interests and $1.9 billion of goodwill and intangibles). Fitch considers Jefferies to be a core subsidiary of Leucadia National Corp. (Leucadia; 'BBB-', Outlook Stable) based on Jefferies' significance relative to Leucadia's equity and the role it is expected to continue playing in the combined company's future strategic direction.

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Contacts

Fitch Ratings
Joo-Yung Lee
Managing Director
+1-212-908-0560
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Nathan Flanders
Managing Director
+1-212-908-0827
or
Michael Dodge
Associate Director
+1-212-908-0379
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com

Contacts

Fitch Ratings
Joo-Yung Lee
Managing Director
+1-212-908-0560
Fitch Ratings, Inc.
33 Whitehall Street
New York, NY 10004
or
Nathan Flanders
Managing Director
+1-212-908-0827
or
Michael Dodge
Associate Director
+1-212-908-0379
or
Media Relations:
Sandro Scenga, +1 212-908-0278
sandro.scenga@fitchratings.com