Jefferies Fires Back as Investors ‘Shoot First’ on Street

Friday, 04 Nov 2011 11:26 AM

 

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The speed and severity of Jefferies Group Inc.’s swoon shows how skeptical investors have become of Wall Street firms after the collapse of MF Global Holdings Ltd. reminded people of 2008.

“The environment is that if you smell smoke, not even see it, then you’re going to worry,” said Kenneth Crawford, a senior portfolio manager at Argent Capital Management in St. Louis, with about $1.2 billion under management. “Given what MF Global did, that caution is not necessarily unwarranted.”

Trading in Jefferies’s stock was halted twice yesterday and the shares plunged as much as 20 percent, the most ever, after Egan-Jones Ratings Co. downgraded the investment bank’s debt, citing large “sovereign obligations” relative to equity. Investors learned from the demise of Lehman Brothers Holdings Inc. and Bear Stearns Cos. that Wall Street wipeouts can be swift, prompting some to head for the exits now.

“In an environment like this, people shoot first,” said Jeffrey Bronchick, chief investment officer and founder of Cove Street Capital LLC in Los Angeles, with about $325 million under management and about 500,000 shares of Jefferies. “Financials are complicated, many people don’t understand them.”

Jefferies shares fell 4.8 percent, or 57 cents, to $11.43 at 10:53 a.m. in New York trading.

Jefferies issued two statements yesterday, in addition to one earlier this week, that may have assuaged investors about its risk from European sovereign debt, which helped lead to MF Global’s collapse. A share purchase by Jefferies’s largest holder yesterday also tempered the decline and the stock closed at $12.01 in New York, down 2.1 percent.

‘Changed Environment’

MF Global, run by former New Jersey governor and Goldman Sachs Group Inc. co-Chairman Jon Corzine, crumbled this week after revealing a $6.3 billion bet on Italian, Spanish, Belgian, Portuguese and Irish debt, which led to credit downgrades, margin calls, regulators’ demands to boost capital and bankruptcy.

Egan-Jones cut New York-based Jefferies’s credit grade one level to BBB-, citing a “changed environment” amid concern that its $2.68 billion in “sovereign obligations” on Aug. 31 is large relative to equity.

Within an hour of the start of trading yesterday on the New York Stock Exchange, Jefferies issued a statement aiming to reassure investors about the amount of its risk tied to the debt of Portugal, Italy, Ireland, Greece and Spain. The company explained that the amount of European government bonds cited by Egan-Jones are balanced by “short positions” and futures, giving the company “net short exposure” of $38 million, or about 1 percent of equity.

Disclosure Insight

Two and a half hours later, with its shares still down as much as 10 percent, the investment bank published a “supplemental” statement to explain that it wasn’t relying on so-called credit-default swaps, contracts that require another party to pay Jefferies if the European debt holdings fail, to hedge the position.

The company also responded to a Disclosure Insight report that stoked concerns that Jefferies could be subject to an investigation by the Securities and Exchange Commission. Disclosure Insight, which uses the Freedom of Information Act to find undisclosed SEC investigations, reported that Jefferies had been involved in a probe dating to April.

Jefferies said in its supplemental statement that it has a “limited number of routine regulatory reviews in process, all of which are insignificant in scope and absolutely immaterial” to the firm.

Bonds Decline

Jefferies Group’s $800 million of 5.125 percent notes due in April 2018 fell 0.75 cent to 84.75 cents on the dollar with a yield of 8.2 percent as of 9:48 a.m. in New York, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.

The yield on the securities compares with 6.8 percent on the average BB grade security, the highest tier of junk debt, according to Bank of America Merrill Lynch index data. The securities are rated Baa2 by Moody’s Investors Service and BBB by Standard & Poor’s, two levels above junk.

The notes, which plunged 5 cents yesterday, were trading at 90 cents on the dollar with a 7 percent yield on Oct. 28, Trace data show.

Leucadia National Corp., Jefferies’s biggest stockholder with a 29 percent stake, said in a regulatory filing later in the day it bought 1 million more shares for $11.84 apiece. New York-based Leucadia, a diversified holding company, is run by Chairman and CEO Ian M. Cumming and President Joseph S. Steinberg.

‘Big, Complicated and Leveraged’

The back-and-forth between Jefferies and its investors highlights how financial stocks have fallen out of favor with investors, said Juan Ocampo, president of New York-based Trajectory Asset Management LLC, which oversees about $250 million and doesn’t own Jefferies shares.

Jefferies’s closing share price of $12.01 yesterday is below the firm’s $13.97 tangible book value per share at the end of August, an indication that investors are questioning the company’s balance sheet and earnings power. Other Wall Street rivals including Bank of America Corp., Goldman Sachs Group Inc. and Morgan Stanley also are trading below tangible book value.

“These firms are opaque and they’re big, complicated and leveraged,” Ocampo said. “There is a dichotomy between those investors who accept comments like, ‘Yes, we do have it hedged, we’re under control, we can run high leverage with that,’ and those who fundamentally now doubt it.”

‘Opportunistic’

Jefferies, founded in 1962 as a block-trading shop, will celebrate its 50th anniversary next year. The firm went public in 1983 and diversified into high-yield bond trading and investment banking in the 1990s. The firm’s founder, Boyd Jefferies, resigned from the firm in 1987 and pleaded guilty to two felonies in connection with the Ivan Boesky insider-trading investigation. He died in 2001.

The firm has been “building its investment bank methodically for over 20 years and using our cash flow from existing core business to fund it,” Chief Executive Officer Richard Handler, 50, said in an interview this week. Handler joined the firm when junk-bond powerhouse Drexel Burnham Lambert Inc. filed for bankruptcy in 1990 and Jefferies hired 60 of its bankers to expand high-yield finance. Since the end of 2007, the firm has expanded its staff by 50 percent.

“Jefferies is opportunistic by history, they have been people who have taken advantage of market disruptions,” Michael Holland, chairman and founder of New York-based Holland & Co. and who doesn’t own Jefferies stock, said yesterday in a phone interview. “The history of the firm indicates that the burden of proof would be on the people who are making the negative observations and assertions.”


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