Quarterly Report — Form 10-Q — Sect. 13 / 15(d) – SEA’34 Filing Table of Contents
Document/ExhibitDescriptionPagesSize 1: 10-Q Jefferies Financial Group Inc. 2Q 2020 10-Q HTML 3.58M
2: EX-31.1 Richard B. Handler EX-31.1 HTML 46K
3: EX-31.2 Teresa S. Gendron EX-31.2 HTML 46K
4: EX-32.1 Richard B. Handler EX-32.1 HTML 40K
5: EX-32.2 Teresa S. Gendron EX-32.2 HTML 40K
12: R1 Cover HTML 89K
13: R2 Consolidated Statements of Financial Condition HTML 162K
14: R3 Consolidated Statements of Financial Condition HTML 64K
(Parenthetical)
15: R4 Consolidated Statements of Operations HTML 144K
16: R5 Consolidated Statements of Comprehensive Income HTML 128K
(Loss)
17: R6 Consolidated Statements of Comprehensive Income HTML 86K
(Loss) (Parenthetical)
18: R7 Consolidated Statements of Cash Flows HTML 171K
19: R8 Consolidated Statements of Cash Flows HTML 46K
(Parenthetical)
20: R9 Consolidated Statements of Changes in Equity HTML 97K
21: R10 Consolidated Statements of Changes in Equity HTML 38K
(Parenthetical)
22: R11 Nature of Operations HTML 45K
23: R12 Basis of Presentation and Significant Accounting HTML 66K
Policies
24: R13 Fair Value Disclosures HTML 1.36M
25: R14 Derivative Financial Instruments HTML 368K
26: R15 Collateralized Transactions HTML 231K
27: R16 Securitization Activities HTML 75K
28: R17 Variable Interest Entities HTML 148K
29: R18 Loans to and Investments in Associated Companies HTML 230K
30: R19 Intangible Assets, Net and Goodwill HTML 72K
31: R20 Short-Term Borrowings HTML 51K
32: R21 Long-Term Debt HTML 91K
33: R22 Leases HTML 85K
34: R23 Mezzanine Equity HTML 40K
35: R24 Compensation Plans HTML 43K
36: R25 Accumulated Other Comprehensive Income (Loss) HTML 72K
37: R26 Revenues from Contracts with Customers HTML 426K
38: R27 Income Taxes HTML 46K
39: R28 Common Share and Earnings Per Common Share HTML 96K
40: R29 Commitments, Contingencies and Guarantees HTML 119K
41: R30 Net Capital Requirements HTML 40K
42: R31 Other Fair Value Information HTML 60K
43: R32 Related Party Transactions HTML 45K
44: R33 Segment Information HTML 169K
45: R34 Basis of Presentation and Significant Accounting HTML 54K
Policies (Policy)
46: R35 Basis of Presentation and Significant Accounting HTML 45K
Policies (Tables)
47: R36 Fair Value Disclosures (Tables) HTML 1.29M
48: R37 Derivative Financial Instruments (Tables) HTML 375K
49: R38 Collateralized Transactions (Tables) HTML 312K
50: R39 Securitization Activities (Tables) HTML 72K
51: R40 Variable Interest Entities (Tables) HTML 129K
52: R41 Loans to and Investments in Associated Companies HTML 214K
(Tables)
53: R42 Intangible Assets, Net and Goodwill (Tables) HTML 73K
54: R43 Short-Term Borrowings (Tables) HTML 48K
55: R44 Long-Term Debt (Tables) HTML 83K
56: R45 Leases (Tables) HTML 88K
57: R46 Accumulated Other Comprehensive Income (Loss) HTML 71K
(Tables)
58: R47 Revenues from Contracts with Customers (Tables) HTML 400K
59: R48 Common Share and Earnings Per Common Share HTML 93K
(Tables)
60: R49 Commitments, Contingencies and Guarantees (Tables) HTML 107K
61: R50 Other Fair Value Information (Tables) HTML 60K
62: R51 Segment Information (Tables) HTML 160K
63: R52 Nature of Operations (Details) HTML 63K
64: R53 Basis of Presentation and Significant Accounting HTML 109K
Policies (Details)
65: R54 Fair Value Disclosures (Schedule of Assets and HTML 184K
Liabilities Measured on Recurring Basis at Fair
Value) (Details)
66: R55 Fair Value Disclosures (Investments at Fair Value) HTML 94K
(Details)
67: R56 Fair Value Disclosures (Investment in FXCM, HTML 41K
Narrative) (Details)
68: R57 Fair Value Disclosures (Nonrecurring Fair Value HTML 71K
Measurements, Narrative) (Details)
69: R58 Fair Value Disclosures (Level 3 Rollforwards) HTML 169K
(Details)
70: R59 Fair Value Disclosures (Analysis of Level 3 Assets HTML 89K
and Liabilities, Narrative) (Details)
71: R60 Fair Value Disclosures (Quantitative Information HTML 397K
About Significant Unobservable Inputs Used in
Level 3 Fair Value Measurements) (Details)
72: R61 Fair Value Disclosures (Summary of Gains (Losses) HTML 55K
Due to Changes in Instrument Specific Credit Risk
on Loans, Other Receivables and Debt Instruments
Measured at Fair Value Under Fair Value Option)
(Details)
73: R62 Fair Value Disclosures (Summary of Amount by which HTML 45K
Contractual Principal Exceeds Fair Value For Loans
and Other Receivables Measured at Fair Value Under
Fair Value Option) (Details)
74: R63 Fair Value Disclosures (Fair Value Option HTML 54K
Election, Narrative) (Details)
75: R64 Fair Value Disclosures (Financial Instruments Not HTML 42K
Measured at Fair Value, Narrative) (Details)
76: R65 Derivative Financial Instruments (Fair Value and HTML 105K
Related Number of Derivative Contracts Categorized
by Predominant Risk Exposure) (Details)
77: R66 Derivative Financial Instruments (Unrealized and HTML 58K
Realized Gains (Losses) on Derivative Contracts
(Details)
78: R67 Derivative Financial Instruments (Remaining HTML 100K
Contract Maturity of Fair Value of OTC Derivative
Assets and Liabilities) (Details)
79: R68 Derivative Financial Instruments (Counterparty HTML 45K
Credit Quality with Respect to Fair Value of OTC
Derivatives Assets) (Details)
80: R69 Derivative Financial Instruments (Credit Related HTML 51K
Derivative Contracts) (Details)
81: R70 Derivative Financial Instruments (Contingent HTML 45K
Features) (Details)
82: R71 Collateralized Transactions (Collateral Pledged) HTML 73K
(Details)
83: R72 Collateralized Transactions (Contractual Maturity) HTML 63K
(Details)
84: R73 Collateralized Transactions (Narrative) (Details) HTML 40K
85: R74 Collateralized Transactions (Offsetting of HTML 125K
Securities Financing Agreements) (Details)
86: R75 Securitization Activities (Activity Related to HTML 42K
Securitizations Accounted for as Sales) (Details)
87: R76 Securitization Activities (Summary of Retained HTML 53K
Interests in SPEs) (Details)
88: R77 Variable Interest Entities (Schedule of HTML 91K
Consolidated VIEs) (Details)
89: R78 Variable Interest Entities (Narrative) (Details) HTML 79K
90: R79 Variable Interest Entities (Schedule of HTML 73K
Nonconsolidated VIEs) (Details)
91: R80 Loans to and Investments in Associated Companies HTML 101K
(Schedule of Loans to and Investments In
Associated Companies) (Details)
92: R81 Loans to and Investments in Associated Companies HTML 84K
(Jefferies Finance, Narrative) (Details)
93: R82 Loans to and Investments in Associated Companies HTML 47K
(Activity Related to Other Transactions with
Jefferies Finance) (Details)
94: R83 Loans to and Investments in Associated Companies HTML 52K
(Berkadia, Narrative) (Details)
95: R84 Loans to and Investments in Associated Companies HTML 41K
(FXCM, Narrative) (Details)
96: R85 Loans to and Investments in Associated Companies HTML 48K
(Linkem, Narrative) (Details)
97: R86 Loans to and Investments in Associated Companies HTML 41K
(HomeFed, Narrative) (Details)
98: R87 Loans to and Investments in Associated Companies HTML 56K
(Real Estate Associated Companies, Narrative)
(Details)
99: R88 Loans to and Investments in Associated Companies HTML 64K
(Other) (Details)
100: R89 Intangible Assets, Net and Goodwill (Schedule of HTML 69K
Intangible Assets, Net And Goodwill) (Details)
101: R90 Intangible Assets, Net and Goodwill (Narrative) HTML 39K
(Details)
102: R91 Intangible Assets, Net and Goodwill (Schedule of HTML 47K
Estimated Future Amortization Expense) (Details)
103: R92 Short-Term Borrowings (Details) HTML 70K
104: R93 Long-Term Debt (Schedule of Debt) (Details) HTML 112K
105: R94 Long-Term Debt (Narrative) (Details) HTML 84K
106: R95 Leases (Information Related to Leases in HTML 45K
Consolidated Statement of Financial Condition)
(Details)
107: R96 Leases (Maturities of Lease Liabilities) (Details) HTML 61K
108: R97 Leases (Narrative) (Details) HTML 43K
109: R98 Leases (Lease Costs) (Details) HTML 46K
110: R99 Leases (Schedule of Cash Flows Supplemental HTML 40K
Information Related to Leases) (Details)
111: R100 Leases (Schedule of Future Minimum Annual Lease HTML 59K
Payments) (Details)
112: R101 Mezzanine Equity (Details) HTML 66K
113: R102 Compensation Plans (Details) HTML 71K
114: R103 Accumulated Other Comprehensive Income (Loss) HTML 63K
(Summary of Accumulated Other Comprehensive Income
(Loss), Net of Taxes) (Details)
115: R104 Accumulated Other Comprehensive Income (Loss) HTML 79K
(Schedule of Accumulated Other Comprehensive
Income (Loss) Reclassification) (Details)
116: R105 Accumulated Other Comprehensive Income (Loss) HTML 39K
(Narrative) (Details)
117: R106 Revenues from Contracts with Customers (Schedule HTML 71K
of Components of Revenue) (Details)
118: R107 Revenues from Contracts with Customers HTML 155K
(Disaggregation of Revenue) (Details)
119: R108 Revenues from Contracts with Customers (Narrative) HTML 54K
(Details)
120: R109 Income Taxes (Details) HTML 57K
121: R110 Common Share and Earnings Per Common Share HTML 89K
(Earnings Per Share Computation) (Details)
122: R111 Common Share and Earnings Per Common Share HTML 56K
(Narrative) (Details)
123: R112 Commitments, Contingencies and Guarantees HTML 69K
(Commitments and Contingencies) (Details)
124: R113 Commitments, Contingencies and Guarantees HTML 67K
(Narrative) (Details)
125: R114 Commitments, Contingencies and Guarantees HTML 56K
(Guarantees) (Details)
126: R115 Net Capital Requirements (Details) HTML 40K
127: R116 Other Fair Value Information (Details) HTML 50K
128: R117 Related Party Transactions (Details) HTML 64K
129: R118 Segment Information (Schedule of Segment Reporting HTML 82K
Information, by Segment) (Details)
130: R119 Segment Information (Narrative) (Details) HTML 46K
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‘10-Q’ — Jefferies Financial Group Inc. 2Q 2020 10-Q
(Exact name of registrant as specified in its Charter)
iNew York
i13-2615557
(State
or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification Number)
i520 Madison Avenue
iNew
York,
iNew York
i10022
(Address of principal executive offices)
(Zip
Code)
(i212) i460-1900
(Registrant's telephone number, including area code)
N/A
(Former name, former address and former fiscal year, if changed since last report)
______________________
Securities
registered or to be registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
iCommon Shares, par value $1 per share
iJEF
iNew
York Stock Exchange
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. iYes☒No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). iYes☒No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer,""accelerated filer,""smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
iLarge
accelerated filer
☒
Accelerated filer
☐
Non-accelerated filer
☐
Smaller reporting company
i☐
Emerging
growth company
i☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate
by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes i☐No ☒
The number of shares outstanding of each of the issuer's classes of common stock at July 1, 2020 was i266,621,060.
Common
shares, par value $1 per share, authorized 600,000,000 shares; 267,111,111 and 291,644,153 shares issued and outstanding, after deducting 49,351,501 and 24,818,459 shares held in treasury
i267,111
i291,644
Additional
paid-in capital
i3,191,893
i3,627,711
Accumulated
other comprehensive income (loss)
(i134,528)
(i273,039)
Retained
earnings
i6,002,078
i5,933,389
Total
Jefferies Financial Group Inc. shareholders' equity
i9,326,554
i9,579,705
Noncontrolling
interests
i34,559
i21,979
Total
equity
i9,361,113
i9,601,684
Total
$
i50,283,215
$
i49,460,234
(1) Total
assets include assets related to variable interest entities of $i709.2 million and $i645.8 million at May 31, 2020 and November 30, 2019, respectively, and Total liabilities
include liabilities related to variable interest entities of $i2,752.3 million and $i3,071.1 million at May 31, 2020 and November 30, 2019, respectively.
See Note 7 for additional information related to variable interest entities.
See notes to interim consolidated financial statements.
Net unrealized holding gains (losses) on investments arising during the period, net of income tax provision (benefit) of $67, $31, $148 and $138
i196
i62
i433
i379
Less:
reclassification adjustment for net (gains) losses included in net income, net of income tax provision (benefit) of $0, $(544,677), $0 and $(545,054)
i—
(i544,307)
i—
(i543,178)
Net
change in unrealized holding gains (losses) on investments, net of income tax provision (benefit) of $67, $544,708, $148 and $545,192
i196
(i544,245)
i433
(i542,799)
Net
unrealized foreign exchange gains (losses) arising during the period, net of income tax provision (benefit) of $(7,838), $(10,439), $(10,985) and $(2,717)
(i25,710)
(i40,147)
(i34,943)
(i9,193)
Less:
reclassification adjustment for foreign exchange (gains) losses included in net income, net of income tax provision (benefit) of $0,$0, $0 and $0
i—
i—
i—
i—
Net
change in unrealized foreign exchange gains (losses), net of income tax provision (benefit) of $(7,838), $(10,439), $(10,985) and $(2,717)
(i25,710)
(i40,147)
(i34,943)
(i9,193)
Net
unrealized gains (losses) on instrument specific credit risk arising during the period, net of income tax provision (benefit) of $51,167, $858, $59,106 and $6,807
i150,040
i2,616
i173,288
i20,151
Less:
reclassification adjustment for instrument specific credit risk (gains) losses included in net income, net of income tax provision (benefit) of $444, $(67), $530 and $(166)
(i1,302)
i199
(i1,554)
i493
Net
change in unrealized instrument specific credit risk gains (losses), net of income tax provision (benefit) of $50,723, $925, $58,576 and $6,973
i148,738
i2,815
i171,734
i20,644
Net
unrealized gains (losses) on cash flow hedges arising during the period, net of income tax provision (benefit) of $0, $86, $0 and $0
i—
i251
i—
i—
Less:
reclassification adjustment for cash flow hedges (gains) losses included in net income (loss), net of income tax provision (benefit) of $0, $161, $0 and $161
i—
(i470)
i—
(i470)
Net
change in unrealized cash flow hedges gains (losses), net of income tax provision (benefit) of $0, $(75), $0 and $(161)
i—
(i219)
i—
(i470)
Net
pension gains (losses) arising during the period, net of income tax provision (benefit) of $0, $0, $0 and $0
i—
i—
i—
i—
Reclassification
adjustment for pension (gains) losses included in net income, net of income tax provision (benefit) of $(214), $(122), $(438) and $(241)
i648
i353
i1,287
i708
Net
change in pension liability, net of income tax provision (benefit) of $214, $122, $438 and $241
i648
i353
i1,287
i708
Other
comprehensive income (loss), net of income taxes
i123,872
(i581,443)
i138,511
(i531,110)
Comprehensive
income
i167,417
i90,833
i294,077
i188,181
Comprehensive
(income) loss attributable to the noncontrolling interests
i2,580
i191
i4,709
(i875)
Comprehensive
(income) loss attributable to the redeemable noncontrolling interests
i198
(i427)
i480
(i289)
Preferred
stock dividends
(i1,404)
(i1,276)
(i2,826)
(i2,552)
Comprehensive
income attributable to Jefferies Financial Group Inc. common shareholders
$
i168,791
$
i89,321
$
i296,440
$
i184,465
See
notes to interim consolidated financial statements.
Net
cash provided by (used for) financing activities
(i969,420)
i167,821
Effect
of foreign exchange rate changes on cash, cash equivalents and restricted cash
(i13,547)
(i3,892)
Net
decrease in cash, cash equivalents and restricted cash
(i985,425)
(i73,650)
Cash,
cash equivalents and restricted cash at beginning of period
i8,480,435
i6,012,662
Cash,
cash equivalents and restricted cash at end of period
$
i7,495,010
$
i5,939,012
The
following presents our cash, cash equivalents and restricted cash by category within the Consolidated Statements of Financial Condition to the total of the same amounts in the Consolidated Statements of Cash Flows above (in thousands):
Jefferies Financial Group Inc. ("Jefferies,""we,""our" or the "Company") is a diversified financial services company engaged in investment banking and capital markets, asset management and direct investing. Jefferies Group LLC ("Jefferies Group"), our largest subsidiary, is the largest independent full-service global investment banking firm headquartered in the U.S.
Jefferies Group operates in itwo
business segments: Investment Banking and Capital Markets, and Asset Management. Investment Banking and Capital Markets includes investment banking, capital markets and other related services. Investment banking provides underwriting and financial advisory services to clients across most industry sectors in the Americas, Europe and Asia. Capital markets businesses operate across the spectrum of equities, fixed income and foreign exchange products. Related services include, among other things, prime brokerage and equity finance, research and strategy, corporate lending and real estate finance.
Our Asset Management segment includes both the operations of Leucadia Asset Management ("LAM") as well as the asset management operations within Jefferies Group. Within Asset Management, we manage, invest in and provide services to a diverse group of alternative asset management platforms across a spectrum of investment strategies
and asset classes. Asset Management offers institutional clients an innovative range of investment strategies through its affiliated managers.
Merchant Banking is where we own a portfolio of businesses and investments, including Linkem (fixed wireless broadband services in Italy); Vitesse Energy, LLC ("Vitesse Energy Finance") and JETX Energy, LLC ("JETX Energy") (oil and gas production and development); real estate, primarily HomeFed LLC ("HomeFed"); Idaho Timber (manufacturing); and FXCM Group, LLC ("FXCM") (provider of online foreign exchange trading services). Our Merchant Banking businesses and investments also included National Beef Packing Company, LLC ("National Beef") (beef processing), prior to its sale in November 2019 and Spectrum Brands Holdings, Inc. ("Spectrum Brands") (consumer products), prior to its distribution to our shareholders in October 2019. The structure of
each of our investments was tailored to the unique opportunity each transaction presented. Our investments may be reflected in our consolidated results as consolidated subsidiaries, equity investments, securities or in other ways, depending on the structure of our specific holdings.
We own approximately i42% of the common shares of Linkem, as well as convertible preferred shares and warrants. If all of
our convertible preferred stock was converted and warrants were exercised, it would increase our ownership to approximately i56% of Linkem's common equity at May 31, 2020. Linkem provides residential broadband services in Italy using LTE technologies deployed over the 3.5 GHz spectrum band. Linkem is accounted for under the equity method.
Vitesse Energy Finance is our i97%
owned consolidated subsidiary that acquires and invests in non-operated working interests and royalties predominantly in the Bakken Shale oil field in North Dakota. JETX Energy is our i98% owned consolidated subsidiary that currently has non-operated working interests and acreage in east Texas.
HomeFed is our i100%
owned consolidated subsidiary that owns and develops residential and mixed use real estate properties. Prior to July 1, 2019, we owned approximately i70% of HomeFed and accounted for it under the equity method. On July 1, 2019, we completed a merger with HomeFed by which we acquired the remaining common stock of HomeFed. From July 1, 2019, the results of HomeFed are reflected on a consolidated basis.
Idaho
Timber is our i100% owned consolidated subsidiary engaged in the manufacture and distribution of various wood products.
Our investment in FXCM and associated companies consist of a senior secured term loan due February 15, 2021, ($i71.6
million principal outstanding at May 31, 2020); a i50% voting interest in FXCM and rights to a majority of all distributions in respect of the equity of FXCM.
9
Note 2. iBasis
of Presentation and Significant Accounting Policies
Our unaudited interim consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes which are normally included in our Form 10-K. These financial statements reflect all adjustments (consisting of normal recurring items or items discussed herein) that management believes are necessary to fairly state results for the interim periods presented. Results of operations for interim periods are not necessarily indicative of annual results of operations. For a detailed discussion about the Company's significant accounting policies, see Note 2, Significant Accounting Policies, included in our Annual Report on Form 10-K for the year ended November
30, 2019 ("2019 10-K").
The preparation of these financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires us to make estimates and assumptions that affect the reported amounts in the financial statements and disclosures of contingent assets and liabilities. On an on-going basis, we evaluate all of these estimates and assumptions. The most important of these estimates and assumptions relate to fair value measurements, compensation and benefits, asset impairment, the ability to realize deferred tax assets, the recognition and measurement of uncertain tax positions and contingencies. Although these and other estimates and assumptions are based on the best available information, actual results could be different from these estimates.
During
the six months ended May 31, 2020, other than the following, there were no significant changes made to the Company's significant accounting policies. The accounting policy changes are attributable to the adoption of the Financial Accounting Standards Board ("FASB") guidance on leases (the "new lease standard") on December 1, 2019. These lease policy updates are applied using a modified retrospective approach. Reported financial information for the historical comparable period was not revised and continues to be reported under the accounting standards in effect during the historical periods.
Lease Accounting
iFor
leases with an original term longer than one year, lease liabilities are initially recognized on the lease commencement date based on the present value of the future minimum lease payments over the lease term, including non-lease components such as fixed common area maintenance costs and other fixed costs for generally all leases. A corresponding right of use ("ROU") asset is initially recognized equal to the lease liability adjusted for any lease prepayments, initial direct costs and lease incentives. The ROU assets are included in Property, equipment and leasehold improvements, net and the lease liabilities are included in Lease liabilities in the Consolidated Statement of Financial Condition.
The discount rates used in determining the present value of leases represent our collateralized borrowing rate considering each lease's term and currency of payment. The lease term
includes options to extend or terminate the lease when it is reasonably certain that we will exercise that option. Certain leases have renewal options that can be exercised at the discretion of the Company. Lease expense is generally recognized on a straight-line basis over the lease term and included in Selling, general and other expenses in the Consolidated Statement of Operations. See Note 12 for further information.
Reclassification to the Consolidated Statements of Operations
During the third quarter of 2019, we reclassified the presentation of certain other fees, primarily related to prime brokerage services offered to clients. These fees were previously presented as Other revenues in the Consolidated Statements of Operations
and are now presented within Commissions and other fees. Previously reported results are presented on a comparable basis. This change had the impact of increasing Commissions and other fees and reducing Other revenues by $ii7.9/ million
and $ii15.7/ million for the three and six months ended May 31, 2019,
respectively. There is no impact on Total revenues as a result of this change in presentation.
10
Receivables
At May 31, 2020 and November 30, 2019, Receivables include receivables from brokers, dealers and clearing organizations of $i4,211.7
million and $i3,011.0 million, respectively, and receivables from customers of securities operations of $i1,077.4 million and
$i1,490.9 million, respectively.
Our subsidiary, Foursight Capital, had auto loan receivables of $i753.0
million and $i741.2 million at May 31, 2020 and November 30, 2019, respectively. Of these amounts, $i670.3 million
and $i621.2 million at May 31, 2020 and November 30, 2019, respectively, were in securitized vehicles. See Notes 6 and 7 for additional information on Foursight Capital's securitization activities. iBased
primarily on Beacon credit scores, Foursight Capital classifies its auto loan receivables as prime, near-prime and sub-prime based on the perceived credit risk at origination and generally considers prime receivables as those with a Beacon score of 680 and above, near-prime with scores between 620 and 679 and sub-prime with scores below 620. The credit quality classification at May 31, 2020 and November 30, 2019 was approximately i14% and i15%
prime, i53% and i53% near-prime and i33%
and i32% sub-prime, respectively.
Other Investments
At May 31, 2020 and November 30, 2019, the Company had other investments (classified as Other assets and Loans to and investments in associated companies) in which fair values are not readily determinable, aggregating $i123.1
million and $i172.8 million, respectively. Impairments recognized on these investments were $i0.6 million and $i0.0 million
during the three months ended May 31, 2020 and 2019, respectively, and $i20.6 million and $i0.0
million during the six months ended May 31, 2020 and 2019, respectively .
Capitalization of Interest
iIn connection with the acquisition of HomeFed in 2019, we began capitalizing interest on qualifying real estate assets. During the three and six months ended May 31, 2020, capitalized interest
of $i1.9 million and $i3.9 million, respectively, was allocated among all of HomeFed's projects that are currently under development.
Payables,
expense accruals and other liabilities
At May 31, 2020 and November 30, 2019, Payables, expense accruals and other liabilities include payables to brokers, dealers and clearing organizations of $i3,006.5 million and $i2,621.7
million, respectively, and payables to customers of securities operations of $i3,655.5 million and $i3,808.6 million, respectively.
Accounting
Developments - Accounting Standards Adopted in Current Annual Reporting Period
Leases. In February 2016, the FASB issued new guidance that affects the accounting and disclosure requirements for leases. We adopted the new lease standard on December 1, 2019 using a modified retrospective transition approach. Accordingly, reported financial information for historical comparable periods is not revised and continues to be reported under the accounting standards in effect during those historical periods. We elected not to reassess whether existing contracts are or contain leases, or the lease classification and initial direct costs of existing leases upon transition. At transition on December
1, 2019, the adoption of this standard resulted in the recognition of operating ROU assets of $i545.8 million and operating lease liabilities of $i614.9 million reflected
in Property, equipment and leasehold improvements, net and Lease liabilities in the Consolidated Statement of Financial Condition, respectively. Finance lease ROU assets and finance lease liabilities were not material and are reflected in Property, equipment and leasehold improvements, net and Lease liabilities in the Consolidated Statement of Financial Condition, respectively.
/
11
Derivatives and Hedging. In August 2017, the FASB issued new guidance to improve the financial reporting of hedging relationships to better portray the economic results of an entity's
risk management activities in its financial statements. We adopted the guidance in the first quarter of fiscal 2020 and the adoption did not have a material impact on our consolidated financial statements.
Accounting Developments - Accounting Standards to be Adopted in Future Periods
Financial Instruments - Credit Losses. In June 2016, the FASB issued new guidance for estimating credit losses on certain types of financial instruments by introducing an approach based on expected losses. The guidance is effective in the first quarter of fiscal 2021. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Goodwill. In January 2017,
the FASB issued new guidance which simplifies goodwill impairment testing. The guidance is effective in the first quarter of fiscal 2021. We do not believe the new guidance will have a material impact on our consolidated financial statements.
Defined Benefit Plans. In August 2018, the FASB issued new guidance to improve the effectiveness of disclosure requirements on defined benefit pension plans and other postretirement plans. The guidance is effective in the first quarter of fiscal 2021. We do not believe the new guidance will have a material impact on our consolidated financial statements.
Internal-Use Software. In August 2018, the FASB issued new guidance which amends the definition of a hosting arrangement and requires that the customer in a hosting
arrangement that is a service contract capitalize certain implementation costs as if the arrangement was an internal-use software project. The guidance is effective in the first quarter of fiscal 2021. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Consolidation. In October 2018, the FASB issued new guidance which requires indirect interests held through related parties under common control arrangements be considered on a proportional basis for determining whether fees paid to decision makers and service providers are variable interests. The guidance is effective in the first quarter of fiscal 2021. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Income
Taxes. In December 2019, the FASB issued new guidance to simplify the accounting for income taxes by removing certain exceptions to the general principles in Topic 740 and to provide more consistent application to improve the comparability of financial statements. The guidance is effective in the first quarter of fiscal 2022. We are currently evaluating the impact of the new guidance on our consolidated financial statements.
Reference Rate Reform. In March 2020, the FASB issued new guidance which provides optional exceptions for applying GAAP to contracts, hedge accounting relationships or other transactions affected by reference rate reform. The optional exceptions can be elected through December 31, 2022.
We are currently evaluating the impact of applying the optional exceptions on our consolidated financial statements.
12
Note 3. iFair Value Disclosures
i
The
following is a summary of our financial assets and liabilities that are accounted for at fair value on a recurring basis, excluding Investments at fair value based on net asset value ("NAV") of $i912.9 million and $i586.9
million at May 31, 2020 and November 30, 2019, respectively, by level within the fair value hierarchy (in thousands):
Total
financial instruments owned, at fair value, excluding investments at fair value based on NAV
$
i5,941,623
$
i11,245,763
$
i554,618
$
(i1,433,197)
$
i16,308,807
Securities
purchased under agreements to resell
$
i—
$
i—
$
i25,000
$
—
$
i25,000
Securities
received as collateral, at fair value
$
i9,500
$
i—
$
i—
$
—
$
i9,500
Liabilities:
Financial
instruments sold, not yet purchased, at fair value:
Corporate equity securities
$
i2,755,601
$
i7,438
$
i4,487
$
—
$
i2,767,526
Corporate
debt securities
i—
i1,471,142
i340
—
i1,471,482
U.S.
government and federal agency securities
i1,851,981
i—
i—
—
i1,851,981
Sovereign
obligations
i1,363,475
i941,065
i—
—
i2,304,540
Commercial
mortgage-backed securities
i—
i—
i35
—
i35
Loans
i—
i1,600,228
i9,463
—
i1,609,691
Derivatives
i871
i2,066,455
i92,057
(i1,632,178)
i527,205
Total
financial instruments sold, not yet purchased, at fair value
$
i5,971,928
$
i6,086,328
$
i106,382
$
(i1,632,178)
$
i10,532,460
Short-term
borrowings
$
i—
$
i20,981
$
i—
$
—
$
i20,981
Long-term
debt
$
i—
$
i735,216
$
i480,069
$
—
$
i1,215,285
Obligation
to return securities received as collateral, at fair value
$
i9,500
$
i—
$
i—
$
—
$
i9,500
(1)Represents
counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.
The following is a description of the valuation basis, including valuation techniques and inputs, used in measuring our financial assets and liabilities that are accounted for at fair value on a recurring basis:
Corporate Equity Securities
•Exchange-Traded Equity Securities: Exchange-traded equity securities are measured based on quoted closing exchange prices, which are generally obtained from external pricing services, and are categorized within Level 1 of the fair value hierarchy, otherwise they are categorized within Level 2 of the fair value
hierarchy. To the extent these securities are actively traded, valuation adjustments are not applied.
14
•Non-Exchange-Traded Equity Securities: Non-exchange-traded equity securities are measured primarily using broker quotations, pricing data from external pricing services and prices observed from recently executed market transactions and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange-traded equity securities are categorized within Level 3 of the fair value hierarchy and measured using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/Earnings before interest, taxes, depreciation
and amortization ("EBITDA"), price/book value), discounted cash flow analyses and transaction prices observed from subsequent financing or capital issuance by Jefferies Group. When using pricing data of comparable companies, judgment must be applied to adjust the pricing data to account for differences between the measured security and the comparable security (e.g., issuer market capitalization, yield, dividend rate, geographical concentration).
•Equity Warrants: Non-exchange-traded equity warrants are measured primarily using pricing data from external pricing services, prices observed from recently executed market transactions and broker quotations and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange-traded equity warrants are generally categorized within Level 3 of the fair value hierarchy and can be measured
using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.
Corporate Debt Securities
•Investment Grade Corporate Bonds: Investment grade corporate bonds are measured primarily using pricing data from external pricing services and broker quotations, where available, prices observed from recently executed market transactions and bond spreads or credit default swap spreads of the issuer adjusted for basis differences between the swap curve and the bond curve. Investment grade corporate bonds measured using these valuation methods are categorized within Level 2 of the fair value hierarchy. If broker quotes, pricing data or spread
data is not available, alternative valuation techniques are used including cash flow models incorporating interest rate curves, single name or index credit default swap curves for comparable issuers and recovery rate assumptions. Investment grade corporate bonds measured using alternative valuation techniques are categorized within Level 2 or Level 3 of the fair value hierarchy and are a limited portion of our investment grade corporate bonds.
•High Yield Corporate and Convertible Bonds: A significant portion of our high yield corporate and convertible bonds are categorized within Level 2 of the fair value hierarchy and are measured primarily using broker quotations and pricing data from external pricing services, where available, and prices observed from recently executed market transactions of institutional size. Where pricing data is less observable, valuations are categorized
within Level 3 of the fair value hierarchy and are based on pending transactions involving the issuer or comparable issuers, prices implied from an issuer's subsequent financing or recapitalization, models incorporating financial ratios and projected cash flows of the issuer and market prices for comparable issuers.
Collateralized Debt Obligations and Collateralized Loan Obligations
Collateralized debt obligations ("CDOs") and collateralized loan obligations ("CLOs") are measured based on prices observed from recently executed market transactions of the same or similar security or based on valuations received from third-party brokers or data providers and are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability and significance of the pricing inputs. Valuation
that is based on recently executed market transactions of similar securities incorporates additional review and analysis of pricing inputs and comparability criteria, including, but not limited to, collateral type, tranche type, rating, origination year, prepayment rates, default rates and loss severity.
U.S. Government and Federal Agency Securities
•U.S. Treasury Securities: U.S. Treasury securities are measured based on quoted market prices obtained from external pricing services and categorized within Level 1 of the fair value hierarchy.
•U.S. Agency Debt Securities: Callable and non-callable U.S. agency debt securities are measured primarily based on quoted market prices
obtained from external pricing services and are generally categorized within Level 1 or Level 2 of the fair value hierarchy.
Municipal Securities
Municipal securities are measured based on quoted prices obtained from external pricing services and are generally categorized within Level 2 of the fair value hierarchy.
15
Sovereign Obligations
Sovereign government obligations are measured based on quoted market prices obtained from external pricing services, where available, or recently executed independent
transactions of comparable size. Sovereign government obligations, with consideration given to the country of issuance, are generally categorized within Level 1 or Level 2 of the fair value hierarchy.
Residential Mortgage-Backed Securities
•Agency Residential Mortgage-Backed Securities: Agency residential mortgage-backed securities include mortgage pass-through securities (fixed and adjustable rate), collateralized mortgage obligations and principal-only and interest-only (including inverse interest-only) securities. Agency residential mortgage-backed securities are generally measured using recent transactions, pricing data from external pricing services or expected future cash flow techniques that incorporate prepayment models and other prepayment assumptions to
amortize the underlying mortgage loan collateral and are categorized within Level 2 or Level 3 of the fair value hierarchy. We use prices observed from recently executed transactions to develop market-clearing spread and yield curve assumptions. Valuation inputs with regard to the underlying collateral incorporate factors such as weighted average coupon, loan-to-value, credit scores, geographic location, maximum and average loan size, originator, servicer and weighted average loan age.
•Non-Agency Residential Mortgage-Backed Securities: The fair value of non-agency residential mortgage-backed securities is determined primarily using discounted cash flow methodologies and securities are categorized within Level 2 or Level 3 of the fair value hierarchy based on the observability and significance of the pricing inputs used. Performance attributes of the underlying mortgage loans
are evaluated to estimate pricing inputs, such as prepayment rates, default rates and the severity of credit losses. Attributes of the underlying mortgage loans that affect the pricing inputs include, but are not limited to, weighted average coupon; average and maximum loan size; loan-to-value; credit scores; documentation type; geographic location; weighted average loan age; originator; servicer; historical prepayment, default and loss severity experience of the mortgage loan pool; and delinquency rate. Yield curves used in the discounted cash flow models are based on observed market prices for comparable securities and published interest rate data to estimate market yields. In addition, broker quotes, where available, are also referenced to compare prices primarily on interest-only securities.
Commercial Mortgage-Backed Securities
•Agency
Commercial Mortgage-Backed Securities: Government National Mortgage Association ("GNMA") project loan bonds are measured based on inputs corroborated from and benchmarked to observed prices of recent securitization transactions of similar securities with adjustments incorporating an evaluation of various factors, including prepayment speeds, default rates and cash flow structures, as well as the likelihood of pricing levels in the current market environment. Federal National Mortgage Association ("FNMA") Delegated Underwriting and Servicing ("DUS") mortgage-backed securities are generally measured by using prices observed from recently executed market transactions to estimate market-clearing spread levels for purposes of estimating fair value. GNMA project loan bonds and FNMA DUS mortgage-backed securities are categorized within Level 2 of the fair value hierarchy.
•Non-Agency
Commercial Mortgage-Backed Securities: Non-agency commercial mortgage-backed securities are measured using pricing data obtained from external pricing services, prices observed from recently executed market transactions or based on expected cash flow models that incorporate underlying loan collateral characteristics and performance. Non-agency commercial mortgage-backed securities are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability of the underlying inputs.
Other Asset-Backed Securities
Other asset-backed securities include, but are not limited to, securities backed by auto loans, credit card receivables, student loans and other consumer loans and are categorized within Level 2 or Level 3 of the fair value hierarchy. Valuations are primarily
determined using pricing data obtained from external pricing services, broker quotes and prices observed from recently executed market transactions. In addition, recent transaction data from comparable deals is deployed to develop market clearing yields and cumulative loss assumptions. The cumulative loss assumptions are based on the analysis of the underlying collateral and comparisons to earlier deals from the same issuer to gauge the relative performance of the deal.
16
Loans and Other Receivables
•Corporate Loans: Corporate loans categorized within Level 2 of the fair value hierarchy are measured based on market
consensus pricing service quotations. Where available, market price quotations from external pricing services are reviewed to ensure they are supported by transaction data. Corporate loans categorized within Level 3 of the fair value hierarchy are measured based on price quotations that are considered to be less transparent, market prices for debt securities of the same creditor and estimates of future cash flows incorporating assumptions regarding creditor default and recovery rates and consideration of the issuer's capital structure.
•Participation Certificates in Agency Residential Loans: Valuations of participation certificates in agency residential loans are based on observed market prices of recently executed purchases and sales of similar loans and data provider pricing. The loan participation certificates are categorized within Level 2 of the fair value hierarchy given
the observability and volume of recently executed transactions and availability of data provider pricing.
•Project Loans and Participation Certificates in GNMA Project and Construction Loans: Valuations of participation certificates in GNMA project and construction loans are based on inputs corroborated from and benchmarked to observed prices of recent securitizations with similar underlying loan collateral to derive an implied spread. Securitization prices are adjusted to estimate the fair value of the loans to account for the arbitrage that is realized at the time of securitization. The measurements are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions.
•Consumer Loans and Funding Facilities: Consumer and small
business whole loans and related funding facilities are valued based on observed market transactions and incorporating valuation inputs including, but not limited to, delinquency and default rates, prepayment rates, borrower characteristics, loan risk grades and loan age. These assets are categorized within Level 2 or Level 3 of the fair value hierarchy.
•Escrow and Claim Receivables: Escrow and claim receivables are categorized within Level 3 of the fair value hierarchy where fair value is estimated based on reference to market prices and implied yields of debt securities of the same or similar issuers. Escrow and claim receivables are categorized within Level 2 of the fair value hierarchy where fair value is based on recent observations in the same receivable.
Derivatives
•Listed
Derivative Contracts: Listed derivative contracts that are actively traded are measured based on quoted exchange prices, broker quotes or vanilla option valuation models, such as Black-Scholes, using observable valuation inputs from the principal market or consensus pricing services. Exchange quotes and/or valuation inputs are generally obtained from external vendors and pricing services. Broker quotes are validated directly through observable and tradeable quotes. Listed derivative contracts that use unadjusted exchange close prices are generally categorized within Level 1 of the fair value hierarchy. All other listed derivative contracts
are generally categorized within Level 2 of the fair value hierarchy.
•Over-the-Counter ("OTC") Derivative Contracts: OTC derivative contracts are generally valued using models, whose inputs reflect assumptions that we believe market participants would use in valuing the derivative in a current transaction. Where available, valuation inputs are calibrated from observable market data. For many OTC derivative contracts, the valuation models do not involve material subjectivity as the methodologies do not entail significant judgment and the inputs to valuation models do not involve a high degree of subjectivity
as the valuation model inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized within Level 2 of the fair value hierarchy given the observability and significance of the inputs to the valuation models. Where significant inputs to the valuation are unobservable, derivative instruments are categorized within Level 3 of the fair value hierarchy.
OTC options include OTC equity, foreign exchange, interest rate and commodity options measured using various valuation models, such as Black-Scholes, with key inputs including the underlying security price, foreign exchange spot rate, commodity price, implied volatility, dividend yield, interest rate curve, strike price and maturity date. Discounted cash flow models are utilized to measure
certain OTC derivative contracts including the valuations of our interest rate swaps, which incorporate observable inputs related to interest rate curves, valuations of our foreign exchange forwards and swaps, which incorporate observable inputs related to foreign currency spot rates and forward curves and valuations of our commodity swaps and forwards, which incorporate observable inputs related to commodity spot prices and forward curves. Discounted cash flow models are also utilized to measure certain variable funding note swaps, which are backed by CLOs and incorporate constant prepayment rate, constant default rate and loss severity assumptions. Credit default swaps include both index and single-name credit default swaps. Where available, external data is used in measuring index credit default swaps and single-name credit default swaps. For commodity and equity total return
swaps, market prices are generally observable for the underlying asset and used as the basis for measuring the fair value of the derivative contracts. Total return swaps executed on other underlyings are measured based on valuations received from external pricing services.
17
•Oil Futures Derivatives: Vitesse Energy Finance uses swaps and call and put options in order to reduce exposure to future oil price fluctuations. Vitesse Energy Finance accounts for the derivative instruments at fair value, which are classified as either Level 1 or Level 2 within the fair value hierarchy. Fair values classified
as Level 1 are measured based on quoted closing exchange prices obtained from external pricing services and Level 2 are determined under the income valuation technique using an option-pricing model that is based on directly or indirectly observable inputs.
Investments at Fair Value
Investments at fair value include investments in hedge funds, fund of funds and private equity funds, which are measured at the NAV of the funds, provided by the fund managers and are excluded from the fair value hierarchy. Investments at fair value also include direct equity investments in private companies, which are measured at fair value using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/EBITDA, price/book value),
discounted cash flow analyses, contingent claims analysis and transaction prices observed for subsequent financing or capital issuance by the company. Direct equity investments in private companies are categorized within Level 2 or Level 3 of the fair value hierarchy.
i
The following tables present information about our investments in entities that have the characteristics of an investment company
(in thousands):
(1)Where
fair value is calculated based on NAV, fair value has been derived from each of the funds' capital statements.
(2)This category includes investments in hedge funds that invest, long and short, primarily in both public and private equity securities in domestic and international markets. At May 31, 2020 and November 30, 2019, i6% and i6%,
respectively, of these investments are redeemable quarterly with ii60/
days prior written notice.
(3)The investments in this category include investments in equity funds that invest in the equity of various U.S. and foreign private companies. These investments cannot be redeemed; instead distributions are received through the liquidation of the underlying assets of the funds, which are expected to be liquidated in approximately one to iinine
years/.
(4)This category includes investments in a hedge fund that invests, long and short, primarily in commodities. Investments in this category are redeemable quarterly with ii60/
days prior written notice.
(5)This category includes investments in hedge funds that invest, long and short, primarily in multi-asset securities in domestic and international markets in both the public and private sectors. At May 31, 2020 and November 30, 2019, investments representing approximately i58% and i5%,
respectively, of the fair value of investments in this category are redeemable monthly with ii30/
or ii60/
days prior written notice.
(6)This category includes investments in a fund that trades and invests in structured finance securities. At May 31, 2020 and November 30, 2019, investments in this category representing approximately i99% and i0%,
respectively, are redeemable quarterly with ii12/
months prior written notice.
/
Investments at fair value also include our investment in The We Company. We invested $i9.0 million in The We Company in 2013 and currently own less than i1%
of The We Company. Our interest in The We Company is reflected in Financial instruments owned, at fair value of $i9.6 million and $i53.8
million at May 31, 2020 and November 30, 2019, respectively.
18
Investment in FXCM
Our investment in FXCM and associated companies consists of a senior secured term loan due February 15, 2021 ($i71.6
million principal outstanding at May 31, 2020), a i50% voting interest in FXCM and rights to a majority of all distributions in respect of the equity of FXCM. Our investment in the FXCM term loan is reported within Financial instruments owned, at fair value in the Consolidated Statements of Financial Condition. We classify our equity investment in FXCM in the Consolidated Statements of Financial Condition as Loans to and investments in associated companies, as we have the ability to significantly influence FXCM through our
seats on the board of directors.
We estimate the fair value of our term loan by using a valuation model with inputs including management's assumptions concerning the amount and timing of expected cash flows, the loan's implied credit rating and effective yield. Because of these inputs and the degree of judgment involved, we have categorized our term loan within Level 3 of the fair value hierarchy.
Securities Purchased Under Agreements to Resell
Securities purchased under agreements to resell may include embedded call features. The valuation of these instruments is based on review of expected future cash flows, interest rates, funding spreads and the fair value of the underlying collateral. Securities purchased under agreements to resell are
categorized within Level 3 of the fair value hierarchy due to limited observability of the embedded derivative and unobservable credit spreads.
Securities Received as Collateral/Obligations to Return Securities Received as Collateral
In connection with securities-for-securities transactions in which we are the lender of securities and are permitted to sell or repledge the securities received as collateral, we report the fair value of the collateral received and the related obligation to return the collateral. Valuation is based on the price of the underlying security and is categorized within Level 1 of the fair value hierarchy.
Short-term Borrowings and Long-term Debt
Short-term
borrowings that are accounted for at fair value include equity-linked notes, which are generally categorized within Level 2 of the fair value hierarchy, as the fair value is based on the price of the underlying equity security. Long-term debt includes variable rate, fixed-to-floating rate, constant maturity swap, digital and Bermudan structured notes. These are valued using various valuation models that incorporate Jefferies Group's own credit spread, market price quotations from external pricing sources referencing the appropriate interest rate curves, volatilities and other inputs as well as prices for transactions in a given note during the period. Long-term debt notes are generally categorized within Level 2 of the fair value hierarchy, where market trades have been observed during the quarter, otherwise they are categorized within Level 3.
Nonrecurring Fair Value Measurements
HomeFed
has a i49% membership interest in the RedSky JZ Fulton Investors ("RedSky JZ Fulton Mall") joint venture, which owns a property in Brooklyn, New York. The property consists of i14 separate tax lots, divided into itwo
development sites which may be redeveloped with buildings consisting of up to i540,000 square feet of floor area development rights. During the three months ended February 29, 2020, difficulties were encountered with attempts to refinance debt within the investment. We viewed this, combined with a softening of the Brooklyn, New York real estate market during the quarter, as a triggering event and evaluated HomeFed's equity method investment in RedSky JZ Fulton Mall to determine if there was an impairment. In connection with
this evaluation, we obtained an appraisal which reflected a reduction in the value of the investment in comparison to an earlier appraisal obtained shortly before the beginning of the quarter. The appraisal was based off of Level 3 inputs consisting of prices of comparable properties and the appraisal indicated that the value of the property was worth less than the debt outstanding. HomeFed recorded an impairment charge of $i55.6 million within Income (loss) related to associated companies during the six months
ended May 31, 2020, which represented all of its carrying value in the joint venture.
Due to a decline in oil and gas prices during the second quarter of 2020, Vitesse Energy Finance performed impairment analyses on its proven oil and gas properties in the Denver-Julesburg Basin ("DJ Basin") of Wyoming and Colorado and the Bakken Shale oil field in North Dakota. Vitesse Energy Finance first determined the estimated undiscounted cash flows based on the reserves and costs utilized in its reserve report and then updated those cash flows based on strip pricing as of May 31, 2020. The expected undiscounted future net cash flows were then compared to the end of quarter net carrying value of the oil and gas properties. No impairment of the Bakken Shale oil field assets was necessary as
the undiscounted future net cash flows significantly exceeded the carrying value of these assets. As undiscounted future net cash flows were lower than the carrying value of the DJ Basin properties, Vitesse Energy Finance then determined the estimated fair value of the proven properties. To
19
measure the estimated fair value of its proven properties, Vitesse Energy Finance used unobservable Level 3 inputs, including a i10.0%
discount rate and estimated future cash flows from its reserve report. The estimated fair value of Vitesse Energy Finance's proven oil and gas properties in the DJ Basin totaled $i26.8 million, which was $i13.2 million
lower than the carrying value as of the end of the second quarter of 2020. As a result, an impairment charge of $ii13.2/ million
was recorded in Selling, general and other expenses during the three and six months ended May 31, 2020.
Due to a decline in oil and gas prices during the first quarter of 2020, JETX Energy performed an impairment analysis for its oil and gas properties in the East Eagle Ford. JETX Energy first determined the estimated undiscounted cash flows based on the reserves and costs utilized in its reserve report and then updated those cash flows based on strip pricing as of February 29, 2020. The expected undiscounted future net cash flows were then compared to the end of quarter net carrying value of the proven properties. As the undiscounted future net cash flows were lower than the carrying value, JETX Energy then determined the estimated fair value of the proven properties. To measure the estimated
fair value of its proven properties, JETX Energy used unobservable Level 3 inputs, including a i10.0% discount rate and estimated future cash flows from its reserve report. The estimated fair value of JETX Energy's proven oil and gas properties in the East Eagle Ford totaled $i9.6
million, which was $i33.0 million lower than the carrying value as of the end of first quarter of 2020. As a result, an impairment charge of $i33.0
million was recorded in Selling, general and other expenses during the six months ended May 31, 2020.
Level 3 Rollforwards
i
The following is a summary of changes in fair value of our financial assets and liabilities
that have been categorized within Level 3 of the fair value hierarchy for the three months ended May 31, 2020 (in thousands):
Changes in unrealized gains/losses included in earnings relating to instruments still held at May 31, 2020 (1)
Assets:
Financial
instruments owned, at fair value:
Corporate equity securities
$
i103,683
$
(i5,346)
$
i63
$
(i68)
$
i—
$
i—
$
(i22,192)
$
i76,140
$
(i5,247)
Corporate
debt securities
i25,090
(i1,480)
i328
(i365)
(i1)
i—
i1,606
i25,178
(i1,464)
CDOs
and CLOs
i29,784
(i12,374)
i—
(i8,471)
(i2,598)
i—
i25,210
i31,551
(i16,451)
Residential
mortgage-backed securities
i16,970
(i1,773)
i1,380
i—
(i7)
i—
i5,769
i22,339
(i1,733)
Commercial
mortgage-backed securities
i4,264
i53
i—
i—
i—
i—
i144
i4,461
i53
Other
asset-backed securities
i41,903
(i2,380)
i11,038
i—
(i8,490)
i—
i43,991
i86,062
(i5,087)
Loans
and other receivables
i103,243
(i1,113)
i45,984
(i46,939)
(i128)
i—
i20,082
i121,129
(i1,069)
Investments
at fair value
i184,507
(i59,962)
i10,599
(i91)
i—
i—
i19,185
i154,238
(i59,962)
FXCM
term loan
i61,628
(i7,863)
i—
i—
i—
i—
i—
i53,765
(i7,863)
Liabilities:
Financial
instruments sold, not yet purchased, at fair value:
Corporate
equity securities
$
i4,275
$
(i60)
$
i—
$
i—
$
i—
$
i—
$
(i25)
$
i4,190
$
i60
Corporate
debt securities
i767
(i23)
(i20)
i—
i—
i—
(i561)
i163
i—
Commercial
mortgage-backed securities
i35
i—
i—
i105
i—
i—
i—
i140
i—
Loans
i7,859
i1,015
(i2,785)
i3,290
i—
i—
i1,295
i10,674
(i1,015)
Net
derivatives (2)
i110,843
(i32,744)
(i10,810)
i33,196
(i603)
i—
(i54,751)
i45,131
i34,259
Long-term
debt (1)
i543,463
(i92,480)
i—
i—
i—
i66,916
(i20,859)
i497,040
i664
(1)Realized
and unrealized gains/losses are primarily reported in Principal transactions revenues in the Consolidated Statements of Operations. Changes in instrument specific credit risk related to structured notes are included in the Consolidated Statements of Comprehensive Income (Loss), net of tax. Changes in unrealized gains/losses included in other comprehensive income (loss) for instruments still held at May 31, 2020 were gains of $i91.8 million
during the three months ended May 31, 2020.
/
20
(2)Net derivatives represent Financial instruments owned, at fair value - Derivatives and Financial instruments sold, not yet purchased, at fair value - Derivatives.
Analysis of Level 3 Assets and Liabilities for the three months ended May 31, 2020
During
the three months ended May 31, 2020, transfers of assets of $i127.5 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Other asset-backed securities of $i44.5 million,
CDOs and CLOs of $i29.6 million, loans and other receivables of $i20.7 million and
investments at fair value of $i19.2 million due to reduced pricing transparency.
During the three months ended May 31, 2020, transfers of assets of $i33.7 million
from Level 3 to Level 2 are primarily attributed to:
•Corporate equity securities of $i26.2 million and CDOs and CLOs of $i4.4 million
due to greater pricing transparency supporting classification into Level 2.
During the three months ended May 31, 2020, transfers of liabilities of $i23.7 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Net
derivatives of $i11.4 million and structured notes of $i11.1 million
due to reduced pricing and market transparency.
During the three months ended May 31, 2020, transfers of liabilities of $i98.6 million from Level 3 to Level 2 of the fair value hierarchy are primarily attributed to:
•Structured notes of $i31.9 million
and net derivatives of $i66.1 million due to greater pricing and market pricing transparency.
Net losses on Level 3 assets were $i92.2 million
and net gains on Level 3 liabilities were $i124.3 million for the three months ended May 31, 2020. Net losses on Level 3 assets were primarily due to decreased market values across CDOs and CLOs, investments at fair value, corporate equity securities and the FXCM term loan. Net gains on Level 3 liabilities were primarily due to decreased
valuations of certain structured notes and market values across derivatives.
21
The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the six months ended May 31, 2020 (in thousands):
Changes in unrealized gains/losses included in earnings relating to instruments still held at May 31, 2020 (1)
Assets:
Financial
instruments owned, at fair value:
Corporate equity securities
$
i58,426
$
(i12,972)
$
i3,016
$
(i2,017)
$
i—
$
i—
$
i29,687
$
i76,140
$
(i12,899)
Corporate
debt securities
i7,490
i1,560
i766
(i479)
(i602)
i—
i16,443
i25,178
i1,190
CDOs
and CLOs
i28,788
(i13,589)
i9,426
(i11,849)
(i4,122)
i—
i22,897
i31,551
(i17,410)
Residential
mortgage-backed securities
i17,740
(i2,248)
i2,062
i—
(i10)
i—
i4,795
i22,339
(i2,195)
Commercial
mortgage-backed securities
i6,110
(i95)
i—
i—
(i1,660)
i—
i106
i4,461
(i680)
Other
asset-backed securities
i42,563
(i2,848)
i33,917
(i664)
(i17,361)
i—
i30,455
i86,062
(i7,226)
Loans
and other receivables
i114,080
(i5,348)
i116,047
(i76,227)
(i56,998)
i—
i29,575
i121,129
(i8,989)
Investments
at fair value
i205,412
(i86,594)
i35,588
(i168)
i—
i—
i—
i154,238
(i86,594)
FXCM
term loan
i59,120
(i5,355)
i—
i—
i—
i—
i—
i53,765
(i5,355)
Securities
purchased under agreements to resell
i25,000
i—
i—
i—
(i25,000)
i—
i—
i—
i—
Liabilities:
Financial
instruments sold, not yet purchased, at fair value:
Corporate equity securities
$
i4,487
$
i216
$
(i513)
$
i—
$
i—
$
i—
$
i—
$
i4,190
$
i140
Corporate
debt securities
i340
(i27)
(i150)
i—
i—
i—
i—
i163
i5
Commercial
mortgage-backed securities
i35
i—
(i35)
i140
i—
i—
i—
i140
i—
Loans
i9,463
i1,072
(i12,958)
i3,290
i—
i—
i9,807
i10,674
(i1,075)
Net
derivatives (2)
i77,168
(i44,729)
(i11,088)
i38,823
(i1,010)
i—
(i14,033)
i45,131
i32,211
Long-term
debt (1)
i480,069
(i101,267)
i—
i—
i—
i175,498
(i57,260)
i497,040
(i4,802)
(1)Realized
and unrealized gains/losses are primarily reported in Principal transactions revenues in the Consolidated Statements of Operations. Changes in instrument specific credit risk related to structured notes are included in the Consolidated Statements of Comprehensive Income (Loss), net of tax. Changes in unrealized gains/losses included in other comprehensive income (loss) for instruments still held at May 31, 2020 were gains of $i106.1
million during the six months ended May 31, 2020.
(2)Net derivatives represent Financial instruments owned, at fair value - Derivatives and Financial instruments sold, not yet purchased, at fair value - Derivatives.
Analysis of Level 3 Assets and Liabilities for the six months ended May 31, 2020
During the six months ended May 31, 2020, transfers of assets of $i148.5
million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Corporate equity securities of $i37.0 million, loans and other receivables of $i33.5 million,
other asset-backed securities of $i31.1 million, CDOs and CLOs of $i22.9 million
and corporate debt securities of $i18.3 million due to reduced pricing transparency.
During the six months ended May 31, 2020, transfers of assets of $i14.6
million from Level 3 to Level 2 are primarily attributed to:
•Corporate equity securities of $i7.3 million and loans and other receivables of $i4.0
million due to greater pricing transparency supporting classification into Level 2.
During the six months ended May 31, 2020, transfers of liabilities of $i37.0 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Net
derivatives of $i26.2 million and loans of $i10.8 million
due to reduced pricing transparency.
22
During the six months ended May 31, 2020, transfers of liabilities of $i98.5 million from Level 3 to Level 2 of the fair value hierarchy are primarily
attributed to:
•Structured notes of $i57.3 million and net derivatives of $i40.2
million due to greater market and pricing transparency.
Net losses on Level 3 assets were $i127.5 million and net gains on Level 3 liabilities were $i144.7
million for the six months ended May 31, 2020. Net losses on Level 3 assets were primarily due to decreased market values across investments at fair value, CDOs and CLOs, corporate equity securities, the FXCM term loan and loans and other receivables. Net gains on Level 3 liabilities were primarily due to decreased valuations of certain structured notes and market values across derivatives.
The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the three months ended May 31, 2019 (in thousands):
Changes in unrealized gains/ losses included in earnings relating to instruments still held at May 31, 2019 (1)
Assets:
Financial
instruments owned, at fair value:
Corporate equity securities
$
i55,576
$
i1,808
$
i221
$
(i179)
$
(i551)
$
i—
$
i2,697
$
i59,572
$
i1,909
Corporate
debt securities
i10,930
(i306)
i816
i—
(i325)
i—
(i2,769)
i8,346
(i307)
CDOs
and CLOs
i43,144
(i1,663)
i—
i—
(i991)
i—
(i14,578)
i25,912
(i2,656)
Residential
mortgage-backed securities
i20,963
(i802)
i—
i—
(i18)
i—
(i2,877)
i17,266
(i759)
Commercial
mortgage-backed securities
i12,820
(i357)
i—
(i331)
(i3,238)
i—
i3,636
i12,530
(i1,292)
Other
asset-backed securities
i35,886
i3,070
i16,531
(i8,868)
(i8,549)
i—
i5,115
i43,185
i3,563
Loans
and other receivables
i78,051
(i2,753)
i38,780
(i13,898)
(i2,438)
i—
i742
i98,484
(i1,277)
Investments
at fair value
i421,098
i35,594
i10,169
(i18,302)
i—
i—
(i39,820)
i408,739
i35,594
FXCM
term loan
i73,600
(i11,412)
i1,500
i—
(i7,088)
i—
i—
i56,600
(i11,412)
Securities
purchased under agreements to resell
i—
i—
i—
i—
i—
i25,000
i—
i25,000
i—
Liabilities:
Financial
instruments sold, not yet purchased, at fair value:
Corporate equity securities
$
i78
$
(i74)
$
(i1,520)
$
i1,737
$
i—
$
i—
$
i—
$
i221
$
i—
Corporate
debt securities
i730
(i148)
(i7)
i1
i22
i—
i71
i669
i90
Commercial
mortgage-backed securities
i70
(i70)
i—
i—
i—
i—
i—
i—
i—
Loans
i3,420
(i191)
(i1,678)
i1,537
i—
i—
i6,340
i9,428
i364
Net
derivatives (2)
i28,975
(i14,760)
(i25)
i4,175
i1,974
i—
i27,110
i47,449
i7,565
Long-term
debt (1)
i283,139
i1,163
i—
i—
(i5,585)
i39,385
(i81,540)
i236,562
(i813)
(1)Realized
and unrealized gains/losses are primarily reported in Principal transactions revenues in the Consolidated Statements of Operations. Changes in instrument specific credit risk related to structured notes are included in the Consolidated Statements of Comprehensive Income (Loss), net of tax. Changes in unrealized gains/losses included in other comprehensive income (loss) for instruments still held at May 31, 2019 were losses of $i0.4 million
during the three months ended May 31, 2019.
(2)Net derivatives represent Financial instruments owned, at fair value - Derivatives and Financial instruments sold, not yet purchased, at fair value - Derivatives.
Analysis of Level 3 Assets and Liabilities for the three months ended May 31, 2019
During the three months ended May 31, 2019, transfers of assets of $i31.7 million
from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Loans and other receivables of $i11.3 million and other asset-backed securities of $i7.6 million
due to reduced pricing transparency.
23
During the three months ended May 31, 2019, transfers of assets of $i79.5 million
from Level 3 to Level 2 are primarily attributed to:
•Investments at fair value of $i39.8 million, CDOs and CLOs of $i17.6 million
and loans and other receivables of $i10.5 million due to greater pricing transparency supporting classification into Level 2.
During the three months ended May 31, 2019, transfers of liabilities of $i57.4 million
from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Structured notes of $i9.5 million and net derivatives of $i41.5 million
due to reduced market and pricing transparency.
During the three months ended May 31, 2019, transfers of liabilities of $i105.4 million from Level 3 to Level 2 of the fair value hierarchy are primarily attributed to:
•Structured notes
of $i91.0 million and net derivatives of $i14.4 million
due to greater market transparency.
Net gains on Level 3 assets were $i23.2 million and net gains on Level 3 liabilities were $i14.1 million
for the three months ended May 31, 2019. Net gains on Level 3 assets were primarily due to increased market values across investments at fair value and other asset-backed securities, partially offset by decreased market values in the FXCM term loan and across loans and other receivables. Net gains on Level 3 liabilities were primarily due to decreased market values across certain derivatives.
The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the six months ended May 31, 2019 (in thousands):
Changes in unrealized gains/ losses included in earnings relating to instruments still held at May 31, 2019 (1)
Assets:
Financial
instruments owned, at fair value:
Corporate equity securities
$
i52,192
$
i5,239
$
i785
$
(i2,031)
$
(i720)
$
i—
$
i4,107
$
i59,572
$
i7,085
Corporate
debt securities
i9,484
(i108)
i2,181
(i2,130)
(i1,177)
i—
i96
i8,346
(i53)
CDOs
and CLOs
i36,105
(i1,233)
i4,782
i—
(i2,130)
i—
(i11,612)
i25,912
(i3,127)
Residential
mortgage-backed securities
i19,603
(i316)
i39
i—
(i45)
i—
(i2,015)
i17,266
(i271)
Commercial
mortgage-backed securities
i10,886
(i180)
i11
(i331)
(i3,278)
i—
i5,422
i12,530
(i1,183)
Other
asset-backed securities
i53,175
(i1,014)
i25,316
(i13,247)
(i9,529)
i—
(i11,516)
i43,185
(i522)
Loans
and other receivables
i46,985
i2,434
i77,004
(i33,549)
(i3,378)
i—
i8,988
i98,484
i844
Investments
at fair value
i396,254
i29,454
i41,512
(i18,302)
i—
i—
(i40,179)
i408,739
i29,454
FXCM
term loan
i73,150
(i10,962)
i1,500
i—
(i7,088)
i—
i—
i56,600
(i10,962)
Securities
purchased under agreements to resell
i—
i—
i—
i—
i—
i25,000
i—
i25,000
i—
Liabilities:
Financial
instruments sold, not yet purchased, at fair value:
Corporate equity securities
$
i—
$
(i76)
$
(i1,546)
$
i1,843
$
i—
$
i—
$
i—
$
i221
$
i—
Corporate
debt securities
i522
(i382)
(i73)
i93
i22
i—
i487
i669
i305
Loans
i6,376
(i401)
(i3,946)
i7,963
i—
i—
(i564)
i9,428
i579
Net
derivatives (2)
i21,614
(i29,079)
(i2,829)
i7,259
i2,031
i—
i48,453
i47,449
i19,607
Long-term
debt (1)
i200,745
(i12,854)
i—
i—
(i11,250)
i101,872
(i41,951)
i236,562
i3,827
(1)Realized
and unrealized gains/losses are primarily reported in Principal transactions revenues in the Consolidated Statements of Operations. Changes in instrument specific credit risk related to structured notes are included in the Consolidated Statements of Comprehensive Income (Loss), net of tax. Changes in unrealized gains (losses) included in other comprehensive income (loss) for instruments still held at May 31, 2019 were gains of $i9.0
million during the six months ended May 31, 2019.
(2)Net derivatives represent Financial instruments owned, at fair value - Derivatives and Financial instruments sold, not yet purchased, at fair value - Derivatives.
24
Analysis of Level 3 Assets and Liabilities for the six months ended May 31, 2019
During the six months ended May 31, 2019, transfers of assets of $i42.3
million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Loans and other receivables of $i15.7 million and other asset-backed securities of $i10.8
million due to reduced pricing transparency.
During the six months ended May 31, 2019, transfers of assets of $i89.0 million from Level 3 to Level 2 are primarily attributed to:
•CDOs and CLOs of $i12.5
million, other asset-backed securities of $i22.3 million and investments at fair value of $i40.2 million
due to greater pricing transparency supporting classification into Level 2.
During the six months ended May 31, 2019, transfers of liabilities of $i69.6 million from Level 2 to Level 3 of the fair value hierarchy are primarily attributed to:
•Structured
notes of $i10.3 million and net derivatives of $i58.7
million due to reduced market and pricing transparency.
During the six months ended May 31, 2019, transfers of liabilities of $i63.2 million from Level 3 to Level 2 of the fair value hierarchy are primarily attributed to:
•Structured
notes of $i52.3 million due to greater market transparency.
Net gains on Level 3 assets were $i23.3 million
and net gains on Level 3 liabilities were $i42.8 million for the six months ended May 31, 2019. Net gains on Level 3 assets were primarily due to increased market values across investments at fair value and corporate equity securities, partially offset by decreased market values in the FXCM term loan and across CDOs and CLOs. Net gains
on Level 3 liabilities were primarily due to decreased market values across derivatives and valuations of certain structured notes.
Quantitative Information about Significant Unobservable Inputs used in Level 3 Fair Value Measurements
i
The tables below present information on the valuation techniques, significant unobservable inputs and their ranges for our
financial assets and liabilities, subject to threshold levels related to the market value of the positions held, measured at fair value on a recurring basis with a significant Level 3 balance. The range of unobservable inputs could differ significantly across different firms given the range of products across different firms in the financial services sector. The inputs are not representative of the inputs that could have been used in the valuation of any one financial instrument (i.e., the input used for valuing one financial instrument within a particular class of financial instruments may not be appropriate for valuing other financial instruments within that given class). Additionally, the ranges of inputs presented below should not be construed to represent uncertainty regarding the fair values of our financial instruments; rather, the range of inputs is reflective of the differences in the underlying characteristics of the financial instruments in each category.
For
certain categories, we have provided a weighted average of the inputs allocated based on the fair values of the financial instruments comprising the category. We do not believe that the range or weighted average of the inputs is indicative of the reasonableness of uncertainty of our Level 3 fair values. The range and weighted average are driven by the individual financial instruments within each category and their relative distribution in the population. The disclosed inputs when compared with the inputs as disclosed in other periods should not be expected to necessarily be indicative of changes in our estimates of unobservable inputs for a particular financial instrument as the population of financial instruments comprising the category will vary from period to period based on purchases and sales of financial instruments during the period as well as transfers into and out of Level 3 each period.
Financial instruments sold, not yet purchased, at fair value
Corporate
equity securities
$
i4,487
Market approach
Transaction level
$i1
—
Loans
$
i9,463
Market
approach
Price
$i50
to
$i100
$i88
Scenario
analysis
Estimated recovery percentage
i1%
—
Derivatives
$
i92,057
Equity
options
Volatility benchmarking
Volatility
i21
%
to
i61%
i43
%
Interest
rate swaps
Market approach
Basis points upfront
i0
to
i22
i13
Cross
currency swaps
Basis points upfront
i2
—
Unfunded commitments
Price
$i88
—
Long-term
debt
Structured notes
$
i480,069
Market
approach
Price
$i84
to
$i108
$i96
Price
€i74
to
€i103
€i91
27
The
fair values of certain Level 3 assets and liabilities that were determined based on third-party pricing information, unadjusted past transaction prices or a percentage of the reported enterprise fair value are excluded from the above tables. At May 31, 2020 and November 30, 2019, asset exclusions consisted of $i117.8 million and $i79.9
million, respectively, primarily comprised of investments at fair value, corporate equity securities, certain derivatives and loans and other receivables. At May 31, 2020 and November 30, 2019, liability exclusions consisted of $i4.8 million and $i0.4
million, respectively, primarily comprised of certain derivatives, corporate debt and commercial mortgage-backed securities.
For recurring fair value measurements categorized within Level 3 of the fair value hierarchy, the uncertainty of the fair value measurement due to the use of significant unobservable inputs and interrelationships between those unobservable inputs (if any) are described below:
•Corporate equity securities, corporate debt securities, loans and other receivables, certain derivatives, other asset-backed securities, private equity securities, securities purchased under agreements to resell and structured notes using a market approach valuation technique. A significant increase (decrease) in the transaction level of corporate equity securities would result in a significantly higher (lower) fair value measurement. A significant increase (decrease)
in the price of the private equity securities, non-exchange-traded securities, unfunded commitments, corporate debt securities, other asset-backed securities, loans and other receivables or structured notes would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the EBITDA multiple related to corporate equity securities would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the underlying stock price of corporate equity securities would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the yield or duration, in isolation, of securities purchased under agreements to resell would result in a significantly lower (higher) fair value measurement. Depending on whether we are a receiver or (payer) of basis points upfront, a significant increase in basis points would result in a significant increase (decrease) in the fair
value measurement of cross currency and interest rate swaps.
•Loans and other receivables, CDOs and CLOs, commercial mortgage-backed securities, corporate debt securities and private equity securities using scenario analysis. A significant increase (decrease) in the possible recovery rates of the cash flow outcomes underlying the financial instrument would result in a significantly higher (lower) fair value measurement for the financial instrument. A significant increase (decrease) in the price of the underlying assets of the financial instruments would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the volatility of the underlying stock price would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the credit spread of the financial instrument would result in a significantly lower (higher) fair
value measurement. A significant increase (decrease) in the discount rate/yield underlying the investment would result in a significantly lower (higher) fair value measurement. A significant increase (decrease) in the revenue growth underlying the investment would result in a significantly higher (lower) fair value measurement.
•CDOs and CLOs, residential mortgage-backed securities, commercial mortgage-backed securities, other asset-backed securities, loans and other receivables and the FXCM term loan using a discounted cash flow valuation technique. A significant increase (decrease) in isolation in the constant default rate, loss severity or cumulative loss rate would result in a significantly lower (higher) fair value measurement. The impact of changes in the constant prepayment rate and duration would have differing impacts depending on the capital structure and type of security. A significant increase
(decrease) in the discount rate/security yield would result in a significantly lower (higher) fair value measurement. A significant increase (decrease) in term based on the time to pay off the loan would result in a lower (higher) fair value measurement.
•Derivative equity options using volatility benchmarking. A significant increase (decrease) in volatility would result in a significantly higher (lower) fair value measurement.
Fair Value Option Election
We have elected the fair value option for all loans and loan commitments made by our investment banking and capital markets businesses. These loans and loan commitments include loans entered into by our investment banking division in connection with client bridge financing and loan syndications,
loans purchased by our leveraged credit trading desk as part of our bank loan trading activities and mortgage and consumer loan commitments, purchases and fundings in connection with mortgage-backed and other asset-backed securitization activities. Loans and loan commitments originated or purchased by our leveraged credit and mortgage-backed businesses are managed on a fair value basis. Loans are included in Financial instruments owned, at fair value and loan commitments are included in Financial instruments owned, at fair value and Financial instruments sold, not yet purchased, at fair value in the Consolidated Statements of Financial Condition. The fair value option election is not applied to loans made to affiliate entities as such loans are entered into as part of ongoing, strategic business ventures. Loans to affiliate entities are included in Loans to and investments in associated companies in the Consolidated Statements of Financial Condition and are accounted
for on an amortized cost basis. We have also elected the fair value option for certain of our
28
structured notes, which are managed by our investment banking and capital markets businesses and are included in Long-term debt and Short-term borrowings in the Consolidated Statements of Financial Condition. We have elected the fair value option for certain financial instruments held by subsidiaries as the investments are risk managed on a fair value basis. The fair value option may be elected for certain secured financings that arise in connection with our securitization activities and other structured financings. Other secured financings, receivables from brokers, dealers and clearing
organizations, receivables from customers of securities operations, other receivables, payables to brokers, dealers and clearing organizations and payables to customers of securities operations, are accounted for at cost plus accrued interest rather than at fair value; however, the recorded amounts approximate fair value due to their liquid or short-term nature.
i
The following is a summary of gains (losses) due to changes in instrument specific credit risk on loans, other receivables and debt instruments
and gains (losses) due to other changes in fair value on long-term debt and short-term borrowings measured at fair value under the fair value option (in thousands):
Financial
Instruments Sold, Not Yet Purchased, at fair value:
Loans
$
i127
$
i—
$
i127
$
i—
Loan
commitments
i1,750
(i757)
i1,089
(i678)
Long-term
Debt:
Changes in instrument specific credit risk (1)
$
i197,737
$
i4,009
$
i227,169
$
i27,492
Other
changes in fair value (2)
(i30,982)
(i36,665)
(i68,624)
(i47,308)
Short-term
borrowings:
Changes in instrument specific credit risk (1)
$
i35
$
i—
$
i91
$
i—
Other
changes in fair value (2)
(i644)
i—
(i881)
i—
(1) Changes
in instrument specific credit risk related to structured notes are included in the Consolidated Statements of Comprehensive Income (Loss), net of tax.
/
(2) Other changes in fair value are included in Principal transactions revenues in the Consolidated Statements of Operations.
i
The
following is a summary of the amount by which contractual principal exceeds fair value for loans and other receivables, long-term debt and short-term borrowings measured at fair value under the fair value option (in thousands):
Loans
and other receivables on nonaccrual status and/or 90 days or greater past due (1) (2)
i331,340
i197,215
Long-term
debt and short-term borrowings
i241,295
i74,408
(1) Interest
income is recognized separately from other changes in fair value and is included in Interest income in the Consolidated Statements of Operations.
/
(2) Amounts include all loans and other receivables 90 days or greater past due by which contractual principal exceeds fair value of $i27.2
million and $i22.2 million at May 31, 2020 and November 30, 2019, respectively.
The aggregate fair value of our loans and other receivables on nonaccrual status and/or 90 days or greater past due was $i175.8
million and $i127.0 million at May 31, 2020 and November 30, 2019, respectively, which includes loans and other receivables 90 days or greater past due of $i16.6
million and $i24.8 million at May 31, 2020 and November 30, 2019, respectively.
As of November 30, 2018, we owned i7,514,477
common shares of Spectrum Brands, representing approximately i15% of Spectrum Brands outstanding common shares. The change in the fair value of our investment in Spectrum Brands aggregated $(i11.3) million and $i24.7
million for the three and six months ended May 31, 2019. We distributed the Spectrum Brands shares
29
through a special pro rata dividend effective on October 11, 2019 to stockholders of record as of the close of business on September 30, 2019. We recorded a $i451.1
million dividend as of the September 16, 2019 declaration date, which was equal to the fair value of Spectrum Brands shares at that time.
We believe accounting for these investments at fair value better reflects the economics of these investments, and quoted market prices for these investments provide an objectively determined fair value at each balance sheet date.
Financial Instruments Not Measured at Fair Value
Certain of our financial instruments are not carried at fair value but are recorded at amounts that approximate fair value due to their liquid or short-term nature and generally negligible credit risk. These financial assets include Cash and cash equivalents and Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and
depository organizations and would generally be presented in Level 1 of the fair value hierarchy. Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations includes U.S. Treasury securities with a fair value of $i96.2 million and $i35.0
million at May 31, 2020 and November 30, 2019, respectively.
Note 4. iDerivative Financial Instruments
Derivative Financial Instruments
Derivative
activities are recorded at fair value in the Consolidated Statements of Financial Condition in Financial instruments owned, at fair value and Financial instruments sold, not yet purchased, at fair value, net of cash paid or received under credit support agreements and on a net counterparty basis when a legally enforceable right to offset exists under a master netting agreement. Predominantly, we enter into derivative transactions to satisfy the needs of our clients and to manage our own exposure to market and credit risks resulting from our trading activities. In addition, we apply hedge accounting to an interest rate swap that has been designated as a fair value hedge of the changes in fair value due to the benchmark interest rate for certain fixed rate senior long-term debt. See Notes 3 and 19 for additional disclosures about derivative financial instruments.
Derivatives are subject to various risks similar to other financial
instruments, including market, credit and operational risk. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with our other trading-related activities. We manage the risks associated with derivatives on an aggregate basis along with the risks associated with proprietary trading as part of our firm wide risk management policies.
In connection with our derivative activities, we may enter into International Swaps and Derivatives Association, Inc. master netting agreements or similar agreements with counterparties.
iThe
following tables present the fair value and related number of derivative contracts at May 31, 2020 and November 30, 2019 categorized by type of derivative contract and the platform on which these derivatives are transacted. The fair value of assets/liabilities represents our receivable/payable for derivative financial instruments, gross of counterparty netting and cash collateral received and pledged. The following tables also provide information regarding (1) the extent to which, under enforceable master netting arrangements, such balances are presented net in the Consolidated Statements of Financial Condition as appropriate under GAAP and (2) the extent to which other rights of setoff associated
with these arrangements exist and could have an effect on our financial position (in thousands, except contract amounts):
Total
derivatives not designated as accounting hedges
i1,822,942
i2,159,383
Total
gross derivative assets/liabilities:
Exchange-traded
i718,685
i962,638
Cleared
OTC
i244,401
i290,201
Bilateral
OTC
i888,519
i906,544
Amounts
offset in Consolidated Statement of Financial Condition (3):
Exchange-traded
(i688,871)
(i688,871)
Cleared
OTC
(i222,869)
(i266,900)
Bilateral
OTC
(i521,457)
(i676,407)
Net
amounts in the Consolidated Statement of Financial Condition (4)
$
i418,408
$
i527,205
(1) Exchange-traded
derivatives include derivatives executed on an organized exchange. Cleared OTC derivatives include derivatives executed bilaterally and subsequently novated to and cleared through central clearing counterparties. Bilateral OTC derivatives include derivatives executed and settled bilaterally without the use of an organized exchange or central clearing counterparty.
(2) Number of exchange-traded contracts may include open futures contracts. The unsettled fair value of these futures contracts is included in Receivables and Payables, expense accruals and other liabilities in the Consolidated Statements of Financial Condition.
(3) Amounts
netted include both netting by counterparty and for cash collateral paid or received.
(4) We have not received or pledged additional collateral under master netting agreements and/or other credit support agreements that is eligible to be offset beyond what has been offset in the Consolidated Statements of Financial Condition.
32
i
The
following table provides information related to gains (losses) recognized in Interest expense of Jefferies Group in the Consolidated Statements of Operations on a fair value hedge (in thousands):
The
following table presents unrealized and realized gains (losses) on derivative contracts which are primarily recognized in Principal transactions revenues in the Consolidated Statements of Operations, which are utilized in connection with our client activities and our economic risk management activities (in thousands):
The
net gains (losses) on derivative contracts in the table above are one of a number of activities comprising our business activities and are before consideration of economic hedging transactions, which generally offset the net gains (losses) included above. We substantially mitigate our exposure to market risk on our cash instruments through derivative contracts, which generally provide offsetting revenues, and we manage the risk associated with these contracts in the context of our overall risk management framework.
OTC Derivatives.iThe
following tables set forth by remaining contract maturity the fair value of OTC derivative assets and liabilities as reflected in the Consolidated Statement of Financial Condition at May 31, 2020 (in thousands):
OTC
Derivative Assets (1) (2) (3)
0-12 Months
1-5 Years
Greater Than 5 Years
Cross- Maturity Netting (4)
Total
Commodity swaps, options and forwards
$
i44,360
$
i10,753
$
i—
$
i—
$
i55,113
Equity
forwards, swaps and options
i46,129
i200
i18,280
(i13,218)
i51,391
Credit
default swaps
i11
i900
i133
(i11)
i1,033
Total
return swaps
i83,333
i63,660
i—
(i8,838)
i138,155
Foreign
currency forwards, swaps and options
i55,197
i11,655
i113
(i6,611)
i60,354
Interest
rate swaps, options and forwards
i70,849
i242,525
i253,402
(i36,319)
i530,457
Total
$
i299,879
$
i329,693
$
i271,928
$
(i64,997)
i836,503
Cross
product counterparty netting
(i37,469)
Total
OTC derivative assets included in Financial instruments owned, at fair value
$
i799,034
(1)At
May 31, 2020, we held net exchange-traded derivative assets, other derivative assets and other credit agreements with a fair value of $i34.1 million, which are not included in this table.
(2)OTC derivative assets in the table above are gross of collateral received. OTC derivative assets are recorded net of collateral received in the Consolidated Statements of Financial Condition. At May 31,
2020, cash collateral received was $i192.6 million.
(3)Derivative fair values include counterparty netting within product category.
(4)Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.
33
OTC
Derivative Liabilities (1) (2) (3)
0-12 Months
1-5 Years
Greater Than 5 Years
Cross-Maturity Netting (4)
Total
Equity
forwards, swaps and options
$
i14,944
$
i251,025
$
i101,362
$
(i13,218)
$
i354,113
Credit
default swaps
i—
i1,489
i69
(i11)
i1,547
Total
return swaps
i61,841
i56,238
i—
(i8,838)
i109,241
Foreign
currency forwards, swaps and options
i74,469
i10,196
i92
(i6,611)
i78,146
Interest
rate swaps, options and forwards
i28,449
i84,262
i80,673
(i36,319)
i157,065
Total
$
i179,703
$
i403,210
$
i182,196
$
(i64,997)
i700,112
Cross
product counterparty netting
(i37,469)
Total
OTC derivative liabilities included in Financial instruments sold, not yet purchased, at fair value
$
i662,643
(1)At
May 31, 2020, we held net exchange-traded derivative liabilities, other derivative liabilities and other credit agreements with a fair value of $i102.4 million, which are not included in this table.
(2)OTC derivative liabilities in the table above are gross of collateral pledged. OTC derivative liabilities are recorded net of collateral pledged in the Consolidated Statements of Financial Condition. At
May 31, 2020, cash collateral pledged was $i347.1 million.
(3)Derivative fair values include counterparty netting within product category.
(4) Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.
i
At
May 31, 2020, the counterparty credit quality with respect to the fair value of our OTC derivative assets was as follows (in thousands):
Counterparty credit quality (1):
A- or higher
$
i188,896
BBB-
to BBB+
i32,975
BB+ or lower
i336,290
Unrated
i240,873
Total
$
i799,034
(1) We
utilize internal credit ratings determined by the Jefferies Group's Risk Management department. Credit ratings determined by Jefferies Group Risk Management use methodologies that produce ratings generally consistent with those produced by external rating agencies.
Certain of Jefferies Group's derivative instruments contain provisions that require its debt to maintain an investment grade credit rating from each of the major credit rating agencies. If Jefferies Group's debt were to fall below investment grade, it would be in violation of these provisions and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on the derivative instruments in liability positions. iThe
following table presents the aggregate fair value of all derivative instruments with such credit-risk-related contingent features that are in a liability position, the collateral amounts posted or received in the normal course of business and the potential collateral we would have been required to return and/or post additionally to our counterparties if the credit-risk-related contingent features underlying these agreements were triggered (in millions):
Derivative instrument liabilities with credit-risk-related contingent features
$
i180.9
$
i42.9
Collateral
posted
(i139.3)
(i3.1)
Collateral
received
i50.9
i114.1
Return
of and additional collateral required in the event of a credit rating downgrade below investment grade (1)
i92.6
i154.0
(1) These
potential outflows include initial margin received from counterparties at the execution of the derivative contract. The initial margin will be returned if counterparties elect to terminate the contract after a downgrade.
Other Derivatives
Vitesse Energy Finance uses swaps and call and put options in order to reduce exposure to future oil price fluctuations. Vitesse Energy Finance accounts for the derivative instruments at fair value. The gains and losses associated with the change in fair value of the derivatives are recorded in Other revenues.
Note
5. iCollateralized Transactions
Our repurchase agreements and securities borrowing and lending arrangements are generally recorded at cost in the Consolidated Statements of Financial Condition, which is a reasonable approximation of their fair values due to their short-term nature. We enter into secured borrowing and lending arrangements to obtain collateral necessary to effect settlement, finance inventory positions, meet customer needs or re-lend as part of dealer operations. We
monitor the fair value of the securities loaned and borrowed on a daily basis as compared with the related payable or receivable, and request additional collateral or return excess collateral, as appropriate. We pledge financial instruments as collateral under repurchase agreements, securities lending agreements and other secured arrangements, including clearing arrangements. Our agreements with counterparties generally contain contractual provisions allowing the counterparty the right to sell or repledge the collateral. Pledged securities owned that can be sold or repledged by the counterparty are included in Financial instruments owned, at fair value, and noted parenthetically as Securities pledged in the Consolidated Statements of Financial Condition.
In instances where we receive securities as collateral in connection with securities-for-securities transactions in which we are the
lender of securities and are permitted to sell or repledge the securities received as collateral, the fair value of the collateral received and the related obligation to return the collateral is reported in the Consolidated Statements of Financial Condition.
35
i
The following tables set forth the carrying value of securities lending arrangements, repurchase
agreements and obligation to return securities received as collateral, at fair value, by class of collateral pledged and remaining contractual maturity (in thousands):
Collateral Pledged
Securities Lending Arrangements
Repurchase
Agreements
Obligation to Return Securities Received as Collateral, at Fair Value
Obligation
to return securities received as collateral, at fair value
i—
i—
i9,500
i—
i9,500
Total
$
i7,308,847
$
i1,556,260
$
i9,670,997
$
i1,755,453
$
i20,291,557
/
We
receive securities as collateral under resale agreements, securities borrowing transactions and customer margin loans. We also receive securities as collateral in connection with securities-for-securities transactions in which we are the lender of securities. In many instances, we are permitted by contract to rehypothecate the securities received as collateral. These securities may be used to secure repurchase agreements, enter into securities lending transactions, satisfy margin requirements on derivative transactions or cover short positions. At May 31, 2020 and November 30, 2019, the approximate fair value of securities received as collateral by us that may be sold or repledged was $i26.8
billion and $i28.7 billion, respectively. At May 31, 2020 and November 30, 2019, a substantial portion of the securities received have been sold or repledged.
36
Offsetting of Securities
Financing Agreements
To manage our exposure to credit risk associated with securities financing transactions, we may enter into master netting agreements and collateral arrangements with counterparties. Generally, transactions are executed under standard industry agreements, including, but not limited to, master securities lending agreements (securities lending transactions) and master repurchase agreements (repurchase transactions).
ii
The
following table provides information regarding repurchase agreements, securities borrowing and lending arrangements and
securities received as collateral, at fair value, and obligation to return securities received as collateral, at fair value, that are recognized in the Consolidated Statements of Financial Condition and (1) the extent to which, under enforceable master netting arrangements, such balances are presented net in the Consolidated Statements of Financial Condition as appropriate under GAAP and (2) the extent to which other rights of setoff associated with these arrangements exist and could have an effect on our consolidated financial position.
(In
thousands)
Gross Amounts
Netting in Consolidated Statements of Financial Condition
Net Amounts in Consolidated Statements of Financial Condition
Obligation
to return securities received as collateral, at fair value
i9,500
—
i9,500
—
—
i9,500
(1)Under
master netting agreements with our counterparties, we have the legal right of offset with a counterparty, which incorporates all of the counterparty's outstanding rights and obligations under the arrangement. These balances reflect additional credit risk mitigation that is available by a counterparty in the event of a counterparty's default, but which are not netted in the Consolidated Statements of Financial Condition because other netting provisions of GAAP are not met.
(2)Includes securities received or paid under collateral arrangements with counterparties that could be liquidated in the event of a counterparty default and thus offset against a counterparty's rights and obligations under the respective repurchase agreements or securities borrowing or lending arrangements.
(3)At May 31,
2020, amounts include $i4,444.7 million of securities borrowing arrangements, for which we have received securities collateral of $i4,337.7
million, and $i470.0 million of repurchase agreements, for which we have pledged securities collateral of $i480.3
million, which are subject to master netting agreements, but we have not determined the agreements to be legally enforceable. At November 30, 2019, amounts include $i5,683.4 million of securities borrowing arrangements, for which we have received securities collateral of $i5,523.6
million, and $i439.7 million of repurchase agreements, for which we have pledged securities collateral of $i447.5
million, which are subject to master netting agreements, but we have not determined the agreements to be legally enforceable.
//
37
Cash and Securities Segregated and on Deposit for Regulatory Purposes or Deposited with Clearing and Depository Organizations
Cash and securities deposited with clearing and depository organizations and segregated in accordance with regulatory regulations
totaled $i668.9 million and $i796.8 million
at May 31, 2020 and November 30, 2019, respectively. Segregated cash and securities consist of deposits in accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, which subjects Jefferies LLC as a broker-dealer carrying customer accounts to requirements related to maintaining cash or qualified securities in segregated special reserve bank accounts for the exclusive benefit of its customers.
Note 6. iSecuritization
Activities
We engage in securitization activities related to corporate loans, mortgage loans, consumer loans and mortgage-backed and other asset-backed securities. In our securitization transactions, we transfer these assets to special purpose entities ("SPEs") and act as the placement or structuring agent for the beneficial interests sold to investors by the SPE. A significant portion of our securitization transactions are the securitization of assets issued or guaranteed by U.S. government agencies. These SPEs generally meet the criteria of variable interest entities ("VIEs"); however, the SPEs are generally not consolidated as we are not considered the primary beneficiary for these SPEs.
We account for our securitization transactions as sales, provided we have relinquished control over the transferred assets. Transferred assets are carried at fair value with
unrealized gains and losses reflected in Principal transactions revenues in the Consolidated Statements of Operations prior to the identification and isolation for securitization. Subsequently, revenues recognized upon securitization are reflected as net underwriting revenues. We generally receive cash proceeds in connection with the transfer of assets to an SPE. We may, however, have continuing involvement with the transferred assets, which is limited to retaining one or more tranches of the securitization (primarily senior and subordinated debt securities in the form of mortgage-backed and other asset-backed securities or CLOs). These securities are included in Financial instruments owned, at fair value in the Consolidated Statements of Financial Condition and are generally initially categorized as Level 2 within the fair value hierarchy.
i
The
following table presents activity related to our securitizations that were accounted for as sales in which we had continuing involvement (in millions):
We
have no explicit or implicit arrangements to provide additional financial support to these SPEs, have no liabilities related to these SPEs and do not have any outstanding derivative contracts executed in connection with these securitization activities at May 31, 2020 and November 30, 2019.
i
The following table summarizes
our retained interests in SPEs where we transferred assets and have continuing involvement and received sale accounting treatment (in millions):
U.S. government agency residential mortgage-backed securities
$
i1,028.5
$
i55.6
$
i10,671.7
$
i103.3
U.S.
government agency commercial mortgage-backed securities
i672.3
i55.2
i1,374.8
i45.8
CLOs
i1,468.1
i121.6
i3,006.7
i58.4
Consumer
and other loans
i707.6
i67.5
i1,149.3
i71.8
/
Total
assets represent the unpaid principal amount of assets in the SPEs in which we have continuing involvement and are presented solely to provide information regarding the size of the transactions and the size of the underlying assets supporting our retained interests, and are not considered representative of the risk of potential loss. Assets retained in connection with a securitization transaction represent the fair value of the securities of one or more tranches issued by an SPE, including senior and subordinated tranches. Our risk of loss is limited to this fair value amount which is included in total Financial instruments owned, at fair value in the Consolidated Statements of Financial Condition.
38
Although not obligated, in connection with secondary market-making activities
we may make a market in the securities issued by these SPEs. In these market-making transactions, we buy these securities from and sell these securities to investors. Securities purchased through these market-making activities are not considered to be continuing involvement in these SPEs. To the extent we purchased securities through these market-making activities and we are not deemed to be the primary beneficiary of the VIE, these securities are included in agency and non-agency mortgage-backed and asset-backed securitizations in the nonconsolidated VIEs section presented in Note 7.
Foursight Capital also utilizes SPEs to securitize automobile loans receivable. These SPEs are VIEs and our subsidiary is the primary beneficiary; the related assets and the secured borrowings are recognized in the Consolidated Statements of Financial Condition. These secured borrowings do not have recourse to our subsidiary's general credit.
See Note 7 for further information on securitization activities and VIEs.
Note 7. iVariable Interest Entities
VIEs are entities in which equity investors lack the characteristics of a controlling financial interest. VIEs are consolidated by the primary beneficiary. The primary beneficiary is the party who has
both (1) the power to direct the activities of a VIE that most significantly impact the entity's economic performance and (2) an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity.
Our variable interests in VIEs include debt and equity interests, equity interests in associated companies, commitments, guarantees and certain fees. Our involvement with VIEs arises primarily from the following activities, but also includes other activities discussed below:
•Purchases of securities in connection with our trading and secondary market-making activities;
•Retained interests held as a result of securitization activities, including the resecuritization of mortgage-backed and other asset-backed securities and the
securitization of mortgage, corporate and consumer loans;
•Acting as placement agent and/or underwriter in connection with client-sponsored securitizations;
•Financing of agency and non-agency mortgage-backed and other asset-backed securities;
•Warehouse funding arrangements for client-sponsored consumer and mortgage loan vehicles and CLOs through participation agreements, forward sale agreements and revolving loan and note commitments; and
•Loans to, investments in and fees from various investment vehicles.
We determine whether we are the primary beneficiary of a VIE upon our initial involvement with the VIE and we reassess whether we are the primary beneficiary
of a VIE on an ongoing basis. Our determination of whether we are the primary beneficiary of a VIE is based upon the facts and circumstances for each VIE and requires judgment. Our considerations in determining the VIE's most significant activities and whether we have power to direct those activities include, but are not limited to, the VIE's purpose and design and the risks passed through to investors, the voting interests of the VIE, management, service and/or other agreements of the VIE, involvement in the VIE's initial design and the existence of explicit or implicit financial guarantees. In situations where we have determined that the power over the VIE's significant activities is shared, we assess whether we are the party with the power over the most significant activities. If we are the party with the power over the most significant activities, we meet the "power" criteria of the primary beneficiary. If we do not have the power over the most significant
activities or we determine that decisions require consent of each sharing party, we do not meet the "power" criteria of the primary beneficiary.
We assess our variable interests in a VIE both individually and in aggregate to determine whether we have an obligation to absorb losses of or a right to receive benefits from the VIE that could potentially be significant to the VIE. The determination of whether our variable interest is significant to the VIE requires judgment. In determining the significance of our variable interest, we consider the terms, characteristics and size of the variable interests, the design and characteristics of the VIE, our involvement in the VIE and our market-making activities related to the variable interests.
39
Consolidated
VIEs
i
The following table presents information about our consolidated VIEs (in millions). The assets and liabilities in the table below are presented prior to consolidation and thus a portion of these assets and liabilities are eliminated in consolidation.
Securities
purchased under agreements to resell (2)
i2,097.5
i—
i2,467.3
i—
Receivables
i650.5
i17.8
i605.6
i—
Other
i36.7
i0.2
i38.7
i—
Total
assets
$
i2,784.7
$
i22.6
$
i3,111.6
$
i1.5
Financial
instruments sold, not yet purchased, at fair value
$
i—
$
i5.3
$
i—
$
i—
Other
secured financings
i2,745.2
i—
i3,068.6
i—
Other
liabilities (3)
i16.7
i0.4
i20.1
i0.2
Total
liabilities
$
i2,761.9
$
i5.7
$
i3,088.7
$
i0.2
(1)Approximately
$i0.6 million of the cash amount at May 31, 2020 represents cash on deposit with a related consolidated entity and is eliminated in consolidation.
(2)Securities purchased under agreements to resell primarily represent amounts due under collateralized transactions on related consolidated entities, which are eliminated in consolidation.
(3)Includes
$i15.3 million and $i17.9
million at May 31, 2020 and November 30, 2019, respectively, of intercompany payables that are eliminated in consolidation.
/
Securitization Vehicles. We are the primary beneficiary of asset-backed financing vehicles to which we sell agency and non-agency residential and commercial mortgage loans and asset-backed securities pursuant to the terms of a master repurchase agreement. Our variable interests in these vehicles consist of our collateral margin maintenance obligations under the master repurchase agreement, which we manage, and retained interests in securities issued. The assets of these VIEs consist of reverse
repurchase agreements, which are available for the benefit of the vehicle's debt holders.
At May 31, 2020 and November 30, 2019, Foursight Capital is the primary beneficiary of SPEs it utilized to securitize automobile loans receivable. Foursight Capital acts as the servicer for which it receives a fee, and owns an equity interest in the SPEs. The notes issued by the SPEs are secured solely by the assets of the SPEs and do not have recourse to Foursight Capital's general credit and the assets of the VIEs are not available to satisfy any other debt. During the six months ended May 31, 2020, automobile loan receivables aggregating $i223.3
million were securitized by Foursight Capital in connection with a secured borrowing offering. The majority of the proceeds from issuance of the secured borrowing were used to pay down Foursight Capital's two credit facilities.
Other. We are the primary beneficiary of certain investment vehicles set up for the benefit of our employees. We manage and invest alongside our employees in these vehicles. The assets of these VIEs consist of private equity securities and are available for the benefit of the entities' equity holders. Our variable interests in these vehicles consist of equity securities. The creditors of these VIEs do not have recourse to our general credit and each such VIE's assets are not available to satisfy any other debt.
40
Nonconsolidated
VIEs
The following table presents information about our variable interests in nonconsolidated VIEs (in millions):
Our
maximum exposure to loss often differs from the carrying value of the variable interests. The maximum exposure to loss is dependent on the nature of the variable interests in the VIEs and is limited to the notional amounts of certain loan and equity commitments and guarantees. Our maximum exposure to loss does not include the offsetting benefit of any financial instruments that may be utilized to hedge the risks associated with our variable interests and is not reduced by the amount of collateral held as part of a transaction with a VIE.
Collateralized Loan Obligations. Assets collateralizing the CLOs include bank loans, participation interests and sub-investment grade and senior secured U.S. loans. We underwrite securities issued in CLO transactions on behalf of sponsors and provide advisory services to the sponsors. We may also sell corporate loans to the CLOs. Our variable interests in connection
with CLOs where we have been involved in providing underwriting and/or advisory services consist of the following:
•Forward sale agreements whereby we commit to sell, at a fixed price, corporate loans and ownership interests in an entity holding such corporate loans to CLOs;
•Warehouse funding arrangements in the form of participation interests in corporate loans held by CLOs and commitments to fund such participation interests;
•Trading positions in securities issued in a CLO transaction; and
•Investments in variable funding notes issued by CLOs.
Asset-Backed Vehicles. We provide financing and
lending related services to certain client-sponsored VIEs in the form of revolving funding note agreements, revolving credit facilities, forward purchase agreements and reverse repurchase agreements. The underlying assets, which are collateralizing the vehicles, are primarily composed of unsecured consumer loans, mortgage loans and trade claims. In addition, we may provide structuring and advisory services and act as an underwriter or placement agent for securities issued by the vehicles. We do not control the activities of these entities.
Related Party Private Equity Vehicles. We committed to invest in private equity funds (the "JCP Funds", including Jefferies Group's interests in Jefferies Capital Partners V L.P. and the Jefferies SBI USA Fund L.P. (together, "JCP Fund V")) managed by Jefferies Capital Partners, LLC (the "JCP Manager").
Additionally, we committed to invest in the general partners of the JCP Funds (the "JCP General Partners") and the JCP Manager. Our variable interests in the JCP Funds, JCP General Partners and JCP Manager (collectively, the "JCP Entities") consist of equity interests that, in total, provide us with limited and general partner investment returns of the JCP Funds, a portion of the carried interest earned by the JCP General Partners and a portion of the management fees earned by the JCP Manager. At May 31, 2020 and November 30, 2019, our total equity commitment in the JCP Entities was $i133.0
million and $i133.0 million, respectively, of which $i121.9 million and $i121.7
million, respectively, had been funded. The carrying value of our equity investments in the JCP Entities was $i16.6 million and $i23.0 million at May 31,
2020 and November 30, 2019, respectively. Our exposure to loss is limited to the total of our carrying value and unfunded equity commitment. The assets of the JCP Entities primarily consist of private equity and equity related investments.
41
Other Investment Vehicles. The carrying amount of our equity investment was $i877.6
million and $i574.0 million at May 31, 2020 and November 30, 2019, respectively. Our unfunded equity commitment related to these investments totaled $i191.5
million and $i192.1 million at May 31, 2020 and November 30, 2019, respectively. Our exposure to loss is limited to the total of our carrying value and unfunded equity commitment. These investment vehicles have assets primarily consisting of private and public equity investments, debt instruments, trade and insurance claims and various oil and gas assets.
Mortgage-Backed
and Other Asset-Backed Secured Funding Vehicles. In connection with our secondary trading and market-making activities, we buy and sell agency and non-agency mortgage-backed securities and other asset-backed securities, which are issued by third-party securitization SPEs and are generally considered variable interests in VIEs. Securities issued by securitization SPEs are backed by residential mortgage loans, U.S. agency collateralized mortgage obligations, commercial mortgage loans, CDOs and CLOs and other consumer loans, such as installment receivables, auto loans and student loans. These securities are accounted for at fair value and included in Financial instruments owned, at fair value in the Consolidated Statements of Financial Condition. We have no other involvement with the related SPEs and therefore do not consolidate these entities.
We also engage in underwriting,
placement and structuring activities for third-party-sponsored securitization trusts generally through agency (FNMA ("Fannie Mae"), Federal Home Loan Mortgage Corporation ("Freddie Mac") or GNMA ("Ginnie Mae")) or non-agency-sponsored SPEs and may purchase loans or mortgage-backed securities from third parties that are subsequently transferred into the securitization trusts. The securitizations are backed by residential and commercial mortgage, home equity and auto loans. We do not consolidate agency-sponsored securitizations as we do not have the power to direct the activities of the SPEs that most significantly impact their economic performance. Further, we are not the servicer of non-agency-sponsored securitizations and therefore do not have power to direct the most significant activities of the SPEs and accordingly, do not consolidate these entities. We may retain unsold senior and/or subordinated interests at the time of securitization in the
form of securities issued by the SPEs.
At May 31, 2020 and November 30, 2019, we held $i2,004.2 million and $i1,453.5
million of agency mortgage-backed securities, respectively, and $i140.4 million and $i134.8 million of non-agency mortgage-backed and other asset-backed securities, respectively, as a result of our secondary trading and market-making activities, and underwriting, placement
and structuring activities. Our maximum exposure to loss on these securities is limited to the carrying value of our investments in these securities. These mortgage-backed and other asset-backed secured funding vehicles discussed are not included in the above table containing information about our variable interests in nonconsolidated VIEs.
FXCM is considered a VIE and our term loan and equity ownership are variable interests. We have determined that we are not the primary beneficiary of FXCM because we do not have the power to direct the activities that most significantly impact FXCM's performance. Therefore, we do not consolidate FXCM and we account for our equity interest under the equity method as an investment in an associated company. Our maximum exposure to loss as a result of our involvement with FXCM is limited to the carrying value of the term loan ($i53.8
million) and the investment in associated company ($i76.2 million), which totaled $i130.0
million at May 31, 2020.
42
Note 8. iLoans to and Investments in Associated Companies
i
A
summary of Loans to and investments in associated companies accounted for under the equity method of accounting during the six months ended May 31, 2020 and 2019 is as follows (in thousands):
Loans
to and investments in associated companies as of beginning of period
Income (losses) related to associated companies
Income (losses) primarily related to Jefferies Group's associated companies (1)
Contributions to (distributions from) associated companies, net
Other
Loans to and investments in associated companies as of end of period
2020
Jefferies
Finance
$
i673,867
$
i—
$
(i47,950)
$
i27,547
$
i—
$
i653,464
Berkadia
i268,949
i—
i21,925
(i36,562)
i472
i254,784
FXCM
(2)
i70,223
i6,252
i—
i—
(i243)
i76,232
Linkem
(3)
i194,847
(i19,809)
i—
i35,242
i3,825
i214,105
Real
estate associated companies (4) (5)
i255,309
(i53,442)
i—
(i31,784)
i—
i170,083
Other
(3)
i189,762
(i7,577)
(i111)
(i186)
i9,237
i191,125
Total
$
i1,652,957
$
(i74,576)
$
(i26,136)
$
(i5,743)
$
i13,291
$
i1,559,793
2019
Jefferies
Finance
$
i728,560
$
i—
$
i7,936
$
(i63,070)
$
i—
$
i673,426
Berkadia
i245,228
i—
i47,945
(i18,124)
i515
i275,564
National
Beef (6)
i653,630
i62,051
i—
(i54,940)
(i9)
i660,732
FXCM
(2)
i75,031
(i5,016)
i—
i—
i10
i70,025
Linkem
i165,157
(i8,581)
i—
i49,590
(i3,973)
i202,193
HomeFed
(4)
i337,542
(i517)
i—
i—
i—
i337,025
Real
estate associated companies
i87,074
i1,072
i—
i—
i—
i88,146
Other
i125,110
i474
(i1,560)
(i16,122)
i881
i108,783
Total
$
i2,417,332
$
i49,483
$
i54,321
$
(i102,666)
$
(i2,576)
$
i2,415,894
(1)Primarily
classified in Other revenues.
(2)As further described in Note 3, our investment in FXCM includes both our equity method investment in FXCM and our term loan with FXCM. Our equity method investment is included in Loans to and investments in associated companies and our term loan is included in Financial instruments owned, at fair value in the Consolidated Statements of Financial Condition.
(3)Loans to and investments in associated companies at May 31, 2020 and November 30, 2019 include loans and debt securities aggregating $i92.3
million and $i70.2 million, respectively, related to Linkem and Other.
(4)During the third quarter of 2019, we completed a merger with HomeFed by which we acquired the remaining common stock of HomeFed. From July 1, 2019, the results of HomeFed are reflected on a consolidated basis. From July 1, 2019, HomeFed's equity method investments are included in Real estate associated companies.
(5)Income
(loss) related to Real estate associated companies for the three and six months ended May 31, 2020 includes a non-cash charge of $ii6.9/ million
to fully write-off the value of HomeFed's interest in the Brooklyn Renaissance Plaza hotel due to the significant impact of the global novel coronavirus ("COVID-19") during the second quarter of 2020 and for the six months ended May 31, 2020, includes a non-cash charge of $i55.6 million to fully write-off the value of HomeFed's RedSky JZ Fulton Mall joint venture investment related to a softening of the Brooklyn real estate market.
(6)On
November 29, 2019, we sold our remaining equity interest in National Beef.
/
43
Income (losses) related to associated companies includes the following (in thousands):
Income
(losses) primarily related to Jefferies Group's associated companies (primarily classified in Other revenues) includes the following (in thousands):
Through Jefferies Group, we own i50% of Jefferies Finance LLC ("Jefferies Finance"), a joint venture entity pursuant to an agreement with Massachusetts Mutual Life Insurance Company ("MassMutual"). Jefferies Finance is a commercial finance company that structures, underwrites and arranges primarily senior secured loans to corporate borrowers. Loans are originated primarily through the investment banking efforts of Jefferies LLC. Jefferies Finance may also underwrite and arrange
other debt products such as second lien term, bridge and mezzanine loans, as well as related equity co-investments. In addition, Jefferies Finance is a registered investment advisor under the Investment Advisers Act of 1940 and, through two of its wholly-owned subsidiaries, Apex Credit Partners LLC and JFIN Asset Management LLC, acts as an investment advisor for various loan funds and CLOs managing direct lending and broadly syndicated loan products.
At May 31, 2020, Jefferies Group and MassMutual each had equity commitments to Jefferies Finance of $i750.0
million. At May 31, 2020, $i652.4 million of Jefferies Group's commitment was funded. The investment commitment is scheduled to expire on March 1, 2021 with automatic ione
year extensions absent a i60-day termination notice by either party.
Jefferies Finance has executed a Secured Revolving Credit Facility with Jefferies Group and MassMutual, to be funded equally, to support loan underwritings by Jefferies Finance, which bears interest based on the interest rates of the related Jefferies Finance underwritten loans and is secured by the underlying loans funded by the proceeds of the facility. The total Secured Revolving Credit Facility is a committed amount of $i500.0
million at May 31, 2020. Advances are shared equally between Jefferies Group and MassMutual. The facility is scheduled to mature on March 1, 2021 with automatic ione year extensions absent a i60-day
termination notice by either party. At May 31, 2020, $i20.0 million of Jefferies Group's $i250.0
million commitment was funded. Jefferies Group recognized interest income and unfunded commitment fees related to the facility of $i1.5 million and $i0.3 million
during the three months ended May 31, 2020 and 2019, respectively, and $i2.6 million and $i0.6
million during the six months ended May 31, 2020 and 2019, respectively.
44
i
The following summarizes activity related to our other transactions with Jefferies Finance (in millions):
(1) Jefferies
Group engages in debt underwriting transactions with Jefferies Finance related to the originations and syndications of loans by Jefferies Finance. In connection with such services, Jefferies Group earned fees, which are recognized in Investment banking revenues in the Consolidated Statements of Operations. In addition, Jefferies Group paid fees to Jefferies Finance in respect of certain loans originated by Jefferies Finance, which are recognized in Selling, general and other expenses in the Consolidated Statements of Operations.
(2) Jefferies Group acts as a placement agent for CLOs managed by Jefferies Finance, for which Jefferies Group recognized fees, which are included in Investment banking revenues in the Consolidated Statements of Operations. At May 31, 2020 and November 30, 2019, Jefferies Group held securities issued
by CLOs managed by Jefferies Finance, which are included in Financial instruments owned, at fair value.
(3) Jefferies Group acted as underwriter in connection with terms loans issued by Jefferies Finance.
(4) Under a service agreement, Jefferies Group charged Jefferies Finance for services provided.
/
In connection with non-U.S. dollar loans originated by Jefferies Finance to borrowers who are investment banking clients of Jefferies Group, Jefferies Group has entered into an agreement to indemnify Jefferies Finance with respect to any foreign currency exposure.
At May 31, 2020 and November 30,
2019, we had receivables from Jefferies Finance, included within Other assets in the Consolidated Statement of Financial Condition of $i27.0 million and $i17.2 million, respectively. At May 31,
2020 and November 30, 2019, we had payables to Jefferies Finance, related to cash deposited with Jefferies Group, included in Payables, expense accruals and other liabilities in the Consolidated Statement of Financial Condition of $i13.7 million and $i13.7 million,
respectively. At November 30, 2019, we had a payable to Jefferies Finance, related to its lending transactions, included in Payables, expense accruals and other liabilities in the Consolidated Statement of Financial Condition of $i17.6 million.
On March 28, 2019, Jefferies Group entered into a promissory note with Jefferies Finance with a principal amount of $i1.0 billion,
the proceeds of which were used in connection with Jefferies Group's investment banking loan syndication activities. Jefferies Group repaid Jefferies Finance the entire outstanding principal amount of this note on May 15, 2019. Interest paid on the note of $ii3.8/ million
is included in Interest expense of Jefferies Group within the Consolidated Statements of Operations for the three and six months ended May 31, 2019.
Berkadia
Berkadia is a commercial mortgage banking and servicing joint venture formed in 2009 with Berkshire Hathaway Inc. We and Berkshire Hathaway each contributed $i217.2 million of equity capital to the joint venture and each have a i50%
membership interest in Berkadia. We are entitled to receive i45% of the profits. Berkadia originates commercial/multifamily real estate loans that are sold to U.S. government agencies, and originates and brokers commercial/multifamily mortgage loans which are not part of government agency programs. Berkadia is an investment sales advisor focused on the multifamily industry. Berkadia is a servicer of commercial real estate loans in the U.S., performing primary, master and special servicing functions for U.S. government agency programs, commercial mortgage-backed securities
transactions, banks, insurance companies and other financial institutions.
Berkadia uses all of the proceeds from the commercial paper sales of an affiliate of Berkadia to fund new mortgage loans, servicer advances, investments and other working capital requirements. Repayment of the commercial paper is supported by a $i1.5 billion surety policy issued by a Berkshire Hathaway insurance subsidiary and corporate guaranty, and we have agreed to reimburse Berkshire Hathaway for one-half of any losses incurred thereunder.
At May 31, 2020, the aggregate amount of commercial paper outstanding was $i1.47 billion.
45
National Beef
National Beef processes and markets fresh and chilled boxed beef, ground beef, beef by-products, consumer-ready beef and pork,
and wet blue leather for domestic and international markets. On November 29, 2019, we sold our remaining equity interest in National Beef.
FXCM
We have a i50% voting interest in FXCM, a provider of online foreign exchange trading services. We account for our equity interest in FXCM on a one month lag. We are amortizing our basis difference between the estimated
fair value and the underlying book value of FXCM customer relationships, technology and tradename over their respective useful lives (weighted average life of i11 years).
Linkem
We own approximately i42%
of the common shares of Linkem, the largest fixed wireless broadband services provider in Italy. In addition, we own convertible preferred stock, which is automatically convertible to common shares in 2022, and warrants. If all of our convertible preferred stock was converted and warrants were exercised, it would increase our ownership to approximately i56% of Linkem's common equity at May 31, 2020. We have approximately i48%
of the total voting securities of Linkem. Additionally, we have made shareholder loans to Linkem with principal outstanding of $i95.2 million at May 31, 2020. These shareholder loans bear interest at i5%
per annum and are due June 30, 2024. We account for our equity interest in Linkem on a two month lag.
HomeFed
HomeFed develops and owns residential and mixed-use real estate properties. Through June 30, 2019, we owned an approximate i70% equity interest of HomeFed's outstanding common shares; however, we had contractually
agreed to limit our voting rights such that we would not be able to vote more than i45% of HomeFed's total voting securities voting on any matter, assuming all HomeFed shares not owned by us were voted. Since we did not control HomeFed, our investment in HomeFed was accounted for under the equity method as an investment in an associated company. We accounted for our equity interest in HomeFed on a two month lag.
On July 1, 2019, we completed a merger with HomeFed by which
we acquired the remaining common stock of HomeFed. From July 1, 2019, the results of HomeFed are reflected on a consolidated basis.
Real Estate Associated Companies
Real estate equity method investments primarily consist of HomeFed's interests in Brooklyn Renaissance Plaza and Hotel and 54 Madison. These equity interests are accounted for on a two month lag.
Brooklyn Renaissance Plaza is comprised of a hotel operated by Marriott, an office building complex and a parking garage located in Brooklyn, New York. HomeFed owns a i25.8%
equity interest in the hotel and a i61.25% equity interest in the office building and garage. Although HomeFed has a majority interest in the office building and garage, it does not have control, but only has the ability to exercise significant influence on this investment. As such, HomeFed accounts for the office building and garage under the equity method of accounting. We are amortizing our basis difference between the estimated fair value and the underlying book value of Brooklyn Renaissance office building and garage over the respective useful lives (weighted average
life of i39 years). Due to the significant impact of COVID-19 during the second quarter of 2020, HomeFed recorded an impairment charge of $iii6.9// million
within Income (loss) related to associated companies during the three and six months ended May 31, 2020, which represented all of its carrying value in the Brooklyn Renaissance Plaza hotel.
We own approximately i48.1% of 54 Madison, a fund that seeks long-term capital appreciation through investment in real estate development and similar projects. 54 Madison invests both in projects which they consolidate
and projects where they have significant influence and utilize the equity method of accounting. Based on total committed capital of the 54 Madison fund, all projects of this fund have already been identified and launched. We have itwo of the ifour
seats on the 54 Madison investment committee and have significant influence over the fund, including a number of protective rights such as the right to block material investments, divestitures and changes outside of agreed upon parameters.
46
Other
The following table provides required summarized data for certain equity method investments, including those accounted for under the fair value option. The table includes Berkadia for the six months ended May 31, 2020 and 2019, and National Beef for the six months ended May
31, 2019 (in thousands):
Exchange and clearing organization membership interests and registrations
$
i8,069
$
i8,273
Amortizable
intangibles:
Customer and other relationships, net of accumulated amortization of $114,909 and $111,060
i55,115
i59,575
Trademarks
and tradenames, net of accumulated amortization of $26,751 and $24,800
i101,071
i103,790
Other,
net of accumulated amortization of $7,225 and $5,366
i9,457
i11,316
Total
intangible assets, net
i173,712
i182,954
Goodwill:
Investment
Banking and Capital Markets (1) (2)
i1,553,322
i1,556,810
Asset
Management (1)
i143,000
i143,000
Real
estate
i36,711
i36,711
Other
operations
i3,459
i3,459
Total
goodwill
i1,736,492
i1,739,980
Total
intangible assets, net and goodwill
$
i1,910,204
$
i1,922,934
(1) As
discussed further in Note 23, during the first quarter of 2020, we changed our internal structure with regard to our operating segments. As a result, we created a separate operating segment that consists of the asset management activity previously included within our Investment Banking, Capital Markets and Asset Management segment. In order to reallocate goodwill that was previously contained in our Investment Banking, Capital Markets and Asset Management segment to the newly created Investment Banking and Capital Markets segment and the Asset Management segment, we performed a fair value analysis of the components.
Estimated fair values were determined based on valuation techniques that we believe market participants would use and included price-to-earnings, price-to-book multiples and discounted cash flow techniques. Based on the relative fair values of each of the components, $i143.0
million of the total $i1,699.8 million goodwill within the historical Investment Banking, Capital Markets and Asset Management segment was allocated to the new Asset Management segment. In order to compare results with prior periods, we have recast November 30, 2019 goodwill in the same manner. We performed an impairment test immediately before and after the reallocation of goodwill between the new segments and the results of the impairment test did not indicate any goodwill impairment.
/
(2) The
decrease in Investment Banking and Capital Markets goodwill during the six months ended May 31, 2020, primarily relates to translation adjustments.
47
Amortization expense on intangible assets was $i3.9 million and $i3.3 million
for the three months ended May 31, 2020 and 2019, respectively, and $i7.7 million and $i6.6
million for the six months ended May 31, 2020 and 2019, respectively.
i
The estimated aggregate future amortization expense for the intangible assets for each of the next five years is as follows (in thousands):
Remainder
of current year
$
i7,411
2021
i14,522
2022
i11,180
2023
i9,945
2024
i9,189
/
Note
10. iShort-Term Borrowings
i
Our short-term borrowings, which mature in one year or less, are as follows (in thousands):
(1) These
short-term borrowings are recorded at cost in the Consolidated Statements of Financial Condition, which is a reasonable approximation of their fair values due to their liquid and short-term nature.
/
At May 31, 2020 and November 30, 2019, the weighted average interest rate on short-term borrowings outstanding was i2.38% and
i3.24% per annum, respectively.
During the six months ended May 31, 2020, we issued floating rate puttable notes with a principal amount of $i6.8 million
and our equity-linked notes with a principal amount of $i5.2 million matured on March 13, 2020.
One of Jefferies Group's subsidiaries has a credit facility agreement ("Jefferies Group Credit Facility") with JPMorgan Chase Bank, N.A. for a committed amount of $i296.0
million, which is included in bank loans. Interest is based on an annual alternative base rate or an adjusted London Interbank Offered Rate ("LIBOR"), as defined in the Jefferies Group Credit Facility. The Jefferies Group Credit Facility contains certain covenants that, among other things, require Jefferies Group LLC to maintain a specified level of tangible net worth. The covenants also require the borrower to maintain specified leverage amounts and impose certain restrictions on the borrower's future indebtedness. During the six months ended May 31, 2020, Jefferies Group was in compliance with all debt covenants under the Jefferies Group Credit Facility.
The Bank of New York Mellon has agreed to make revolving intraday credit advances ("Intraday Credit Facility") to Jefferies Group for an aggregate committed amount of $i150.0
million. The Intraday Credit Facility is structured so that advances are generally repaid before the end of each business day. However, if an advance is not repaid by the end of any business day, the advance is converted to an overnight loan. Intraday loans accrue interest at a rate of i0.12%. Interest is charged based on the number of minutes in a day the advance is outstanding. Overnight loans are charged interest at the base rate plus i3%
on a daily basis. The base rate is the higher of the federal funds rate plus i0.50% or the prime rate in effect at that time. The Intraday Credit Facility contains financial covenants, which include a minimum regulatory net capital requirement for Jefferies Group. At May 31, 2020, Jefferies Group was in compliance with debt covenants under the Intraday Credit Facility.
48
Note
11. iLong-Term Debt
i
The principal amount (net of unamortized discounts, premiums and debt issuance costs), stated interest rate and maturity
date of outstanding debt are as follows (dollars in thousands):
(1) Amount
includes losses of $i47.2 million and $i43.8
million during the six months ended May 31, 2020 and 2019, respectively, associated with an interest rate swap based on its designation as a fair value hedge. See Note 4 for further information.
/
(2) These structured notes contain various interest rate payment terms and are accounted for at fair value, with changes in fair value resulting from a change in the instrument specific credit risk presented in Accumulated other comprehensive income (loss) and changes in fair value resulting from non-credit components recognized in Principal transactions revenues.
Subsidiary Debt:
During
the six months ended May 31, 2020, Jefferies Group's i2.375% Euro Medium Term Notes matured and were repaid. Additionally, during the six months ended May 31, 2020, structured notes with a total principal amount of approximately $i191.3
million, net of retirements, and an additional $i150.0 million principal amount of i5.125% Senior Notes due 2023 were issued by Jefferies Group.
Jefferies
Group has a senior secured revolving credit facility ("Jefferies Group Revolving Credit Facility") with a group of commercial banks for an aggregate principal amount of $i190.0 million. The Jefferies Group Revolving Credit Facility contains certain covenants that, among other things, requires Jefferies Group LLC to maintain specified level of tangible net worth and liquidity amounts, and imposes certain restrictions on future indebtedness of and requires specified levels of regulated capital for certain of Jefferies Group's subsidiaries.
Interest is based on an annual alternative base rate or an adjusted LIBOR, as
49
defined in the Jefferies Group Revolving Credit Facility agreement. The obligations of certain of Jefferies Group's subsidiaries under the Jefferies Group Revolving Credit Facility are secured by substantially all its assets. At May 31, 2020, Jefferies Group was in compliance with the debt covenants under the Jefferies Group Revolving Credit Facility.
One of Jefferies Group's subsidiaries
has a Loan and Security Agreement with a bank for a term loan with a principal amount of $i50.0 million ("Jefferies Group Secured Bank Loan"). This Jefferies Group Secured Bank Loan matures on September 27, 2021 and is collateralized by certain trading securities. Interest on the Jefferies Group Secured Bank Loan is i1.25%
plus LIBOR. The agreement contains certain covenants that, among other things, restrict lien or encumbrance upon any of the pledged collateral. At May 31, 2020, Jefferies Group was in compliance with all covenants under the Loan and Security Agreement.
HomeFed funds certain of its real estate projects in part by raising funds under the Immigrant Investor Program administered by the U.S. Citizenship and Immigration Services pursuant to the Immigration and Nationality Act ("EB-5 Program"). This program was created to stimulate the U.S. economy through the creation of jobs and capital investments in U.S. companies by foreign investors. This debt is secured by certain real estate of HomeFed. At May 31, 2020, HomeFed was in compliance with all debt covenants which include, among other
requirements, limitations on incurrence of debt, collateral requirements and restricted use of proceeds. Primarily all of HomeFed's debt matures in 2024 and 2025.
At May 31, 2020, Foursight Capital's credit facilities consisted of itwo warehouse credit commitments aggregating $i150.0
million, which mature in May 2021. One of the credit facilities bears interest based on the three month LIBOR plus a credit spread fixed through its maturity and the other credit facility bears interest based on the one month LIBOR plus a credit spread fixed through its maturity. As a condition of the credit facilities, Foursight Capital is obligated to maintain cash reserves to comply with the hedging requirements of the credit commitment. The credit facilities are secured by first priority liens on auto loan receivables owed to Foursight Capital of approximately $i67.9 million
at May 31, 2020. At May 31, 2020 and November 30, 2019, $i57.0 million and $i98.7
million, respectively, was outstanding under Foursight Capital's credit facilities.
Vitesse Energy Finance has a revolving credit facility with a syndicate of banks that matures in April 2023 and has a maximum borrowing base of $i170.0 million at May 31, 2020. Amounts outstanding under the facility at May 31, 2020 and November
30, 2019 were $i106.0 million and $i104.0 million, respectively. Borrowings under the facility have been made as Eurodollar loans that bear interest at adjusted
LIBOR plus a spread based on the borrowing base utilization percentage. The credit facility is guaranteed by Vitesse Energy Finance's subsidiaries and is collateralized with a minimum of i85% of Vitesse Energy Finance's proved reserve value of its oil and gas properties. Vitesse Energy Finance's borrowing base is subject to regular re-determination on or about April 1 and October 1 of each year based
on proved oil and natural gas reserves, hedge positions and estimated future cash flows from these reserves calculated using future commodity pricing provided by Vitesse Energy Finance's lenders. As a result of the decline in oil prices, Vitesse Energy Finance's borrowing base was decreased from $i170.0 million to $i120.0 million
on June 9, 2020.
Note 12. iLeases
We enter into lease and sublease agreements primarily for office space across our geographic locations. Finance lease ROU assets and finance lease liabilities are not material. iInformation
related to operating leases in the Consolidated Statement of Financial Condition at May 31, 2020 is as follows (in thousands, except lease term and discount rate):
Premises and equipment - ROU assets
$
i523,616
Weighted
average:
Remaining lease term (in years)
i10.8 years
Discount rate
i2.9
%
50
i
The
following table presents the maturities of our operating lease liabilities and a reconciliation to the Lease liabilities included in the Consolidated Statement of Financial Condition at May 31, 2020 (in thousands):
Lease Liabilities
Remainder of 2020
$
i31,760
2021
i77,283
2022
i74,684
2023
i65,174
2024
i61,965
2025
and thereafter
i393,447
Total undiscounted cash flows
i704,313
Less:
Difference between undiscounted and discounted cash flows
(i107,046)
Operating leases amount in the Consolidated Statement of Financial Condition
i597,267
Finance
leases amount in the Consolidated Statement of Financial Condition
i290
Total amount in the Consolidated Statement of Financial Condition
$
i597,557
/
In
addition to the table above, at May 31, 2020, we have a lease agreement that we entered into that was signed but has not yet commenced. We expect this operating lease to commence by the end of 2020 with a lease term of iseven years. Lease payments for this agreement will be $i0.8
million for the period from lease commencement to the end of the lease term.
The following table presents our lease costs (in thousands):
(1)
Includes short-term leases, which are not material.
(2) Includes property taxes, insurance costs, common area maintenance, utilities, and other costs that are not fixed. The amount also includes rent increases resulting from inflation indices and periodic market rent reviews.
Consolidated Statement of Cash Flows supplemental information is as follows (in thousands):
Non-cash - ROU assets recorded for new and modified leases
$
i20,145
51
Minimum
Future Lease Commitments (under Previous GAAP). As lessee, we lease certain premises and equipment under non-cancelable agreements expiring at various dates through 2039 which are operating leases. iAt November 30, 2019, future minimum annual lease payments under such leases (net of sublease income) were as follows (in thousands):
2020
$
i70,886
2021
i73,374
2022
i71,464
2023
i62,552
2024
i59,714
Thereafter
i393,995
i731,985
Less:
sublease income
(i21,883)
$
i710,102
Rental
expense, net of sublease rental income, was $i65.6 million, $i55.7 million, and $i60.2
million for the twelve months ended November 30, 2019, the eleven months ended November 30, 2018 and the twelve months ended December 31, 2017, respectively.
Note 13. iMezzanine Equity
Redeemable
Noncontrolling Interests
At May 31, 2020 and November 30, 2019, redeemable noncontrolling interests include other redeemable noncontrolling interests of $i22.3 million and $i26.6
million, respectively, primarily related to our oil and gas exploration and development businesses.
In connection with our acquisition of Jefferies Group in March 2013, we issued a new series of i3.25% Cumulative Convertible Preferred Shares ("Preferred Shares") ($i125.0
million at mandatory redemption value) in exchange for Jefferies Group's outstanding i3.25% Series A-1 Cumulative Convertible Preferred Stock. The Preferred Shares have a i3.25%
annual, cumulative cash dividend and are currently convertible into i4,440,863 common shares, an effective conversion price of $i28.15
per share. The holders of the Preferred Shares are also entitled to an additional quarterly payment in the event we declare and pay a dividend on our common stock in an amount greater than $i0.0625 per common share per quarter. The additional quarterly payment would be paid to the holders of Preferred Shares on an as converted basis and on a per share basis would equal the quarterly dividend declared and paid to a holder of a share of common stock in excess of $i0.0625
per share.
In the first quarter of 2020, we increased our quarterly dividend from $i0.125 to $i0.15
per common share. This increased the preferred stock dividend from $i2.6 million for the six months ended May 31, 2019 to $i2.8
million for the six months ended May 31, 2020. Based on our current quarterly dividend of $i0.15 per common share, the effective rate on these Preferred Shares is approximately i4.5%.
The Preferred Shares are callable beginning in 2023 at a price of $i1,000 per share plus accrued interest and are mandatorily redeemable in 2038.
Note 14. iCompensation
Plans
Restricted Stock and Restricted Stock Units. Restricted stock and restricted stock units ("RSUs") may be granted to new employees as "sign-on" awards, to existing employees as "retention" awards and to certain executive officers as awards for multiple years. Sign-on and retention awards are generally subject to annual ratable vesting over a four year service period and are amortized as compensation expense on a straight-line basis over the related ifour
years. Restricted stock and RSUs are granted to certain senior executives with market, performance and service conditions. Market conditions are incorporated into the grant-date fair value of senior executive awards using a Monte Carlo valuation model. Compensation expense for awards with market conditions is recognized over the service period and is not reversed if the market condition is not met. Awards with performance conditions are amortized over the service period if it is determined that it is probable that the performance condition will be achieved.
Stock-Based Compensation Expense. Share-based compensation expense relating to grants made under our share-based compensation plans was $i10.7 million
and $i13.1 million for the three months ended May 31, 2020 and 2019, respectively, and
52
$i20.7
million and $i24.9 million for the six months ended May 31, 2020 and 2019, respectively. Total compensation cost includes the amortization of sign-on, retention and senior executive awards, less forfeitures and clawbacks. The total tax benefit recognized in results of operations related to share-based compensation expenses was $i2.7 million
and $i3.4 million for the three months ended May 31, 2020 and 2019, respectively, and $i5.3
million and $i6.3 million for the six months ended May 31, 2020 and 2019, respectively. At May 31, 2020, total unrecognized compensation cost related to nonvested share-based compensation plans was $i61.9
million; this cost is expected to be recognized over a weighted average period of i2.1 years.
At May 31, 2020, there were i1,838,000
shares of restricted stock outstanding with future service required, i4,149,000 RSUs outstanding with future service required (including target RSUs issuable under the senior executive compensation plan), i18,322,000
RSUs outstanding with no future service required and i1,092,000 shares issuable under other plans. The maximum potential increase to common shares outstanding resulting from these outstanding awards is i23,563,000.
Restricted
Cash Awards. Jefferies Group provides compensation to certain new and existing employees in the form of loans and/or other cash awards which are subject to ratable vesting terms with service requirements. These awards are amortized to compensation expense over the relevant service period, which is generally considered to start at the beginning of the annual compensation year. At May 31, 2020, the remaining unamortized amount of the restricted cash awards was $i627.4
million and is included within Other assets in the Consolidated Statement of Financial Condition; this cost is expected to be recognized over a weighted average period of three years.
Note 15. iAccumulated Other Comprehensive Income (Loss)
Activity in accumulated other comprehensive
income (loss) is reflected in the Consolidated Statements of Comprehensive Income (Loss) and Consolidated Statements of Changes in Equity but not in the Consolidated Statements of Operations. iA summary of accumulated other comprehensive income (loss), net of taxes is as follows (in thousands):
Net unrealized gains on available for sale securities, net of income tax provision (benefit) of $0 and $(545,054)
$
i—
$
i543,178
Other
revenues and Income tax provision (benefit)
Net unrealized gains (losses) on instrument specific credit risk, net of income tax provision (benefit) of $530 and $(166)
i1,554
(i493)
Principal
transactions revenues
Net unrealized gains on cash flow hedges, net of income tax provision of $0 and $161
i—
i470
Other
revenues
Amortization of defined benefit pension plan actuarial losses, net of income tax benefit of $(438) and $(241)
(i1,287)
(i708)
Selling,
general and other expenses, which includes pension expense
Total reclassifications for the period, net of tax
$
i267
$
i542,447
/
During
the second quarter of 2019, we completed the sale of our available for sale portfolio. In connection therewith, we recognized a tax benefit of $ii544.6/ million
during the three and six months ended May 31, 2019. Unrealized gains and losses on available for sale securities, and their associated tax impacts, are recorded directly to equity as part of the Accumulated other comprehensive income (loss) balance. Following the portfolio approach, when unrealized gains and losses and their associated tax impacts are recorded at a then current tax rate, and then realized later at a different tax rate, the difference between the tax impact initially recorded in Accumulated other comprehensive income (loss) and the tax impact removed from Accumulated other comprehensive income (loss) upon realization remains in Accumulated other comprehensive income (loss) until the disposal of the portfolio and is referred to as a "lodged tax effect." Large changes in the fair value of our available for sale securities, primarily during 2008 through 2010, combined with fluctuations in our tax rate
during those periods, generated a lodged tax benefit of $i544.6 million. As a result of steps to improve our Corporate investment management efforts, we sold the remaining portion of our available for sale portfolio in the second quarter of 2019, which resulted in the realization of the $i544.6 million
tax benefit. While this realization did not impact total equity, it resulted in a tax benefit reflected in the Consolidated Statement of Operations of $i544.6 million and, as a result, Retained earnings increased and Accumulated other comprehensive income (loss) decreased by corresponding amounts. The remaining net unrealized gains (losses) on available for sale securities at May 31, 2020 and November 30,
2019 represents Jefferies Group's share of Berkadia's net unrealized gains on available for sale securities recorded under the equity method of accounting.
The following table presents our total revenues separated for our revenues from contracts with customers and our other sources of revenues (in thousands):
(1)
During the third quarter of 2019, we have reclassified the presentation of certain other fees, primarily related to prime brokerage services offered to clients. These fees were previously presented as Other revenues in the Consolidated Statements of Operations and are now presented within Commissions and other fees. There is no impact on Total revenues as a result of this change in presentation. Previously reported results are presented on a comparable basis.
/
Revenues from contracts with customers are recognized when, or as, we satisfy our performance obligations by transferring the promised goods or services to the customers. A good or service is transferred to a customer when, or as, the customer
obtains control of that good or service. A performance obligation may be satisfied over time or at a point in time. Revenue from a performance obligation satisfied over time is recognized by measuring our progress in satisfying the performance obligation in a manner that depicts the transfer of the goods or services to the customer. Revenue from a performance obligation satisfied at a point in time is recognized at the point in time that we determine the customer obtains control over the promised good or service. The amount of revenue recognized reflects the consideration we expect to be entitled to in exchange for those promised goods or services (the "transaction price"). In determining the transaction price, we consider multiple factors, including the effects of variable consideration. Variable consideration is included in the transaction price only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will
not occur when the uncertainties with respect to the amount are resolved. In determining when to include variable consideration in the transaction price, we consider the range of possible outcomes, the predictive value of our past experiences, the time period of when uncertainties expect to be resolved and the amount of consideration that is susceptible to factors outside of our influence, such as market volatility or the judgment and actions of third parties.
The following provides detailed information on the recognition of our revenues from contracts with customers:
Commissions and Other Fees. We earn commission and other fee revenues by executing, settling and clearing transactions for clients primarily in equity, equity-related and futures products. Trade execution
and clearing services, when provided together, represent a single performance obligation as the services are not separately identifiable in the context of the contract. Commission revenues associated with combined trade execution and clearing services, as well as trade execution services on a standalone basis, are recognized at a point in time on trade-date. Commission revenues are generally paid on settlement date and we record a receivable between trade-date and payment on settlement date. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. We act as an agent in the soft dollar arrangements as the customer controls the use of the soft dollars and directs our payments to third-party
service providers on our behalf. Accordingly, amounts allocated to soft dollar arrangements are netted against commission revenues in the Consolidated Statements of Operations.
We earn account advisory and distribution fees in connection with wealth management services. Account advisory fees are recognized over time using the time-elapsed method as we determined that the customer simultaneously receives and consumes the benefits of investment advisory services as they are provided. Account advisory fees may be paid in advance of a specified
55
service period or in arrears at the end of the specified service period (e.g., quarterly). Account advisory fees paid in advance are initially deferred within Payables, expense accruals and
other liabilities in the Consolidated Statements of Financial Condition. Distribution fees are variable and recognized when the uncertainties with respect to the amounts are resolved.
Investment Banking. We provide our clients with a full range of financial advisory and underwriting services. Revenues from financial advisory services primarily consist of fees generated in connection with merger, acquisition and restructuring transactions. Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed, as the performance obligation is to successfully broker a specific transaction. Fees received prior to the completion of the transaction are deferred within Payables, expense accruals and other liabilities in the Consolidated Statements of Financial Condition. Advisory fees from restructuring engagements are recognized over time using
a time elapsed measure of progress as our clients simultaneously receive and consume the benefits of those services as they are provided. A significant portion of the fees we receive for our advisory services are considered variable as they are contingent upon a future event (e.g., completion of a transaction or third-party emergence from bankruptcy) and are excluded from the transaction price until the uncertainty associated with the variable consideration is subsequently resolved, which is expected to occur upon achievement of the specified milestone. Payment for advisory services are generally due promptly upon completion of a specified milestone or, for retainer fees, periodically over the course of the engagement. We recognize a receivable between the date of completion of the milestone and payment by the customer. Expenses associated with investment banking advisory engagements are deferred only to the extent they are explicitly reimbursable by the client and the
related revenue is recognized at a point in time. All other investment banking advisory related expenses, including expenses incurred related to restructuring assignments, are expensed as incurred. All investment banking advisory expenses are recognized within their respective expense category in the Consolidated Statements of Operations and any expenses reimbursed by our clients are recognized as Investment banking revenues.
Underwriting services include underwriting and placement agent services in both the equity and debt capital markets, including private equity placements, initial public offerings, follow-on offerings and equity-linked convertible securities transactions and structuring, underwriting and distributing public and private debt, including investment grade debt, high yield bonds, leveraged loans, municipal bonds and mortgage-backed and asset-backed securities. Underwriting and placement agent revenues are recognized
at a point in time on trade-date, as the client obtains the control and benefit of the underwriting offering at that point. Costs associated with underwriting transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded, and are recorded on a gross basis within underwriting costs in the Consolidated Statements of Operations as we are acting as a principal in the arrangement. Any expenses reimbursed by our clients are recognized as Investment banking revenues.
Asset Management Fees. We earn management and performance fees in connection with investment advisory services provided to various funds and accounts, which are satisfied over time and measured using a time elapsed measure of progress as the customer receives the benefits of the services evenly throughout the term of the contract.
Management and performance fees are considered variable as they are subject to fluctuation (e.g., changes in assets under management, market performance) and/or are contingent on a future event during the measurement period (e.g., meeting a specified benchmark) and are recognized only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Management fees are generally based on month-end assets under management or an agreed upon notional amount and are included in the transaction price at the end of each month when the assets under management or notional amount is known. Performance fees are received when the return on assets under management for a specified performance period exceed certain benchmark returns, "high-water marks" or other performance targets. The performance period related to our performance fees is annual or semi-annual. Accordingly, performance fee
revenue will generally be recognized only at the end of the performance period to the extent that the benchmark return has been met.
Manufacturing Revenues. Idaho Timber's primary business consists of the sale of lumber that is manufactured or remanufactured at one of its locations. Agreements with customers for these sales specify the type, quantity and price of products to be delivered as well as the delivery date and payment terms. The transaction price is fixed at the time of sale and revenue is generally recognized when the customer takes control of the product.
56
Disaggregation of Revenue
The following presents our revenues from contracts
with customers disaggregated by major business activity and primary geographic regions (in thousands):
(1) We
now present Asset Management as a separate reporting segment. Prior year amounts have been reclassified to conform to current segment disclosure. See Note 23 for further information.
(2) Revenues from contracts with customers associated with the equities and fixed income businesses primarily represent commissions and other fee revenue.
58
Information on Remaining Performance Obligations and Revenue Recognized from Past Performance
We do not disclose information about remaining performance obligations pertaining to contracts
that have an original expected duration of one year or less. The transaction price allocated to remaining unsatisfied or partially unsatisfied performance obligations with an original expected duration exceeding one year was not material at May 31, 2020. Investment banking advisory fees that are contingent upon completion of a specific milestone and fees associated with certain distribution services are also excluded as the fees are considered variable and not included in the transaction price at May 31, 2020.
We recognized $i7.4 million
and $i15.3 million during the three months ended May 31, 2020 and 2019, respectively, and $i10.5
million and $i23.0 million during the six months ended May 31, 2020 and 2019, respectively, of revenues related to performance obligations satisfied (or partially satisfied) in previous periods, mainly due to resolving uncertainties in variable consideration that was constrained in prior periods. In addition, we recognized $i4.5 million
and $i4.8 million during the three months ended May 31, 2020 and 2019, respectively, and $i10.1
million and $i9.8 million during the six months ended May 31, 2020 and 2019, respectively, of revenues primarily associated with distribution services, a portion of which relates to prior periods.
The
timing of revenue recognition may differ from the timing of payment by customers. We record a receivable when revenue is recognized prior to payment and we have an unconditional right to payment. Alternatively, when payment precedes the provision of the related services, we record deferred revenue until the performance obligations are satisfied.
We had receivables related to revenues from contracts with customers of $i228.9
million and $i263.7 million at May 31, 2020 and November 30, 2019, respectively. We had no significant impairments related to these receivables during the three and six months ended May 31, 2020 and 2019.
Our deferred revenue primarily relates to retainer and milestone fees received in
investment banking advisory engagements where the performance obligation has not yet been satisfied. Deferred revenues were $i28.0 million and $i12.8 million at
May 31, 2020 and November 30, 2019, respectively, which are recorded as Payables, expense accruals and other liabilities in the Consolidated Statements of Financial Condition. During the three months ended May 31, 2020, we recognized $i7.2 million of deferred revenue from the balance at February 29, 2020. During the three
months ended May 31, 2019, we recognized $i1.8 million of deferred revenue from the balance at February 28, 2019. During the six months ended May 31, 2020, we recognized $i7.9
million of deferred revenue from the balance at November 30, 2019. During the six months ended May 31, 2019, we recognized $i9.4 million of deferred revenue from the balance at November 30, 2018.
We
capitalize costs to fulfill contracts associated with investment banking advisory engagements where the revenue is recognized at a point in time and the costs are determined to be recoverable. Capitalized costs to fulfill a contract are recognized at the point in time that the related revenue is recognized.
At May 31, 2020 and November 30, 2019, capitalized costs to fulfill a contract were $i3.2
million and $i4.8 million, respectively, which are recorded in Receivables in the Consolidated Statements of Financial Condition. We recognized expenses of $i1.8 million
and $i1.8 million, during the three months ended May 31, 2020 and 2019, respectively, and $i3.7
million and $i3.4 million, during the six months ended May 31, 2020 and 2019, respectively, related to costs to fulfill a contract that were capitalized as of the beginning of the period. There were no significant impairment charges recognized in relation to these capitalized costs during the three and six months ended May
31, 2020 and 2019.
59
Note 17. iIncome Taxes
The aggregate amount of gross unrecognized tax benefits related
to uncertain tax positions was $i364.3 million (including $i78.4 million for interest) at May 31,
2020, of which $i217.8 million related to Jefferies Group, and was $i327.3 million (including $i67.2
million for interest) at November 30, 2019, of which $i181.2 million related to Jefferies Group. If recognized, such amounts would lower our effective tax rate. We recognize interest and penalties, if any, related to unrecognized tax benefits in income tax expense. No material penalties were accrued for the six months ended May 31, 2020 and 2019.
The net deferred
tax asset was $i392.6 million and $i462.5 million at May 31, 2020 and November 30,
2019, respectively. The deferred tax asset is predominately attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases, the largest component of which relates to compensation and benefits.
The statute of limitations with respect to our federal income tax returns has expired for all years through 2015. We are currently under examination by various major tax jurisdictions. Prior to becoming a wholly-owned subsidiary, Jefferies Group filed a consolidated U.S. federal income tax return with its qualifying subsidiaries and was subject to income tax in various states, municipalities and foreign jurisdictions and Jefferies Group is also currently under examination by various major tax jurisdictions. We do not expect
that resolution of these examinations will have a significant effect on the Consolidated Statements of Financial Condition, but could have a significant impact on the Consolidated Statements of Operations for the period in which resolution occurs.
Our provision for income taxes for the six months ended May 31, 2020 was $i77.7 million, representing an effective tax rate of i33.3%.
Our
benefit for income taxes for the six months ended May 31, 2019 was $i486.5 million. During the second quarter of 2019, we completed the sale of our available for sale portfolio. In connection therewith, we recognized a tax benefit of $ii544.6/ million
during the three and six months ended May 31, 2019. Unrealized gains and losses on available for sale securities, and their associated tax impacts, are recorded directly to equity as part of the Accumulated other comprehensive income (loss) balance. Following the portfolio approach, when unrealized gains and losses and their associated tax impacts are recorded at a then current tax rate, and then realized later at a different tax rate, the difference between the tax impact initially recorded in Accumulated other comprehensive income (loss) and the tax impact removed from Accumulated other comprehensive income (loss) upon realization remains in Accumulated other comprehensive income (loss) until the disposal of the portfolio and is referred to as a "lodged tax effect." Large changes in the fair value of our available for sale securities, primarily during 2008 through 2010, combined with fluctuations in our tax rate
during those periods, generated a lodged tax benefit of $i544.6 million. As a result of steps to improve our Corporate investment management efforts, we sold the remaining portion of our available for sale portfolio in the second quarter of 2019, which resulted in the realization of the $i544.6 million
tax benefit. While this realization did not impact total equity, it resulted in a tax benefit reflected in the Consolidated Statement of Operations of $i544.6 million and, as a result, Retained earnings increased and Accumulated other comprehensive income (loss) decreased by corresponding amounts.
60
Note
18. iCommon Share and Earnings Per Common Share
Basic and diluted earnings per share amounts were calculated by dividing net income by the weighted average number of common shares outstanding. iThe
numerators and denominators used to calculate basic and diluted earnings per share are as follows (in thousands):
(1)Represents
dividends declared during the period on participating securities plus an allocation of undistributed earnings to participating securities. Net losses are not allocated to participating securities. Participating securities represent restricted stock and RSUs for which requisite service has not yet been rendered and amounted to weighted average shares of i1,846,400 and i1,881,600
for the three months ended May 31, 2020 and 2019, respectively, and i1,874,100 and i1,856,400
for the six months ended May 31, 2020 and 2019, respectively. Dividends declared on participating securities were not material during the three and six months ended May 31, 2020 and 2019. Undistributed earnings are allocated to participating securities based upon their right to share in earnings if all earnings for the period had been distributed.
For the three and six months ended May 31, 2020, shares related to the mandatorily redeemable convertible preferred shares were not included in the computation of diluted per share amounts as the effect was antidilutive.
Our
Board of Directors from time to time has authorized the repurchase of our common shares. In January 2019, the Board of Directors approved a $i500.0 million share repurchase authorization and in January 2020, the Board of Directors approved an increase of $i250.0
million to the share repurchase authorization. Additionally, in connection with the HomeFed merger on July 1, 2019, our Board of Directors authorized the repurchase of an additional i9.25 million shares in the open market. In March 2020, the Board of Directors approved an additional share repurchase authorization of $i100 million.
During the six months ended May 31, 2020, we purchased a total of i24,784,910 of our common shares for an aggregate purchase price of $i491.9
million, or an average price of $i19.85 per share. At May 31, 2020, we had approximately $i73.3
million available for future purchases. In June 2020, the Board of Directors increased the share repurchase authorization to $i250.0 million, including the $i73.3 million
61
Note
19. iCommitments, Contingencies and Guarantees
Commitments
i
The
following table summarizes commitments associated with certain business activities at May 31, 2020 (in millions):
Expected
Maturity Date
2020
2021
2022 and 2023
2024 and 2025
2026 and Later
Maximum
Payout
Equity commitments (1)
$
i89.5
$
i156.0
$
i76.4
$
i—
$
i12.7
$
i334.6
Loan
commitments (1)
i—
i276.0
i35.0
i—
i—
i311.0
Underwriting
commitments
i58.0
i—
i—
i—
i—
i58.0
Forward
starting reverse repos (2)
i3,300.0
i—
i—
i—
i—
i3,300.0
Forward
starting repos (2)
i4,048.1
i—
i—
i—
i—
i4,048.1
Other
unfunded commitments (1)
i—
i136.4
i—
i4.9
i—
i141.3
$
i7,495.6
$
i568.4
$
i111.4
$
i4.9
$
i12.7
$
i8,193.0
(1)Equity
commitments, loan commitments and other unfunded commitments are presented by contractual maturity date. The amounts are however mostly available on demand.
(2)At May 31, 2020, all of the forward starting securities purchased under agreements to resell and forward starting securities sold under agreements to repurchase settled within three business days.
/
Equity Commitments. Equity commitments include a commitment to invest in Jefferies Group's joint venture, Jefferies Finance, and commitments to invest in private equity funds and in Jefferies Capital Partners,
LLC, the manager of the private equity funds, which consists of a team led by our President and a Director. At May 31, 2020, Jefferies Group's outstanding commitments relating to Jefferies Capital Partners, LLC and its private equity funds were $i11.3 million.
See Note 8 for additional information regarding Jefferies Group's investment in Jefferies Finance.
Additionally, as of May 31,
2020, we have other equity commitments to invest up to $i225.7 million in various other investments.
Loan Commitments. From time to time we make commitments to extend credit to investment banking and other clients in loan syndication, acquisition finance and securities transactions and to SPE sponsors in connection with the funding of CLO and other asset-backed transactions. These commitments and any related drawdowns of these facilities typically have fixed maturity dates and are contingent
on certain representations, warranties and contractual conditions applicable to the borrower. At May 31, 2020, we had $i80.0 million of outstanding loan commitments to clients.
Loan commitments outstanding at May 31, 2020 also include Jefferies Group's portion of the outstanding secured revolving credit facility provided to Jefferies Finance to support loan underwritings by Jefferies Finance.
At May 31, 2020, $i20.0 million of Jefferies Group's $i250.0
million commitment was funded.
Underwriting Commitments. In connection with investment banking activities, we may from time to time provide underwriting commitments to our clients in connection with capital raising transactions.
Forward Starting Reverse Repos and Repos. We enter into commitments to take possession of securities with agreements to resell on a forward starting basis and to sell securities with agreements to repurchase on a forward starting basis that are primarily secured by U.S. government and agency securities.
Other Unfunded Commitments. Other unfunded commitments include obligations in the form of revolving notes, warehouse financings and debt securities to provide financing to asset-backed and CLO vehicles. Upon advancing
funds, drawn amounts are collateralized by the assets of an entity.
Contingencies
We and our subsidiaries are parties to legal and regulatory proceedings that are considered to be either ordinary, routine litigation incidental to their business or not significant to our consolidated financial position. We and our subsidiaries are also
62
involved, from time to time, in other exams, investigations and similar reviews (both formal
and informal) by governmental and self-regulatory agencies regarding our businesses, certain of which may result in judgments, settlements, fines, penalties or other injunctions. We do not believe that any of these actions will have a significant adverse effect on our consolidated financial position or liquidity, but any amounts paid could be significant to results of operations for the period.
Guarantees
Derivative Contracts. Our dealer activities cause us to make markets and trade in a variety of derivative instruments. Certain derivative contracts that we have entered into meet the accounting definition of a guarantee under GAAP, including credit
default swaps, written foreign currency options and written equity put options. On certain of these contracts, such as written interest rate caps and foreign currency options, the maximum payout cannot be quantified since the increase in interest or foreign exchange rates are not contractually limited by the terms of the contract. As such, we have disclosed notional values as a measure of our maximum potential payout under these contracts.
i
The
following table summarizes the notional amounts associated with our derivative contracts meeting the definition of a guarantee under GAAP at May 31, 2020 (in millions):
The
derivative contracts deemed to meet the definition of a guarantee under GAAP are before consideration of hedging transactions and only reflect a partial or "one-sided" component of any risk exposure. Written equity options and written credit default swaps are often executed in a strategy that is in tandem with long cash instruments (e.g., equity and debt securities). We substantially mitigate our exposure to market risk on these contracts through hedges, such as other derivative contracts and/or cash instruments, and we manage the risk associated with these contracts in the context of our overall risk management
framework. We believe notional amounts overstate our expected payout and that fair value of these contracts is a more relevant measure of our obligations. The fair value of derivative contracts meeting the definition of a guarantee is approximately $i192.7 million at May 31, 2020.
Berkadia.
We have agreed to reimburse Berkshire Hathaway for up to one-half of any losses incurred under a $i1.5 billion surety policy securing outstanding commercial paper issued by an affiliate of Berkadia. At May 31, 2020, the aggregate amount of commercial paper outstanding was $i1.47
billion.
HomeFed. For real estate development projects, HomeFed is generally required to obtain infrastructure improvement bonds at the beginning of construction work and warranty bonds upon completion of such improvements. These bonds are issued by surety companies to guarantee satisfactory completion of a project and provide funds primarily to a municipality in the event HomeFed is unable or unwilling to complete certain infrastructure improvements. As HomeFed develops the planned area and the municipality accepts the improvements, the bonds are released. Should the respective municipality or others draw on the bonds for any reason, certain of HomeFed's subsidiaries would be obligated to pay. At May 31, 2020, the aggregate amount of
infrastructure improvement bonds outstanding was $i66.6 million.
Other Guarantees. We are members of various exchanges and clearing houses. In the normal course of business, we provide guarantees to securities clearing houses and exchanges. These guarantees generally are required under the standard membership agreements, such that members are required to guarantee the performance of other members. Additionally, if a member becomes unable to satisfy
its obligations to the clearing house, other members would be required to meet these shortfalls. To mitigate these performance risks, the exchanges and clearing houses often require members to post collateral. Our obligations under such guarantees could exceed the collateral amounts posted. Our maximum potential liability under these arrangements cannot be quantified; however, the potential for us to be required to make payments under such guarantees is deemed remote. Accordingly, no liability has been recognized for these arrangements.
Standby Letters of Credit. At May 31, 2020, we provided guarantees to certain counterparties in the form of standby letters of credit totaling $i38.5
million. Standby letters of credit commit us to make payment to the beneficiary if the guaranteed party
63
fails to fulfill its obligation under a contractual arrangement with that beneficiary. Since commitments associated with these collateral instruments may expire unused, the amount shown does not necessarily reflect the actual future cash funding requirement. Primarily all letters of credit expire within ione year.
Note
20. iNet Capital Requirements
Jefferies LLC operates as a broker-dealer registered with the SEC and a member firm of the Financial Industry Regulatory Authority ("FINRA"). Jefferies LLC is subject to the Securities and Exchange Commission Uniform Net Capital Rule ("Rule 15c3-1"), which requires the maintenance of minimum net capital and has elected to calculate minimum capital requirements using the alternative method permitted by Rule 15c3-1 in calculating
net capital. Jefferies LLC, as a dually-registered U.S. broker-dealer and futures commission merchant ("FCM"), is also subject to Rule 1.17 of the Commodity Futures Trading Commission ("CFTC"), which sets forth minimum financial requirements. The minimum net capital requirement in determining excess net capital for a dually-registered U.S. broker-dealer and FCM is equal to the greater of the requirement under Rule 15c3-1 or CFTC Rule 1.17.
Jefferies LLC's net capital and excess net capital at May 31, 2020 were $i1,507.7
million and $i1,430.7 million, respectively.
FINRA is the designated examining authority for Jefferies LLC and the National Futures Association is the designated self-regulatory organization for Jefferies LLC as an FCM.
Certain other U.S. and non-U.S. subsidiaries of Jefferies Group are subject to capital adequacy requirements as prescribed by the regulatory authorities
in their respective jurisdictions, including Jefferies International Limited, which is authorized and regulated by the Financial Conduct Authority in the United Kingdom.
The regulatory capital requirements referred to above may restrict our ability to withdraw capital from Jefferies Group's regulated subsidiaries. Some of our other consolidated subsidiaries also have credit agreements which may restrict the payment of cash dividends, or the ability to make loans or advances to the parent company.
Note 21. iOther
Fair Value Information
i
The carrying amounts and estimated fair values of our principal financial instruments that are not recognized at fair value on a recurring basis are as follows (in thousands):
(1)Notes
and loans receivable: The fair values are estimated principally based on a discounted future cash flows model using market interest rates for similar instruments. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy.
(2)Short-term borrowings: The fair values of short-term borrowings carried at cost are estimated to be the carrying amount due to their short maturities. If measured at fair value in the financial statements, these financial instruments would be classified as Level 3 in the fair value hierarchy. Short-term borrowings that are accounted for at fair value include equity-linked notes, which are generally categorized within Level 2 of the fair value hierarchy, as the fair value is based on the price of the underlying equity security.
(3)Long-term
debt: The fair values are estimated using quoted prices, pricing information obtained from external data providers and, for certain variable rate debt, is estimated to be the carrying amount. If measured at fair value in the financial statements, these financial instruments would be classified as Level 2 and Level 3 in the fair value hierarchy.
/
64
Note 22. iRelated
Party Transactions
Jefferies Capital Partners Related Funds. Jefferies Group has equity investments in the JCP Manager and in private equity funds (including JCP Fund V), which are managed by a team led by our President and a Director ("Private Equity Related Funds"). Reflected in the Consolidated Statements of Financial Condition at May 31, 2020 and November 30, 2019 are Jefferies Group's equity investments in Private Equity Related Funds of $i16.6
million and $i23.0 million, respectively. Net gains (losses) from Jefferies Group's investment in JCP Fund V aggregating $(i7.0) million
and $i3.8 million for the three months ended May 31, 2020 and 2019, respectively, $(i5.5)
million and $i0.6 million for the six months ended May 31, 2020 and 2019, respectively, were recorded in Principal transactions revenues. Gains (losses) for other funds were not material. For further information regarding our commitments and funded amounts to the Private Equity Related Funds, see Notes 7 and 19.
Berkadia Commercial Mortgage,
LLC. At May 31, 2020 and November 30, 2019, Jefferies Group has commitments to purchase $i209.7 million and $i360.4
million, respectively, in agency commercial mortgage-backed securities from Berkadia.
FXCM. Jefferies Group entered into a foreign exchange prime brokerage agreement with FXCM in 2017. In connection with the foreign exchange contracts entered into under this agreement, Jefferies Group had $i2.1 million and $i9.9
million at May 31, 2020 and November 30, 2019, respectively, included in Payables, expense accruals and other liabilities in the Consolidated Statements of Financial Condition.
Officers, Directors and Employees. We have $i42.3 million and $i44.8
million of loans outstanding to certain officers and employees (none of whom are an executive officer or director of the Company) at May 31, 2020 and November 30, 2019, respectively. Receivables from and payables to customers include balances arising from officers', directors' and employees' individual security transactions. These transactions are subject to the same regulations as all customer transactions and are provided on substantially the same terms.
Jefferies Finance. During November 2019, we purchased $i65.3
million of loan receivables from Jefferies Finance which settled during the six months ended May 31, 2020. See Note 8 for additional information on transactions with Jefferies Finance.
Note 23. iSegment Information
We are a diversified
financial services company engaged in investment banking and capital markets, asset management and direct investing. During the first quarter of 2020, we changed our internal structure with regard to our operating segments. Previously, our segments consisted of: 1) Investment Banking, Capital Markets and Asset Management, which included all of the financial results of Jefferies Group; 2) Merchant Banking; and 3) Corporate. In the first quarter of 2020, we appointed co-Presidents of Asset Management and created a separate operating segment that consists of the asset management activity previously included in our Investment Banking, Capital Markets and Asset Management segment, together with asset management activity previously included in our Merchant Banking segment. In order to compare results with prior periods, we have recast our segment results for the three and six months ended May 31, 2019.
The
Investment Banking and Capital Markets segment includes investment banking, capital markets and other related services. Investment banking provides underwriting and financial advisory services to clients across most industry sectors in the Americas, Europe and Asia. Capital markets businesses operate across the spectrum of equities, fixed income and foreign exchange products. Related services include, among other things, prime brokerage and equity finance, research and strategy, corporate lending and real estate finance.
Our Asset Management segment includes both the operations of LAM as well as the asset management operations within Jefferies Group. Within Asset Management, we manage, invest in and provide services to a diverse group of alternative asset management platforms across a spectrum of investment strategies and asset classes. Asset Management offers institutional clients an innovative range of investment strategies
through its affiliated managers.
Merchant Banking consists of our various merchant banking businesses and investments, primarily including Linkem, Vitesse Energy Finance and JETX Energy, real estate, Idaho Timber, FXCM and The We Company. Our Merchant Banking businesses and investments also included National Beef, prior to its sale in November 2019 and Spectrum Brands, prior to its distribution to shareholders in October 2019.
Corporate assets primarily consist of cash and cash equivalents, financial instruments owned and the deferred tax asset (exclusive of Jefferies Group's deferred tax asset). Corporate revenues primarily include interest income.
65
i
Certain
information concerning our segments is presented in the following table. Consolidated subsidiaries are reflected as of the date a majority controlling interest was acquired.
Identifiable
assets employed related to reportable segments
i50,560,088
i49,554,729
Consolidation
adjustments
(i276,873)
(i94,495)
Total
consolidated assets
$
i50,283,215
$
i49,460,234
/
66
Interest expense classified as a component of Net revenues relates to Jefferies Group. For the three months ended May 31, 2020 and 2019, interest expense classified as a component of Expenses was primarily comprised of parent company interest ($i12.9 million and $i14.8 million,
respectively) and Merchant Banking ($i8.3 million and $i8.4 million, respectively). For the six months ended May 31, 2020 and 2019,
interest expense classified as a component of Expenses was primarily comprised of parent company interest ($i25.7 million and $i29.5 million, respectively) and Merchant Banking ($i17.1
million and $i16.6 million, respectively).
67
Item
2.
Management's Discussion and Analysis of Financial Condition and Results of Operations.
Statements included in this report may contain forward-looking statements. See "Cautionary Statement for Forward-Looking Information" below. The following should be read in conjunction with the Management's Discussion and Analysis of Financial Condition and Results of Operations, Risk Factors and the description of our businesses included in our Annual Report on Form 10-K for the year ended November 30, 2019 (the "2019 10-K").
Results
of Operations
We are a diversified financial services company engaged in investment banking and capital markets, asset management and direct investing. During the first quarter of 2020, we changed our internal structure with regard to our operating segments. Previously, our segments consisted of: 1) Investment Banking, Capital Markets and Asset Management, which included all of the financial results of Jefferies Group LLC ("Jefferies Group"); 2) Merchant Banking; and 3) Corporate. In the first quarter, we appointed co-Presidents of Asset Management and created a separate fourth operating segment that consists of the asset management activity previously included in our Investment Banking, Capital Markets and Asset Management segment, together with asset management activity previously included in our Merchant Banking segment. In order to compare results with prior periods, we have recast our segment results for the three
and six months ended May 31, 2019. The discussion that follows is presented on the basis of our recast segments.
A summary of results of operations for the second quarter of 2020 is as follows (in thousands):
Investment
Banking and Capital Markets
Asset Management
Merchant Banking
Corporate
Parent Company Interest
Consolidation Adjustments
Total
Net
revenues
$
1,028,832
$
7,391
$
107,162
$
1,525
$
—
$
2,679
$
1,147,589
Expenses:
Compensation
and benefits
551,821
26,502
13,973
6,171
—
—
598,467
Cost
of sales (1)
67,601
7,878
80,771
—
—
—
156,250
Interest
expense (2)
—
—
8,282
—
12,878
—
21,160
Depreciation
and amortization
19,981
2,133
17,378
874
—
—
40,366
Selling,
general and other expenses
174,895
12,431
54,753
7,334
—
(295)
249,118
Total
expenses
814,298
48,944
175,157
14,379
12,878
(295)
1,065,361
Income
(loss) before income taxes and loss related to associated companies
214,534
(41,553)
(67,995)
(12,854)
(12,878)
2,974
82,228
Loss
related to associated companies
—
—
(6,721)
—
—
—
(6,721)
Income
(loss) before income taxes
$
214,534
$
(41,553)
$
(74,716)
$
(12,854)
$
(12,878)
$
2,974
$
75,507
Income
tax provision
31,962
Net
income
$
43,545
(1) Includes Floor brokerage and clearing fees.
(2) Interest expense within Merchant Banking of $8.3 million for the second quarter of 2020, primarily includes $7.0 million for Foursight Capital and $1.2 million for Vitesse Energy, LLC ("Vitesse Energy Finance").
68
A
summary of results of operations for the first half of 2020 is as follows (in thousands):
Investment
Banking and Capital Markets
Asset Management
Merchant Banking
Corporate
Parent Company Interest
Consolidation Adjustments
Total
Net
revenues
$
2,177,661
$
27,720
$
311,721
$
11,317
$
—
$
5,498
$
2,533,917
Expenses:
Compensation
and benefits
1,172,745
48,723
31,163
16,029
—
—
1,268,660
Cost
of sales (1)
120,475
14,185
153,214
—
—
—
287,874
Interest
expense (2)
—
—
17,055
—
25,659
—
42,714
Depreciation
and amortization
39,097
2,758
36,219
1,762
—
—
79,836
Selling,
general and other expenses
380,853
24,536
127,833
14,134
—
(400)
546,956
Total
expenses
1,713,170
90,202
365,484
31,925
25,659
(400)
2,226,040
Income
(loss) before income taxes and loss related to associated companies
464,491
(62,482)
(53,763)
(20,608)
(25,659)
5,898
307,877
Loss
related to associated companies
—
—
(74,576)
—
—
—
(74,576)
Income
(loss) before income taxes
$
464,491
$
(62,482)
$
(128,339)
$
(20,608)
$
(25,659)
$
5,898
233,301
Income
tax provision
77,735
Net
income
$
155,566
(1) Includes Floor brokerage and clearing fees.
(2) Interest expense within Merchant Banking of $17.1 million for the first half of 2020, primarily includes $14.4 million for Foursight Capital and $2.6 million for Vitesse Energy Finance.
A summary of results for the second quarter of
2019 is as follows (in thousands):
Investment Banking
and Capital Markets
Asset Management
Merchant Banking
Corporate
Parent Company Interest
Consolidation Adjustments
Total
Net
revenues
$
859,275
$
44,362
$
185,379
$
8,974
$
—
$
3,667
$
1,101,657
Expenses:
Compensation
and benefits
470,530
13,338
13,931
12,761
—
—
510,560
Cost
of sales (1)
50,218
10,169
80,415
—
—
—
140,802
Interest
expense (2)
—
—
8,372
—
14,766
—
23,138
Depreciation
and amortization
18,588
505
16,826
867
—
—
36,786
Selling,
general and other expenses
177,358
12,240
30,356
9,231
—
(123)
229,062
Total
expenses
716,694
36,252
149,900
22,859
14,766
(123)
940,348
Income
(loss) before income taxes and income related to associated companies
142,581
8,110
35,479
(13,885)
(14,766)
3,790
161,309
Income
related to associated companies
—
120
22,050
—
—
—
22,170
Income
(loss) before income taxes
$
142,581
$
8,230
$
57,529
$
(13,885)
$
(14,766)
$
3,790
183,479
Income
tax benefit
(488,797)
Net
income
$
672,276
(1) Includes Floor brokerage and clearing fees.
(2) Interest expense within Merchant Banking of $8.4 million for the second quarter of 2019, primarily includes $7.1 million for Foursight Capital and $1.2 million for Vitesse Energy Finance.
69
A
summary of results for the first half of 2019 is as follows (in thousands):
Investment
Banking and Capital Markets
Asset Management
Merchant Banking
Corporate
Parent Company Interest
Consolidation Adjustments
Total
Net
revenues
$
1,517,522
$
75,107
$
318,071
$
13,167
$
—
$
6,233
$
1,930,100
Expenses:
Compensation
and benefits
831,844
30,192
27,834
30,282
—
—
920,152
Cost
of sales (1)
97,354
14,901
147,336
—
—
—
259,591
Interest
expense (2)
—
—
16,628
—
29,528
—
46,156
Depreciation
and amortization
35,918
960
32,120
1,722
—
—
70,720
Selling,
general and other expenses
354,708
19,980
59,378
16,391
—
(289)
450,168
Total
expenses
1,319,824
66,033
283,296
48,395
29,528
(289)
1,746,787
Income
(loss) before income taxes and income related to associated companies
197,698
9,074
34,775
(35,228)
(29,528)
6,522
183,313
Income
related to associated companies
—
340
49,143
—
—
—
49,483
Income
(loss) before income taxes
$
197,698
$
9,414
$
83,918
$
(35,228)
$
(29,528)
$
6,522
232,796
Income
tax benefit
(486,495)
Net
income
$
719,291
(1) Includes Floor brokerage and clearing fees.
(2) Interest expense within Merchant Banking of $16.6 million for the first half of 2019, primarily includes $14.1 million for Foursight Capital and $2.3 million for Vitesse Energy Finance.
The composition of our financial results
has varied over time and we expect will continue to evolve over time. Our strategy is designed to transform Jefferies into a pure financial services firm and, as such, we are focused on the development of our Investment Banking and Capital Markets, and Asset Management segments, while we continue to realize the value of or otherwise transform our investments in Merchant Banking. The following factors and events should be considered in evaluating our financial results as they impact comparisons:
Our financial results for the second quarter of 2020 were impacted by:
•Pre-tax income of $172.9 million from the Jefferies Group reflecting total net revenues of $1,034.4 million, including:
◦Record quarterly combined
Capital Markets net revenues of $730.3 million, including equities net revenues of $237.1 million and record fixed income net revenues of $493.2 million; and
◦Investment Banking net revenues of $316.3 million, including advisory net revenues of $182.1 million.
•Pre-tax loss of $74.7 million related to our Merchant Banking businesses reflecting:
◦Positive impact of hedging gains at Vitesse Energy Finance, solid results at Idaho Timber and a record quarter for FXCM; offset by
◦A $44.2 million non-cash charge to write-down the value of our investment in The We Company in light of SoftBank Group's withdrawal of its $3 billion tender offer and The We Company's current performance outlook;
◦Non-cash
charge of $13.2 million to write-down Vitesse Energy Finance's oil and gas assets in the Denver-Julesburg Basin ("DJ Basin"), reflecting a significant decrease in oil and gas prices;
◦A total of $12.2 million in non-cash write-downs of HomeFed LLC's ("HomeFed") interests in a hotel and a retail center significantly impacted by the external events of the second quarter;
◦ $19.3 million in mark-to-market unrealized decreases in the values of some of our investments in public companies; and
◦ A continued operating loss at Linkem, which experienced increased subscriber growth and network usage.
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Our
financial results for the first half of 2020 were impacted by:
•Record pre-tax income of $408.2 million from the Jefferies Group reflecting total record net revenues of $2,205.1 million, including:
◦Record combined six months Capital Markets net revenues of $1,224.1 million, including record equities net revenues of $482.8 million and record fixed income net revenues of $741.3 million; and
◦Investment Banking net revenues of $893.7 million, including record six months advisory net revenues of $525.2 million.
•Pre-tax loss of $128.3 million related to our Merchant Banking businesses reflecting:
◦Positive
contributions from Vitesse Energy Finance, Idaho Timber and FXCM;
◦A gain of $61.5 million from effective short-term hedges against mark-to-market and fair value decreases in some of our other investments within Merchant Banking;
◦A $44.2 million non-cash charge to write-down the value of our investment in The We Company in light of SoftBank Group's withdrawal of its $3 billion tender offer and The We Company's current performance outlook;
◦$45.4 million in mark-to-market unrealized decreases in the values of some of our investments in public companies;
◦Non-cash charges of $67.8 million related to write-downs of real estate investments at HomeFed; and
◦Non-cash
charge of $13.2 million to write-down Vitesse Energy Finance's oil and gas assets in the DJ Basin and $33.0 million to write-down the value of our investment in JETX Energy, LLC ("JETX Energy") to reflect the decline in oil prices.
Our financial results for the second quarter of 2019 were impacted by:
•A nonrecurring tax benefit of $544.6 million related to the closing of our available for sale portfolio, which triggered the realization of lodged tax benefits from earlier years;
•Pre-tax income of $155.1 million from the Jefferies Group, reflecting total net revenues of $901.9 million;
•Pre-tax income of $57.5 million related to our Merchant Banking businesses reflecting:
◦A
$11.3 million mark-to-market decrease in the value of our investment in Spectrum Brands Holdings, Inc. ("Spectrum Brands"); and
◦$34.9 million of income from associated companies in respect of our 31% investment in National Beef Packing Company, LLC ("National Beef").
Our financial results for the first half of 2019 were impacted by:
•A nonrecurring tax benefit of $544.6 million related to the closing of our available for sale portfolio, which triggered the realization of lodged tax benefits from earlier years;
•Pre-tax income of $217.7 million from Jefferies Group reflecting below-normal results in investment banking due to
the severe market downturn in December 2018, which heavily muted issuance activity, the five-week shutdown of the U.S. government in late December 2018 and January 2019, which further dampened new issue transactions in the capital markets and, Jefferies Group's advisory revenues in the second quarter of 2018, which were held back by the lag effect resulting from capital markets conditions in December 2018 and the U.S. government shutdown in December 2018 and January 2019;
•Pre-tax income of $83.9 million related to our Merchant Banking businesses reflecting:
◦A $24.7 million mark-to-market increase in the value of our investment in Spectrum Brands; and
◦$62.1 million of income from associated companies in respect of our 31% investment in National Beef.
During
March 2020, the global novel coronavirus ("COVID-19") pandemic and initial actions taken in response wreaked havoc on the global economy and all financial markets, and adversely affected our businesses. In April and May 2020, the unprecedented interventions of the U.S. Federal Reserve Bank, other central banks and various governments drove a sharp rebound in the financial markets and spurred renewed activity in the equity and debt new issue capital markets. As a result, Jefferies Group's performance improved considerably in April and May. Jefferies Group experienced strong market volumes and volatility was significantly higher during the quarter ended May 31, 2020 than in the prior year quarter, resulting in increased client activity across our capital markets businesses. Our investment banking net revenues were below normal for the quarter, but our backlog remains solid and our current level of incoming new business
is strong. We continue to monitor the impact of the pandemic on the operations and value of our investments.
Our leadership is continuously monitoring circumstances around COVID-19, as well as economic and capital market conditions, and providing frequent communications to both our clients and our employees. Peg Broadbent, Jefferies Group's longstanding, esteemed Chief Financial Officer, tragically died from complications of COVID-19 in March. We lost an incredible individual whom we all cherished and miss dearly. In Peg's memory, our clients, employees and firm came together
71
to contribute $9.25 million to over 85 front line charities aiding those most affected by COVID-19 and in the
greatest need. Throughout the quarter ended May 31, 2020, we have announced a number of important initiatives to support our employees, our clients and the broader public during this crisis:
• We have worked proactively providing our clients with advice, execution and liquidity during the market disruption. In May 2020, Greenwich Associates named Jefferies Group as the top firm in helping clients navigate the markets as COVID-19 significantly impacted equity markets in mid-March, causing volatility and increased trading volumes. These results were based on a survey they had recently conducted of more than 75 buy-side institutions evaluating brokers' performances in providing clients with liquidity, hedging solutions, market color and insights.
• We have monitored the health and welfare of our employees and worked actively with many
individuals diagnosed with COVID-19.
• We are working with a newly established public-private consortium combining the U.S. Department of Health and Human Services (through its Office of the Assistant Secretary for Preparedness and Response) and ApiJect Systems America, a public-benefit corporation, to raise up to $1 billion to build sterile manufacturing facilities worldwide.
• We have adopted enhanced cleaning practices across our offices and have restricted business travel.
• We implemented our Business Continuity Planning plan and have largely moved to a remote working environment across all functions without any significant disruptions to our business or control processes.
• We are working continuously with all of our critical vendors regarding their own pandemic responses to ensure there
is minimal impact on our business operations.
• We have honored the full financial commitment to our Jefferies Group summer intern class who will have a truncated program.
At May 31, 2020, we had goodwill recorded in our Consolidated Statement of Financial Condition of $1,736.5 million. Goodwill is allocated to reporting units and tested for impairment at least annually, or when circumstances or events make it more likely than not that an impairment occurred. As discussed further in Note 9, goodwill is primarily allocated to Investment Banking and Capital Markets of $1,553.3 million and Asset Management of $143.0 million. During the second quarter of 2020, COVID-19 broadly impacted the global operating environment, including a contraction in economic activity and significant volatility in the
financial markets. Given the significance of this event and its adverse impact on the global economic outlook and market valuations, we performed an interim impairment test of goodwill for impairment as of May 31, 2020. The results of the impairment test did not indicate any impairment. The valuation methodology for our reporting units are sensitive to management's forecasts of future profitability and come with a level of uncertainty regarding trading volumes, capital market transaction levels, client transaction activity and expected growth prospects for certain business lines. The impact of COVID-19 on our forecasts also remains uncertain and increases the subjectivity that will be involved in evaluating our goodwill for potential impairment going forward. If the future were to differ adversely from these assumptions, the estimated fair value may decline and result in an impairment.
Investment
Banking and Capital Markets
A summary of results of operations for our Investment Banking and Capital Markets segment is as follows (in thousands):
Our
Investment Banking and Capital Markets segment comprises many business units, with many interactions and much integration among them. Business activities include the sales, trading, origination and advisory effort for various equity, fixed income, commodities, foreign exchange and advisory services. Our Investment Banking and Capital Markets business, by its nature, does not produce predictable or necessarily recurring revenues or earnings. Our results in any given period can be materially affected by conditions in global financial markets, economic conditions generally, and our own activities and positions.
72
Revenues by Source
Net revenues presented for our Investment Banking and
Capital Markets segment include allocations of interest income and interest expense as we assess the profitability of these businesses inclusive of the net interest revenue or expense associated with the respective activities, including the net interest cost of allocated long-term debt, which is a function of the mix of each business's associated assets and liabilities and the related funding costs.
The following provides a summary of net revenues by source (in thousands):
Total
Investment Banking and Capital Markets (1) (2)
$
1,028,832
$
859,275
$
2,177,661
$
1,517,522
(1)Includes net interest revenues of $(0.8) million and $16.4 million for the second quarter of 2020 and 2019, respectively, and $2.1 million and $21.0
million for the first half of 2020 and 2019, respectively.
(2)Allocated net interest is not separately disaggregated in presenting our Investment Banking and Capital Markets reportable segment within our Net Revenues by Source. This presentation is aligned to our Investment Banking and Capital Markets internal performance measurement.
Investment Banking Revenues
Investment banking is comprised of revenues from:
• advisory services with respect to mergers and acquisitions and restructurings and recapitalizations;
•underwriting services, which include underwriting and placement services related to corporate debt, municipal bonds, mortgage-backed
and asset-backed securities and equity and equity-linked securities and loan syndication;
• our share of net earnings from Jefferies Group's corporate lending joint venture, Jefferies Finance LLC ("Jefferies Finance"); and
• securities and loans received or acquired in connection with our investment banking activities.
The following table sets forth our investment banking activities (dollars in billions):
Public
and private equity and convertible offerings (2)
50
49
106
70
$
25.4
$
17.4
$
37.2
$
20.4
73
(1) The
number of advisory deals completed includes seven and five restructuring and recapitalization transactions during the second quarter of 2020 and 2019, respectively, and ten and nine restructuring and recapitalization transactions during the first half of 2020 and 2019, respectively.
(2) We acted as sole or joint bookrunner on 44 and 47 offerings during the second quarter of 2020 and 2019, respectively, and 100 and 68 offerings during the first half of 2020 and 2019, respectively.
Total investment banking revenues were $316.3 million for the second quarter of 2020, as compared to $447.7 million for the second quarter of 2019, reflecting solid performance in mergers, acquisitions and advisory and equity underwriting, offset by lower revenues in debt underwriting and write-downs and reserves from Jefferies Group's Jefferies Finance joint venture.
Our
advisory revenues were $182.1 million, or 2.0% higher than the prior year quarter, and our equity underwriting revenues were 15.1% higher than the prior year quarter. Our results in mergers and acquisitions and equity underwriting were offset by lower revenues in debt underwriting, impacted by less acquisition finance activity and volatile debt markets. From equity and debt underwriting activities, we generated $124.4 million and $81.0 million in revenues, respectively, for the second quarter of 2020, compared with $108.0 million and $151.5 million in revenues, respectively, for the second quarter of 2019.
Other investment banking revenues were a loss of $71.2 million for the second quarter of 2020, compared with revenues of $9.6 million for the second quarter of 2019. Other investment banking revenues during the second quarter of 2020 include a net loss of $49.7 million from our share
of the net results of the Jefferies Finance joint venture, reflecting unrealized losses related to the write-down of commitments and loans held-for-sale, as well as reserves recorded on the loan portfolio during the current year quarter, primarily due to the impact of COVID-19 on the markets and economy. This compares with net revenues of $25.1 million in the second quarter of 2019 from our share of the net results of the Jefferies Finance joint venture. Results in the current year quarter also include a $9.5 million write-down of a private equity investment. The results in both quarters also include the amortization of costs and allocated interest expense related to our investment in the Jefferies Finance business.
Investment banking revenues for the first half of 2020 were $893.7 million for the first half of 2020, as compared to $725.7 million for the first half of 2019, reflecting
record performance in mergers and acquisitions, record results in equity underwriting and solid performance in debt underwriting. The prior year period results were also impacted by the severe market downturn in the early part of the prior year period, which heavily muted issuance activity, which was exacerbated by the five-week shutdown of the U.S. Government in late December and January, which further dampened new issue underwriting transactions.
Our advisory revenues were a record $525.2 million, up $166.2 million, or 46.3% higher than the prior year, reflecting record performance in our mergers and acquisitions business. Our underwriting revenues for the first half of 2020 were $454.3 million, an increase of $89.6 million, or 24.6%, from the same period last year, due to record results in equity underwriting and solid performance in debt underwriting, with broad contribution from
our sector teams and regional presence. From equity and debt underwriting activities, we generated $256.1 million and $198.2 million in revenues, respectively, for the first half of 2020, compared with $159.4 million and $205.3 million in revenues, respectively, for the first half of 2019.
Other investment banking revenues were a loss of $85.8 million for the first half of 2020, compared with revenues of $2.0 million for the first half of 2019. Other investment banking revenues during the first half of 2020 include a net loss of $39.3 million from our share of the net results of the Jefferies Finance joint venture, reflecting unrealized losses related to the write-down of commitments and loans held-for-sale, as well as reserves recorded on the loan portfolio during the current year period, primarily due to the impact of COVID-19 on the markets and the economy. This compares with net revenues
of $23.9 million in the first half of 2019 from our share of the net results of the Jefferies Finance joint venture. Other investment banking results during the first half of 2020 also includes a $24.5 million write-down of a private equity investment. The results in the first half of 2020 and 2019 also included an aggregate of $39.3 million and $46.5 million, respectively, representing the amortization of costs and allocated interest expense related to our investment in the Jefferies Finance business.
Equities Net Revenues
Equities are comprised of net revenues from:
•services provided to our clients from which we earn commissions or spread revenue by executing, settling and clearing transactions for clients;
•advisory
services offered to clients;
•financing, securities lending, outsourced trading and other prime brokerage services offered to clients; and
•wealth management services, which include providing clients access to all of our institutional execution capabilities.
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In May, Greenwich Associates named Jefferies Group as the top firm in helping clients navigate the markets as COVID-19 significantly impacted equity markets in mid-March, causing volatility and increased trading volumes. These results were based on a survey they had recently conducted of more than 75 buy-side institutions evaluating brokers' performances
in providing clients with liquidity, hedging solutions, market color and insights.
Total equities net revenues were $237.1 million for the second quarter of 2020, an increase of 15.1%, compared with $206.1 million for the second quarter of 2019, primarily due to record results in certain of our equities businesses, as a result of increased volumes and client activity, as well as the continued diversification of our business both from a product and geographic perspective. We believe we continued to extend our client franchise as we were in a position to provide consistent and strong service to our clients throughout this unprecedented period.
Our results include record net revenues in our International cash equities businesses across both Europe and Asia-Pacific, as well as across every region in our market-leading
global electronic trading franchise. We also had record net revenues in our prime brokerage business.
Results in our European and Asian cash equities businesses were driven by increased client activity and trading revenue, which is a result of higher market volumes and the expansion we have made in advisory and execution capabilities across Asia-Pacific. The record results in our global electronic trading business were driven by increased global market volumes, volatility, and the continued strength of the global platform. Our prime brokerage business also had record quarterly results as the business benefited from the continued growth and expansion of our outsourced trading business. Our equity options business had double-digit growth, driven by improved trading results and higher volatility.
Our Americas
cash equities business posted lower results driven by trading activity and the COVID-19 related market sell-off, partially offset by higher levels of client activity. Our global convertibles business had lower results driven by trading conditions as a result of the COVID-19 market environment. Results in our Securities Finance business were lower due to reduced trading activity and the overall market environment.
The increase in our global equities net revenues was partially offset by higher losses on certain block positions in the current year quarter.
Total equities net revenues were a record $482.8 million for the first half of 2020, an increase of 26.8%, compared with $380.6 million for the first half of 2019, primarily due to strong results in most of our equities businesses, as a result of increased
market volumes and client activity, higher levels of volatility, and the continued diversification of our business both from a product as well as geographic perspective. We believe we increased our market share in the first quarter of this year and additionally as we were in a position to provide consistent and strong service to our clients throughout this unprecedented period, we continued to extend our client franchise.
Our overall results include record net revenues in our International cash equities businesses across both Europe and Asia- Pacific, as well as across every region in our market-leading global electronic trading franchise.
Results in our global cash equities businesses were driven by increased client activity, market volumes and improved trading. While global market volumes and higher
volatility drove an increase in commissions, our results in Asia-Pacific were also driven by our expansion and investment in the region across advisory and execution capabilities. Our global electronic trading business achieved record results, which were driven by increased global market volumes, volatility, and the continued strength of the global platform. Our equity options business had double-digit growth, driven by higher volatility and improved trading. Our domestic and international convertibles business also had increased growth, driven by strong secondary trading activity, primarily in the U.S., and exceptional strength in the first quarter, globally.
The increase and record results in our global equities business was partially offset by lower revenues in our prime services businesses, driven by client activity in prime brokerage and reduced trading activity in our securities
finance business due to the impact of COVID-19.
The increase and record results in our global equities net revenues was partially offset by higher losses on certain block positions in the current year period.
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Fixed Income Net Revenues
Fixed income is comprised of net revenues from:
•executing transactions for clients and making markets in securitized products, investment grade, high-yield, emerging markets, municipal and sovereign securities and bank loans, as well as foreign exchange execution on behalf of
clients; and
•interest rate derivatives and credit derivatives.
Fixed income net revenues totaled $493.1 million for the second quarter of 2020, an increase of 184.6% from net revenues of $173.3 million for the second quarter of 2019, due to strong trading volumes from the impact of COVID-19 on the markets across many of our fixed income businesses.
Fixed income record net revenues for the second quarter of 2020 were a record in our U.S. and international rates, leveraged credit, Europe and Asia credit, investment grade corporates and emerging markets businesses. Our U.S. and international rates businesses delivered record net revenues in the current year quarter, primarily due to increased trading opportunities as a result of the U.S.
Federal Reserve Bank and other government interventions to support the markets during the quarter. Our international rates business in the prior year quarter underperformed due to a subdued market environment. Similarly, our leveraged credit, European and Asian credit and investment grade corporates businesses performed well due to increased client activity, higher levels of volatility and trading opportunities that presented in April and May of the current year quarter as compared with the prior year quarter. Our global emerging markets business similarly benefited in the current year quarter, with government support of the credit markets driving increased trading activity, especially in the latter part of the quarter.
The current year quarter results were partially offset by trading losses in our municipal securities business, which was impacted by the significant sell-off in this business
due to the impact of COVID-19. Revenues in our U.S. and international securitized markets groups were also lower in the current year quarter due to a decline in demand in the securitization markets for those product classes and trading losses in certain asset classes as credit spreads widened for structured products.
Fixed income net revenues totaled a record $741.3 million for the first half of 2020, an increase of 100.4% from net revenues of $370.0 million for the first half of 2019, primarily due to strong trading volumes, as markets were more active, and the fixed income businesses' results reflect having successfully managed though the markets' high level of volatility during the period.
Our U.S. and international rates businesses had record net revenues in the current year period, as there were more
trading opportunities in the U.S. treasuries trading market in the first half of the period and increased trading opportunities as a result of the U.S. Federal Reserve Bank and other government interventions due to the impact of COVID-19 in the second half of the period. Our international rates business in the prior year period underperformed as concerns over Brexit and economic challenges in other countries limited trading opportunities in the prior year period. Similarly, our leveraged credit, European and Asian credit and investment grade corporates businesses performed well due to increased client activity and higher levels of volatility throughout most of the current year period. Our global emerging markets business similarly benefited in the current year period, with more favorable market conditions which drove strong investor demand and an increase in new issuance in certain countries in the first half of the period, while government support of the credit markets
drove increased trading activity in the second half of the period.
The current year period results were partially offset by trading losses in our municipal securities business, which was impacted by the significant sell-off in this business due to the impact of COVID-19 in the second half of the current year period. Revenues in our U.S. and international securitized markets groups were also lower in the current year period due to a decline in demand in the securitization markets for those product classes and trading losses in certain asset classes as credit spreads widened for structured products.
Other
Other is comprised of revenues from:
• Berkadia Commercial Mortgage Holding LLC ("Berkadia")
and other investments (other than Jefferies Finance);
• principal investments in private equity and hedge funds managed by third parties or related parties and that are not part of our Leucadia Asset Management ("LAM") platform; and
• investments held as part of employee benefit plans, including deferred compensation plans (for which we incur equal and offsetting compensation expenses).
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Net revenues from our Investment Banking and Capital Markets segment's other business category were a net loss of $17.7 million for the second quarter of 2020, an decrease of $49.9 million compared with $32.2 million for the second quarter of 2019.
Results
in the second quarter of 2020 include negligible net revenues due to our share of the net income of Berkadia compared with net revenues of $25.3 million in the second quarter of 2019, due to the impairment of mortgage servicing rights as a result of lower interest rates, higher loan loss provisions and a decline in loan originations due to the impact of COVID-19 in the current quarter. The results in the second quarter of 2020 also include net mark-to-market losses related to certain investments compared with mark-to-market gains in the second quarter of 2019.
Net revenues from our Investment Banking and Capital Markets segment's other business category totaled $59.8 million for the first half of 2020, an increase of $18.6 million compared with $41.2 million for the first half of 2019. The results in the first half of 2020 include gains of $61.5 million from hedges that were bought and
sold in February to offset the anticipated severe drop in equity markets at the end of the first quarter.
Results in the first half of 2020 also include net revenues of $21.9 million due to our share of the net income of Berkadia compared with $47.9 million in the first half of 2019, as the second half of the current year period includes the impairment of mortgage servicing rights as a result of lower interest rates, higher loan loss provisions and a decline in loan originations due to the impact of COVID-19.
Compensation and Benefits
Compensation and benefits expense consists of salaries, benefits, commissions, annual cash compensation awards and the amortization of share-based and cash compensation awards to employees. Cash and share-based awards and a portion
of cash awards granted to employees as part of year end compensation generally contain provisions such that employees who terminate their employment or are terminated without cause may continue to vest in their awards, so long as those awards are not forfeited as a result of other forfeiture provisions (primarily non-compete clauses) of those awards. Accordingly, the compensation expense for a portion of awards granted at year end as part of annual compensation is recorded in the year of the award. Compensation and benefits expense includes amortization expense associated with these awards to the extent there are respective future service periods. In addition, the senior executive awards contain market and performance conditions.
Compensation and benefits expense increased in line with the increase in net revenues. A significant portion of our compensation expense remains highly variable. Compensation and benefits as a percentage
of Net revenues were 53.6% and 54.8% for the second quarter of 2020 and 2019, respectively, and 53.9% and 54.8% for the first half of 2020 and 2019, respectively, due to the change in the mix of Jefferies Group's net revenues, with higher revenues in our core operating businesses and lower net revenues from our Jefferies Finance joint venture and Other businesses, including our investment in Berkadia. Compensation expense related to the amortization of share-based and cash-based awards amounted to $79.4 million and $73.0 million for the second quarter of 2020 and 2019, respectively, and $162.5 million and $145.5 million for the first half of 2020 and 2019, respectively, reflecting Jefferies Group's hiring in recent periods.
Non-Compensation Expenses
Non-compensation expenses include floor brokerage and clearing fees,
underwriting costs, technology and communications expense, occupancy and equipment rental expense, business development, professional services, bad debt provision, impairment charges, depreciation and amortization expense and other costs. All of these expenses, other than floor brokerage and clearing fees and depreciation and amortization expense, are included in Selling, general and other expenses in the Consolidated Statements of Operations.
Non-compensation expenses were $262.5 million for the second quarter of 2020, an increase of $16.3 million, or 6.6%, compared with $246.2 million in the second quarter of 2019. The increase in non-compensation expenses was primarily due to higher Floor brokerage and clearing fees due to an increase in trading volumes across the equities and fixed income businesses. The increase was also due to higher technology and communication expenses primarily related to increased market data and
connectivity usage and costs associated with the development of various trading systems and costs associated with our move to a largely remote working environment. Non-compensation expense also increased due to higher other expenses, which included our charitable donations of $8.6 million, in memory of Peg Broadbent, Jefferies Group's longstanding, esteemed Chief Financial Officer who tragically died from complications of COVID-19 in March. The increase in non-compensation expenses was partially offset by lower business development expenses as business travel and hosted events were curtailed due to COVID-19.
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Non-compensation expenses were $540.4 million for the first half of 2020, an increase of $52.4 million, or 10.7%, compared with $488.0 million in the first half of
2019. The increase in non-compensation expenses was primarily due to higher Floor brokerage and clearing fees due to an increase in trading volumes primarily across our equities businesses, as well as in the fixed income businesses. The increase was also due to higher technology and communication expenses primarily related to costs associated with the development of various trading systems, increased market data and connectivity usage and costs associated with our move to a largely remote working environment. The increase also included higher professional services expenses primarily due to an increase in consulting fees and higher underwriting costs primarily due to an increase in investment banking engagements in the first quarter of the period. Non-compensation expense also increased due to higher other expenses, which included our charitable donations, in memory of Peg Broadbent, Jefferies Group's longstanding, esteemed Chief Financial Officer who tragically died
from complications of COVID-19 in March and our donation made to various charities in support of the Australian wildfire relief effort. The increase in non-compensation expenses was partially offset by lower business development expenses as business travel and hosted events were curtailed due to COVID-19.
Asset Management
In the first quarter of 2020, we reorganized our segments to separately report our Asset Management businesses. In connection with this change, we have reclassified the prior periods to conform to our current presentation. A summary of results of operations for our Asset Management segment is as follows (in thousands):
Income (loss) before income taxes and income related to associated companies
(41,553)
8,110
(62,482)
9,074
Income
related to associated companies
—
120
—
340
Income (loss) before income taxes
$
(41,553)
$
8,230
$
(62,482)
$
9,414
Asset
management revenues include the following:
• management and performance fees from funds and accounts managed by us;
•revenue from strategic partners pursuant to agreements which entitle us to portions of our partners' revenues and/or profits; and
• investment income from our investments managed by our asset management business and other strategic partners.
The key components of asset management revenues are the level of assets under management and the performance return, whether on an absolute basis or relative to a benchmark or hurdle. These components can be affected by financial markets, profits and losses in the applicable investment portfolios and client capital activity. Further, asset management fees vary with the nature of
investment management services. The terms under which clients may terminate our investment management authority, and the requisite notice period for such termination, varies depending on the nature of the investment vehicle and the liquidity of the portfolio assets. Performance fees are generally recognized once a year, typically in December, at the end of the relevant performance period, to the extent that the benchmark return has been met.
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The following summarizes the results of our Asset Management businesses revenues by asset class (dollars in thousands):
Revenues from arrangements with strategic partners (1)
2,339
549
9,655
911
Total
asset management fees and revenues
5,835
6,724
19,242
15,404
Investment return (2) (3)
14,541
47,687
32,155
81,362
Allocated
net interest (2) (4)
(12,985)
(10,049)
(23,677)
(21,659)
Total Asset Management
$
7,391
$
44,362
$
27,720
$
75,107
(1)These
amounts include our share of fees received by third party asset management companies with which we have revenue and profit share arrangements.
(2)Net revenues attributed to the Investment return in our Asset Management segment have been disaggregated to separately present Investment return and Allocated net interest (see footnote 4 below). This disaggregation is intended to increase transparency and to make clearer actual Investment return. We believe that aggregating Investment return and Allocated net interest would obscure the Investment return by including an amount that is unique to our credit spreads, debt maturity profile, capital structure, liquidity risks and allocation methods, none of which are pertinent to the Investment returns generated by the performance of the portfolio.
(3)Includes net interest expense of $7.2 million
and $0.6 million for the second quarter of 2020 and 2019, respectively, and $13.6 million and $1.7 million for the first half of 2020 and 2019, respectively.
(4)Allocated net interest represents the allocation of long-term debt interest expense to our Asset Management reportable segment, net of interest income on Cash and cash equivalents and other sources of liquidity. For discussion of sources of liquidity, refer to the "Liquidity and Capital Resources" section herein.
Asset management net revenues for the second quarter of 2020 were $7.4 million, compared with $44.4 million in the second quarter of 2019. The decrease was primarily due to lower investment returns in certain of our investments in separately managed accounts and funds due to the impact of COVID-19 on the markets and economy during the current
year quarter. Asset management net revenues for the first half of 2020 were $27.7 million, compared with $75.1 million in the first half of 2019. The decrease was due to lower investment returns in certain of our investments in separately managed accounts and funds due to the impact of COVID-19 on the markets and economy during the second half of the current year period, partially offset by higher revenues from our share of fees received by third party asset management companies with which we have revenue and profit share arrangements.
The increase in expenses in the second quarter and first half of 2020 as compared with the second quarter and first half of 2019, respectively, primarily reflects the expansion of the Asset Management business, additional costs from the wind down of one of our asset management businesses and the dedication of resources previously included in Corporate.
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Assets under Management
Assets under management by predominant asset class were as follows (in millions):
(1) Assets
under management include third-party net assets actively managed by us, including hedge funds and certain managed accounts. The amounts at May 31, 2020 and November 30, 2019 also include $149 million and $150 million, respectively, of assets under management in a strategy, which represents a net asset value equivalent of an asset management strategy where we earn performance fees. We may consolidate certain funds and for such consolidated funds, assets under management includes the pro-rata portion of third-party net assets in consolidated funds based on the percentage ownership of third-party investors in the consolidated fund. The above amounts do not include assets under management at non-consolidated strategic partners or investments.
(2) Subsequent to May 31, 2020, $396 million
of these assets under management are in the process of being liquidated and the funds will be returned to the third-party investors.
Change in assets under management were as follows (in millions):
The
change in assets under management during the second quarter of 2020 is primarily due to redemptions from certain funds and market depreciation due to the impact of COVID-19 on the markets and economy. The change in assets under management during the second quarter of 2019 is primarily due to redemptions from certain funds and separately managed accounts and the dissolution of a fund. The change in assets under management during the first half of 2020 is primarily due to redemptions from certain funds, dissolution of a fund and market depreciation due to the impact of COVID-19 on the markets and economy, partially offset by new subscriptions and investments from third-parties. The change in assets under management during the first half of 2019 is primarily due to redemptions from certain funds and separately managed accounts and the dissolution of a fund partially offset by new subscriptions and investments from third-parties.
Our
definition of assets under management is not based on any definition contained in any of our investment management agreements and differs from the manner in which "Regulatory Assets Under Management" is reported to the SEC on Form ADV.
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Asset Management Investments
Our asset management business invests directly in hedge funds and separately managed accounts where we act as the asset manager. Additionally, we make investments in and enter into revenue sharing arrangements with third-party asset managers. Subsequent to May 31, 2020, $78.8 million of the asset management investments included in
the table below at May 31, 2020 are in the process of being liquidated due to the wind down of an asset management platform and the liquidation of funds. The following table represents our investments by asset manager (in thousands):
(1) Due
to the level or nature of an investment in a fund, we may consolidate that fund; and accordingly, the assets and liabilities of the fund are included in the representative line items in the consolidated financial statements. At May 31, 2020 and November 30, 2019, $17.5 million and $22.6 million, respectively, represent net investments in funds that have been consolidated in our financial statements.
(2) Where we have investments in a separately managed account, the assets and liabilities of such account are presented on the Consolidated Statement of Financial Condition within each respective line item.
(3) The increase for the first half of 2020 was primarily due to an investment in a new fund in the current year period.
(4) Of the $1,683.1
million total invested in the funds at May 31, 2020, $1,387.1 million was sourced from the proceeds of long-term and permanent capital. At May 31, 2020 and November 30, 2019, Jefferies Group has borrowed $296.0 million and $135.0 million, respectively, under a credit facility agreement ("Jefferies Group Credit Facility") with JPMorgan Chase Bank, N.A., which is secured by our investment in a fund managed by us, with a carrying value of $224.2 million and $218.1 million at May 31, 2020 and November 30, 2019, respectively, and our investment in a fund managed by a third-party with a carrying value of $284.7 million at May 31, 2020.
Our
asset management investments generated an investment return of $14.5 million and $47.7 million for the second quarter of 2020 and 2019, respectively, and $32.2 million and $81.4 million for the first half of 2020 and 2019, respectively.
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Merchant Banking
The composition of our Merchant Banking portfolio has been impacted by a number of transactions during recent years. The following chart reflects the significant components of our portfolio each year:
Oil and gas net revenues primarily consist of three components:
unrealized gains and losses related to oil hedges, mark-to-market increases and decreases related to a financial instrument held at fair value, and production revenues, which also include the impact of realized gains and losses related to oil hedges. Oil and gas net revenues include net unrealized gains related to oil hedge derivatives of $15.0 million and $26.0 million for the second quarter of 2020 and 2019, respectively, and $34.9 million and $0.6 million for the first half of 2020 and 2019, respectively. As discussed further in Note 3 to the consolidated financial statements, Vitesse Energy Finance uses swaps and call and put options in order to reduce exposure to future oil price fluctuations. For the remainder of 2020, over 100% of expected oil production is hedged at a weighted average price of approximately $60/barrel. Mark-to-market losses related to a financial instrument owned held at fair value were $3.2 million and $7.4 million for the second quarter of
2020 and 2019, respectively, and $5.7 million and $17.0 million during the first half of 2020 and 2019, respectively. Production revenues were $40.0 million and $44.3 million for the second quarter of 2020 and 2019, respectively, and $85.3 million and $84.7 million during the first half of 2020 and 2019, respectively.
Net revenues for Idaho Timber decreased in the second quarter of 2020 as compared to the second quarter of 2019, primarily due to a decrease in average selling price, offset slightly by an increase in average weekly shipments. Net revenues for Idaho Timber decreased in the first half of 2020 as compared to the first half of 2019, primarily due to a decrease in average selling price, offset slightly by an increase in average weekly shipments.
The increase in real estate revenues for the second
quarter and first half of 2020 as compared to the prior year periods relates to the acquisition of HomeFed in the third quarter of 2019.
Net revenues from our FXCM term loan primarily consist of adjustments to its carrying value, which is at fair value and include losses of $7.9 million and $11.4 million during the second quarter of 2020 and 2019, respectively, and $5.4 million and $11.0 million during the first half of 2020 and 2019, respectively.
Spectrum Brands net revenues reflect changes in the value of our investment. We classified Spectrum Brands as a financial instrument owned, at fair value for which the fair value option was elected and we reflected mark-to-market adjustments in Principal transactions revenues. In September 2019, our Board of Directors approved a distribution to stockholders
of our Spectrum Brands shares. We distributed the Spectrum Brands shares through a special pro rata dividend effective on October 11, 2019.
Other revenues reflect realized and unrealized gains (losses) on financial instruments owned, which are held at fair value, of $(63.4) million and $20.3 million for the second quarter of 2020 and 2019, respectively, and $(25.0) million and $3.9 million during the first half of 2020 and 2019, respectively. The gains (losses) on financial instruments owned include unrealized gains (losses) on The We Company of $(44.2) million and $28.6 million for the second quarter of 2020 and 2019, respectively, and $(44.2) million and $33.1 million during the first half of 2020 and 2019, respectively. The gains on financial instruments owned for the first half of 2020, also include a gain of $61.5 million from effective
short-term hedges against mark-to-market and fair value decreases in our portfolio investments.
The following provides a summary of total expenses by source (in thousands):
Total expenses for Oil and gas increased in the second quarter of 2020 as compared to the second quarter of 2019, primarily due to a non-cash charge of $13.2 million to write-down the value of a subset of Vitesse Energy Finance's oil and gas assets located in
the DJ Basin, reflecting the impact of oil price declines during the quarter. Total expenses for Oil and gas increased in the first half of 2020 as compared to the first half of 2019, primarily due to non-cash charges to JETX Energy's oil and gas assets of $33.0 million and to Vitesse Energy Finance's oil and gas assets in the DJ Basin of $13.2 million.
The decrease in total expenses for Idaho Timber in the second quarter of 2020 as compared to the second quarter of 2019 and the first half of 2020 as compared to the first half of 2019 primarily relates to a decrease in average cost of wood due to lower lumber prices in 2020 offset slightly by an increase in cost of sales associated with an increase in average weekly shipments.
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The
increase in real estate expenses for the second quarter and first half of 2020 as compared to the prior year periods relates to the acquisition of HomeFed in the third quarter of 2019.
The following provides a summary of Income (loss) related to associated companies (in thousands):
Income (loss) related to associated companies primarily includes our investments in National Beef, prior to its sale in November 2019.
Income
(loss) related to Real estate associated companies for the second quarter and first half of 2020, includes a non-cash charge of $6.9 million to fully write-off HomeFed's interest in the Brooklyn Renaissance Plaza hotel related to the significant impact of COVID-19 during the second quarter of 2020. Income (loss) related to Real estate associated companies for the first half of 2020, also includes a non-cash charge of $55.6 million to fully write-off the value of HomeFed's RedSky JZ Fulton Mall joint venture investment related to a softening of the Brooklyn real estate market.
A summary of results for Merchant Banking by source is as follows (in thousands):
Net
revenues primarily include realized and unrealized securities gains and interest income for investments held at the holding company. Total expenses include share-based compensation expense of $3.9 million and $6.5 million for the second quarter of 2020 and 2019, respectively, and $7.3 million and $11.8 million for the first half of 2020 and 2019, respectively.
Parent Company Interest
Parent company interest expense totaled $12.9 million and $14.8 million for the second quarter of 2020 and 2019, respectively, and $25.7 million and $29.5 million for the first half of 2020 and 2019, respectively. In connection with the acquisition of HomeFed in the third quarter of 2019, we began capitalizing interest. Capitalized interest was allocated among all of HomeFed's projects that are currently under development.
Parent company interest capitalized during the second quarter and first half of 2020 was $1.9 million and $3.9 million, respectively.
Income Taxes
Our provisions for income taxes were $32.0 million and $77.7 million for the second quarter and first half of 2020, respectively, representing an effective tax rate of 42.3% and 33.3%, respectively. Tax expense for the second quarter includes an additional expense to bring the year-to-date tax expense in line with the projected full year effective rate at May 31, 2020.
Our benefit for income taxes from continuing operations was $488.8 million and $486.5 million for the second quarter and first half of 2019, respectively.
During the second quarter of 2019, we completed the sale of our available for sale portfolio. In connection therewith, we recognized a tax benefit of $544.6 million during the second quarter and first half of 2019. Unrealized gains and losses on available for sale securities, and their associated tax impacts, are recorded directly to equity as part of the Accumulated other comprehensive income (loss) balance. Following the portfolio approach, when unrealized gains and losses and their associated tax impacts are recorded at a then current tax rate, and then realized later at a different tax rate, the difference between the tax impact initially recorded in Accumulated other comprehensive income (loss) and the tax impact removed from Accumulated other comprehensive income (loss) upon realization remains in Accumulated other comprehensive income (loss) until the disposal of the portfolio and is referred to as a "lodged tax effect." Large changes in the fair value
of our available for sale securities, primarily during 2008 through 2010, combined with fluctuations in our tax rate during those periods, generated a lodged tax benefit of $544.6 million. As a result of steps to improve our Corporate investment management efforts, we sold the remaining portion of our available for sale portfolio in the second quarter of 2019, which resulted in the realization of the $544.6 million tax benefit. While this realization did not impact total equity, it resulted in a tax benefit reflected in the Consolidated Statement of Operations of $544.6 million and, as a result, Retained earnings increased and Accumulated other comprehensive income (loss) decreased by corresponding amounts.
Refer to Note 17 in the consolidated financial statements included in this Quarterly Report on Form 10-Q, for further details on income taxes.
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Selected
Statement of Financial Condition Data
The tables below reconcile the balance sheet for each of our segments to our consolidated balance sheet (in thousands):
Total
Jefferies Financial Group Inc. shareholders' equity
$
5,844,660
$
886,450
$
1,939,400
$
656,044
$
—
$
9,326,554
(1) Jefferies
Group long-term debt of $6.7 billion at May 31, 2020 is allocated to Investment Banking and Capital Markets, and Asset Management segments based on an internal management view only and may not be reflective of what long-term debt would be on a stand-alone segment basis.
(2) Long-term debt within Merchant Banking of $351.1 million at May 31, 2020, primarily includes $189.2 million for real estate businesses, $105.2 million for Vitesse Energy Finance and $56.7 million for Foursight Capital. At May 31, 2020, Vitesse Energy Finance had $106.0 million drawn out of the maximum $170.0 million borrowing base on its credit facility and Foursight Capital had $57.0 million drawn out of the maximum $150.0 million credit commitment on its credit facilities.
See Note 11 in our consolidated financial statements for additional information.
Total
Jefferies Financial Group Inc. shareholders' equity
$
5,606,818
$
802,773
$
2,144,477
$
1,025,637
$
—
$
9,579,705
(1)
Jefferies Group long-term debt of $7.0 billion at November 30, 2019 is allocated to Investment Banking and Capital Markets, and Asset Management segments based on an internal management view only and may not be reflective of what long-term debt would be on a stand-alone segment basis.
(2) Long-term debt within Merchant Banking of $342.3 million at November 30, 2019, primarily includes $140.7 million for real estate businesses, $103.1 million for Vitesse Energy Finance and $98.3 million for Foursight Capital. At November 30, 2019, Vitesse Energy Finance had $104.0 million drawn out of the maximum $170.0 million borrowing base on its credit facility and Foursight Capital had $98.7 million drawn out of the maximum $175.0 million credit commitment
on its credit facilities. See Note 11 in our consolidated financial statements for additional information.
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The table below presents our capital by significant business and investment (in thousands):
Assets held on behalf of Asset Management (excluding Jefferies Group)
259,719
227,908
Merchant
Banking:
Oil and gas
575,613
585,493
Real estate
540,722
645,328
Linkem
214,105
194,847
FXCM
129,997
129,343
Idaho
Timber
84,567
77,914
The We Company
9,608
53,798
Investments in other public companies
126,878
178,593
Other
257,910
279,161
Total
Merchant Banking
1,939,400
2,144,477
Corporate liquidity and other assets, net of Corporate liabilities including long-term debt
656,044
1,025,637
Total
Capital
$
9,326,554
$
9,579,705
Below is a brief description of the captions in the table above:
•Investment Banking and Capital Markets includes our investment banking, capital markets and other related services. Investment banking provides underwriting and financial advisory services to our clients across most industry sectors in the Americas, Europe and Asia. Our capital markets businesses operate across the spectrum of equities and fixed income products. Related services include, among
other things, prime brokerage and equity finance, research and strategy, corporate lending and real estate finance. Our Investment Banking and Capital Markets businesses are conducted by Jefferies Group, our wholly-owned subsidiary, which is the largest independent U.S. headquartered global full-service, integrated investment banking and securities firm.
•Asset Management provides investment management services to investors in the U.S. and overseas and invests capital in hedge funds, separately managed accounts and third-party asset managers. Under the LAM umbrella, we manage, invest in and provide services to a diverse group of alternative asset management platforms across a spectrum of investment strategies and asset classes. LAM offers institutional clients an innovative range of investment strategies through its affiliated managers.
•Merchant
Banking:
◦Our oil and gas business consists of Vitesse Energy Finance and JETX Energy. Vitesse Energy Finance is our 97% owned consolidated subsidiary that acquires and invests in non-operated oil and gas working interests and royalties predominantly in the Bakken Shale oil field in North Dakota. JETX Energy is our 98% owned consolidated subsidiary that currently has non-operated working interests and acreage in east Texas.
◦Our real estate assets primarily consist of our 100% ownership of HomeFed, a developer and owner of residential and mixed-use real estate properties in California, New York, Florida, Virginia and South Carolina. HomeFed's key assets include Otay Ranch, a master planned community that is under development in Chula Vista, CA, made up of approximately 4,450 acres of land entitled for 13,050 total units;
and Renaissance Plaza, a mixed-use asset in Brooklyn, NY, comprised of an office building, hotel and garage.
◦We own approximately 42% of the common shares of Linkem, as well as convertible preferred shares and warrants. If all of our convertible preferred stock was converted and warrants were exercised, it would increase our ownership to approximately 56% of Linkem's common equity at May 31, 2020. Linkem provides residential broadband services in Italy using LTE technologies deployed over the 3.5 GHz spectrum band. Linkem is accounted for under the equity method.
◦Our investment in FXCM and associated companies consist of a senior secured term loan due February 15, 2021, ($71.6 million principal outstanding at May 31,
2020); a 50% voting interest in FXCM and rights to a majority of all
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distributions in respect of the equity in FXCM. FXCM is a provider of online foreign exchange trading, contract for difference trading, spread betting and related services.
◦Idaho Timber is our consolidated subsidiary engaged in the manufacture and distribution of various wood products.
◦We invested $9.0 million in 2013 in The We Company, which creates collaborative office communities. Currently we own less than 1% of the
company. Our interest in The We Company is reflected in Financial instruments owned, at fair value in our financial statements.
•Corporate liquidity and other assets, net of Corporate liabilities, primarily consist of cash and cash equivalents, financial instruments owned and the deferred tax asset (exclusive of Jefferies Group's deferred tax asset), net of long-term debt, trade payables and accruals, as well as our outstanding mandatorily redeemable convertible preferred shares.
Liquidity and Capital Resources
Parent Company Liquidity
Our
strategy focuses on strengthening and expanding our core business of Investment Banking and Capital Markets and Asset Management, while continuing to simplify our structure and return capital to our shareholders. We are simplifying our structure through a managed transformation of Merchant Banking, which to date has included divestitures, special distributions of assets, as well as transfers of financial assets out of our Merchant Banking portfolio and into Jefferies Group. We anticipate additional transactions as our transformation progresses. Some of these transactions generate significant excess liquidity; some of these transactions also reduce the future receipt of periodic distributions from subsidiaries to the parent company.
Parent company liquidity, which includes cash and investments that are easily convertible into cash within
a relatively short period of time, total $1,636.1 million at May 31, 2020 and are primarily comprised of cash, prime and government money market funds and other publicly traded securities. These are classified in the Consolidated Statement of Financial Condition as cash and cash equivalents and financial instruments owned, at fair value. At May 31, 2020, $1,288.1 million of this amount is invested in U.S. government money funds that invest at least 99.5% of its total assets in cash, securities issued by the U.S. government and U.S. government-sponsored entities and repurchase agreements that are fully collateralized by cash or government securities.
During the first half of 2020, our parent company received cash distributions of $86.6 million from our existing subsidiary businesses, including $44.6 million from Jefferies Group.
We also received $111.8 million from divestitures and repayments of advances.
Our recurring cash requirements, including the payment of interest on our parent company debt, dividends and corporate cash overhead expenses, aggregate approximately $292.4 million on an annual basis. Dividends paid during the first half of 2020 of $83.4 million include quarterly dividends of $0.15 per share. The payment of dividends is subject to the discretion of our Board of Directors and depends upon general business conditions, legal and contractual restrictions on the payment of dividends and other factors that our Board of Directors may deem to be relevant.
For many years, we have benefited from federal net operating loss carryovers ("NOLs") which have substantially offset our federal cash tax requirements. During the twelve months ended November
30, 2019, we used about $1.0 billion of our NOLs to offset taxable income, with about $111 million remaining NOLs as of November 30, 2019. Based on this, we anticipate incurring federal cash tax liabilities during the upcoming quarters.
Our primary long-term parent company cash requirement is our $1.0 billion principal outstanding as of May 31, 2020 under our long-term debt, of which $750.0 million is due in 2023 and $250.0 million in 2043. As we generate excess liquidity, we evaluate the best use of the proceeds, which may include reductions to existing debt, share repurchases, special dividends, investments in our businesses, or any of a number of other options available to us.
Shares Outstanding
In
January 2020, the Board of Directors approved an additional $250.0 million share repurchase authorization. In March 2020, having completed the repurchase of shares under the previous authorization, the Board of Directors approved an additional share repurchase authorization of $100 million. During the first half of 2020, we purchased a total of 24,784,910 of our common shares for $491.9 million, or an average price per share of $19.85. At May 31, 2020, we had approximately $73.3 million available for future repurchases. In June 2020, the Board of Directors increased the share repurchase authorization to $250.0 million, including the $73.3 million.
At May 31, 2020, we had outstanding 267,111,111 common shares and 23,563,000 share-based awards that do not require the holder to pay any exercise price (potentially an aggregate of
290,674,111 outstanding common shares if all awards become
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outstanding common shares). The 23,563,000 share-based awards include the target number of shares under the senior executive award plan.
Concentration and Liquidity Targets
From time to time in the past, we have accessed public and private credit markets and raised capital in underwritten bond financings. The funds raised have been used by us for general corporate purposes, including for our existing businesses and new investment opportunities. In addition, the ratings of Jefferies are a factor considered by rating agencies that rate the debt of our subsidiary companies, including
Jefferies Group, whose access to external financing is important to its day to day operations. Ratings issued by bond rating agencies, subject to change at any time, are as follows:
Rating
Outlook
Moody's Investors Service (1)
Baa3
Stable
Standard and Poor's (2)
BBB
Negative
Fitch
Ratings
BBB
Stable
(1) On April 15, 2020, Moody's Investors Service affirmed our rating of Baa3 and rating outlook of stable.
(2) On April 14, 2020, Standard and Poor's affirmed our rating of BBB and revised our rating outlook from stable to negative.
We target specific concentration and liquidity principles although there is no legal requirement to do so.
Concentration Target: As a diversification measure, we limit cash investments such that our
single largest investment does not exceed 20% of equity excluding Jefferies Group, and that our next largest investment does not exceed 10% of equity excluding Jefferies Group, in each case measured at the time the investment was made. On this basis, Linkem is our largest investment excluding Jefferies Group and Vitesse Energy Finance is our next largest investment excluding Jefferies Group. There were no investments made during the year that approached 10% of equity excluding Jefferies Group.
Liquidity Target: We hold a liquidity reserve calculated as a minimum of twenty-four months of holding company expenses (excluding non-cash components), parent company interest, and dividends. Maturities of parent company debt within the upcoming year are also included in the target; however, our next maturity is during 2023 so there is no current inclusion.
As discussed above, we have historically relied on our available liquidity to meet short-term and long-term needs, and to make acquisitions of new businesses
and investments. Except as otherwise disclosed herein, our operating businesses do not generally require significant funds to support their operating activities. The mix of our operating businesses and investments can change as a result of acquisitions or divestitures, the timing of which is impossible to predict but which often have a significant impact on the Consolidated Statements of Cash Flows in any one period. Further, the timing and amounts of distributions from investments in associated companies may be outside our control. As a result, reported cash flows from operating, investing and financing activities do not generally follow any particular pattern or trend, and reported results in the most recent period should not be expected to recur in any subsequent period.
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The
following table provides a summary of our cash flows (in thousands):
Cash, cash equivalents and restricted cash at beginning of period
$
8,480,435
$
6,012,662
Net
cash provided by (used for) operating activities
160,960
(1,440,361)
Net cash provided by (used for) investing activities
(163,418)
1,202,782
Net cash provided by (used for) financing activities
(969,420)
167,821
Effect
of foreign exchange rate changes on cash, cash equivalents and restricted cash
(13,547)
(3,892)
Cash, cash equivalents and restricted cash at end of period
$
7,495,010
$
5,939,012
During
the first half of 2020, net cash provided by operating activities primarily relates to funds provided by Jefferies Group of $92.0 million. Net losses related to property and equipment, and other assets includes the non-cash charge of $52.9 million to write-down the value of certain of our investments during the first half of 2020.
During the first half of 2019, net cash used for operating activities primarily relates to funds used by Jefferies Group of $1,464.5 million. Net cash used for operating activities for 2019 also includes $54.9 million of distributions from National Beef.
During the first half of 2020, net cash used for investing activities principally reflects $1,382.8 million of loans to and investments in associated companies and $120.7 million for acquisitions of property, equipment and leasehold improvements, and other assets, partially offset by $1,344.6 million of
capital distributions and loan repayments from associated companies.
During the first half of 2019, net cash provided by investing activities includes proceeds from maturities of investments of $531.1 million and proceeds from sales of investments of $886.9 million. Jefferies Group used funds of $42.7 million for investing activities in 2019.
During the first half of 2020, net cash used for financing activities primarily relates to funds used to repurchase common shares for treasury of $495.3 million, funds used to pay dividends of $83.4 million and funds used by Jefferies Group of $450.2 million. This includes funds used for the repayments of debt of $1,762.4 million and payments of other secured financings of $369.7 million, partially offset by funds provided by the issuance of debt of $1,667.8 million. This was partially offset by proceeds from other secured financings of $44.5
million in our Merchant Banking segment.
During the first half of 2019, net cash provided by financing activities primarily reflects funds generated by Jefferies Group of $598.5 million. This includes funds provided by the issuance of debt of $1,094.3 million and proceeds from other secured financings of $385.0 million, partially offset by repayments of debt of $870.5 million. Net cash provided by financing activities also reflects funds used to repurchase common shares for treasury of $364.7 million, funds used to pay dividends of $74.6 million and payments on secured financings in our Merchant Banking segment of $120.8 million.
Jefferies Group Liquidity
General
The Interim Chief Financial Officer and Global Treasurer of Jefferies Group are responsible for developing and implementing liquidity,
funding and capital management strategies for Jefferies Group. These policies are determined by the nature and needs of day to day business operations, business opportunities, regulatory obligations and liquidity requirements.
The actual levels of capital, total assets and financial leverage are a function of a number of factors, including asset composition, business initiatives and opportunities, regulatory requirements and cost and availability of both long-term and short-term funding. Jefferies Group has historically maintained a balance sheet consisting of a large portion of total assets in cash and liquid marketable securities, arising principally from traditional securities brokerage and trading activity. The liquid nature of these assets provides flexibility in financing and managing our business.
Jefferies Group maintains modest leverage to support its investment grade ratings.
The growth of its balance sheet is supported by its equity and we have quantitative metrics in place to monitor leverage and double leverage. Jefferies Group capital plan is
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robust, in order to sustain its operating model through stressed conditions. We maintain adequate financial resources to support business activities in both normal and stressed market conditions, including a buffer in excess of regulatory, or other internal or external, requirements. Jefferies Group's access to funding and liquidity is stable and efficient to ensure that there is sufficient liquidity to meet its financial obligations in normal and stressed market conditions.
During the second quarter of 2020, the global capital markets experienced a higher
level of stress due to the COVID-19 pandemic. Higher volumes and price volatility led to increased margin requirements at clearing corporations and exchanges, along with increased levels of fails due to operational friction in the financial system. Margin requirements moderated as the quarter progressed but remain elevated relative to pre-COVID-19 markets. Operational friction has been reduced as the counterparties have adapted to a work from home environment.
During the second quarter, we increased the frequency and timing of our daily reporting for excess liquidity, cash and capital usage and excess secured funding capacity. We worked closely with the business units and management to closely monitor fails, exchange margin requirements and all changes to secured funding arrangements. During the quarter, Jefferies Group's business units generally operated within defined balance sheet
and capital limits. These limits and results were reported to senior management on a daily basis during the height of the stress period.
We were in regular dialogue during the quarter with all regulatory bodies and all three rating agencies. On April 14, 2020, Standard and Poor's affirmed our rating of BBB, but revised our rating outlook and the rating outlooks of our principal operating broker-dealers from stable to negative. On April 15, 2020, Moody's Investors Service affirmed our rating of Baa3 and our rating outlook of stable.
In general, the liquidity outflows experienced during the peak of the market stress were well within the assumptions of our liquidity stress model, or Maximum Liquidity Outflow.
Due to increased volumes and heightened volatility in March, we experienced outsized margin requirements on some exchanges. Based on that experience, we increased the stress liquidity buffer during the quarter for the affected exchanges on a go forward basis.
Our secured funding model operated efficiently during this stress period. Some counterparties exited secured funding trades and
were replaced with new counterparties or with excess capacity from existing lenders. We have tracked all changes in secured funding haircuts by product and have adjusted capital assumptions as needed. During this time, we extended the term of our secured funding arrangements and created additional funding capacity for various product groups. The weighted average maturity of our secured funding at May 31, 2020 increased
by approximately 35 days as compared to the weighted average maturity at February 29, 2020. Our U.S. broker-dealer, Jefferies LLC, as a primary dealer, has access to the Federal Reserve's Primary Dealer Credit Facility ("PDCF"). During the second quarter of 2020, Jefferies LLC accessed the PDCF for up to $50.0 million. The amount drawn under the facility at May 31, 2020 was $8.0 million.
A business unit level balance sheet and cash capital analysis is prepared and reviewed with senior management on a weekly basis. As a part of this balance sheet review process, capital is allocated to all assets and gross balance sheet limits are adjusted, as necessary. This process ensures that the allocation of capital and costs of capital are incorporated into business decisions. The goals of this process are to protect the firm's platform,
enable the businesses to remain competitive, maintain the ability to manage capital proactively and hold businesses accountable for both balance sheet and capital usage.
We actively monitor and evaluate our financial condition and the composition of assets and liabilities. The overall securities inventory is continually monitored, including the inventory turnover rate, which confirms the liquidity of overall assets. Substantially all of Jefferies Group's financial instruments are valued on a daily basis and we monitor and employ balance sheet limits for its various businesses.
At May 31, 2020, the Consolidated Statement of Financial Condition includes Jefferies Group's Level 3 financial instruments owned, at fair value that are approximately 2% of total financial instruments owned, at fair value.
Securities
financing assets and liabilities include financing for financial instruments trading activity, matched book transactions and mortgage finance transactions. Matched book transactions accommodate customers, as well as obtain securities for the settlement and financing of inventory positions.
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The following table presents period end balance, average balance and maximum balance at any month end within the periods presented for Securities purchased under agreements to resell and Securities sold under agreements to repurchase (in millions):
Fluctuations in the balance of repurchase agreements from period to period and intraperiod are dependent on business activity in those periods. Additionally, the fluctuations in the balances of securities purchased under agreements to resell are influenced in any given period by our clients' balances and our clients' desires
to execute collateralized financing arrangements via the repurchase market or via other financing products. Average balances and period end balances will fluctuate based on market and liquidity conditions and we consider the fluctuations intraperiod to be typical for the repurchase market.
Liquidity Management
The key objectives of Jefferies Group's liquidity management framework are to support the successful execution of its business strategies while ensuring sufficient liquidity through the business cycle and during periods of financial distress. The liquidity management policies are designed to mitigate the potential risk that adequate financing may not be accessible to service financial obligations without material franchise or business impact.
The principal elements of Jefferies Group's liquidity
management framework are the Contingency Funding Plan, the Cash Capital Policy and the assessment of Maximum Liquidity Outflow.
Contingency Funding Plan. Jefferies Group's Contingency Funding Plan is based on a model of a potential liquidity contraction over a one year time period. This incorporates potential cash outflows during a liquidity stress event, including, but not limited to, the following:
•Repayment of all unsecured debt maturing within one year and no incremental unsecured debt issuance;
•Maturity rolloff of outstanding letters of credit with no further issuance and replacement with cash collateral;
•Higher margin requirements than currently exist on assets on securities financing activity,
including repurchase agreements;
•Liquidity outflows related to possible credit downgrade;
•Lower availability of secured funding;
•Client cash withdrawals;
•The anticipated funding of outstanding investment and loan commitments; and
•Certain accrued expenses and other liabilities and fixed costs.
Cash Capital Policy. A cash capital model is maintained that measures long-term funding sources against requirements. Sources of cash capital include equity and the noncurrent portion of long-term borrowings. Uses of cash capital include the following:
•Illiquid
assets such as equipment, goodwill, net intangible assets, exchange memberships, deferred tax assets and certain investments;
•A portion of securities inventory that is not expected to be financed on a secured basis in a credit stressed environment (i.e., margin requirements); and
•Drawdowns of unfunded commitments.
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To ensure that inventory does not need to be liquidated in the event of a funding crisis, we seek to maintain surplus cash capital, which is reflected in the leverage ratios Jefferies Group maintains. Jefferies Group's total long-term capital of $12.1 billion at May 31, 2020
exceeded its cash capital requirements.
Maximum Liquidity Outflow. Jefferies Group's businesses are diverse, and liquidity needs are determined by many factors, including market movements, collateral requirements and client commitments, all of which can change dramatically in a difficult funding environment. During a liquidity crisis, credit-sensitive funding, including unsecured debt and some types of secured financing agreements, may be unavailable, and the terms (e.g., interest rates, collateral provisions and tenor) or availability of other types of secured financing may change. As a result of Jefferies Group's policy to ensure it has sufficient funds to cover estimates of what may be needed in a liquidity crisis, Jefferies Group holds more cash and unencumbered securities and has greater long-term debt balances than the businesses would otherwise require. As part of this estimation process, we calculate
a Maximum Liquidity Outflow that could be experienced in a liquidity crisis. Maximum Liquidity Outflow is based on a scenario that includes both a market-wide stress and firm-specific stress.
Based on the sources and uses of liquidity calculated under the Maximum Liquidity Outflow scenarios, we determine, based on a calculated surplus or deficit, additional long-term funding that may be needed versus funding through the repurchase financing market and consider any adjustments that may be necessary to Jefferies Group's inventory balances and cash holdings. At May 31, 2020, Jefferies Group had sufficient excess liquidity to meet all contingent cash outflows detailed in the Maximum Liquidity Outflow. We regularly refine our model to reflect changes in market or economic conditions and the firm's business mix. As a result of the experience and knowledge gathered during the COVID-19
stress period, beginning in February 2020, Jefferies Group has adjusted certain assumptions in its Maximum Liquidity Outflow scenarios.
Sources of Liquidity
Within Jefferies Group, the following are financial instruments that are cash and cash equivalents or are deemed by management to be generally readily convertible into cash, marginable or accessible for liquidity purposes within a relatively short period of time, as reflected in the Consolidated Statements of Financial Condition (in thousands):
Debt securities owned and securities purchased under agreements to resell (3)
998,216
940,165
972,624
Other (4)
292,311
384,885
377,296
Total
other sources
1,290,527
1,325,050
1,349,920
Total cash and cash equivalents and other liquidity sources
$
6,542,396
$
5,702,986
$
6,917,823
(1)Average
balances are calculated based on weekly balances.
(2)At May 31, 2020 and November 30, 2019, $4,134.0 million and $4,496.7 million, respectively, was invested in U.S. government money funds that invest at least 99.5% of its total assets in cash, securities issued by the U.S. government and U.S. government-sponsored entities, and repurchase agreements that are fully collateralized by cash or government securities. The remaining $12.4 million and $87.4 million at May 31, 2020 and November 30, 2019, respectively, are invested in AAA rated prime money funds. The average balance of U.S. government money funds for the quarter ended May 31, 2020 was $2,113.3 million.
(3)Consists
of high quality sovereign government securities and reverse repurchase agreements collateralized by U.S. government securities and other high quality sovereign government securities; deposits with a central bank within the European Economic Area, Canada, Australia, Japan, Switzerland or the U.S.; and securities issued by a designated multilateral development bank and reverse repurchase agreements with underlying collateral comprised of these securities.
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(4)Other includes unencumbered inventory representing an estimate of the amount of additional secured financing that could be reasonably expected to be obtained from financial instruments owned that are currently not pledged after considering reasonable financing haircuts.
In
addition to the cash balances and liquidity pool presented above, the majority of financial instruments (both long and short) in our trading accounts are actively traded and readily marketable. At May 31, 2020, repurchase financing can be readily obtained for approximately 72.7% of Jefferies Group's inventory at haircuts of 10% or less, which reflects the liquidity of the inventory. In addition, as a matter of our policy, all of these assets have internal capital assessed, which is in addition to the funding haircuts provided in the securities finance markets. Additionally, certain of Jefferies Group's financial instruments owned primarily consisting of bank loans, consumer loans and investments are predominantly funded by Jefferies Group's long-term capital. Under Jefferies Group's cash capital policy, capital allocation levels are modeled that are more stringent than the haircuts used in the market for secured funding;
and surplus capital is maintained at these more stringent levels. We continually assess the liquidity of Jefferies Group's inventory based on the level at which Jefferies Group could obtain financing in the marketplace for a given asset. Assets are considered to be liquid if financing can be obtained in the repurchase market or the securities lending market at collateral haircut levels of 10% or less.
The following summarizes Jefferies Group's financial instruments by asset class that are considered to be of a liquid nature and the amount of such assets that have not been pledged as collateral as reflected in the Consolidated Statements of Financial Condition (in thousands):
(1)Consists
solely of agency mortgage-backed securities issued by Freddie Mac, Fannie Mae and Ginnie Mae. These securities include pass-through securities, securities backed by adjustable rate mortgages, collateralized mortgage obligations, commercial mortgage-backed securities and interest- and principal-only securities.
(2)Unencumbered liquid balances represent assets that can be sold or used as collateral for a loan, but have not been.
In addition to being able to be readily financed at modest haircut levels, it is estimated that each of the individual securities within each asset class above could be sold into the market and converted into cash within three business days under normal market conditions, assuming that the entire portfolio of a given asset class was not simultaneously liquidated. There are no restrictions on the
unencumbered liquid securities, nor have they been pledged as collateral.
Sources of Funding and Capital Resources
Secured Financing
Readily available secured funding is used to finance Jefferies Group's inventory of financial instruments. Jefferies Group's ability to support increases in total assets is largely a function of the ability to obtain short- and intermediate-term secured funding, primarily through securities financing transactions. Repurchase or reverse repurchase agreements (collectively "repos"), respectively, are used to finance a portion of long inventory and cover some of short inventory by pledging and borrowing securities. Approximately 71.4% of Jefferies Group's cash and noncash repurchase financing activities use collateral that is considered eligible collateral by central
clearing corporations. Central clearing corporations are situated between participating members who borrow cash and lend securities (or vice versa); accordingly, repo participants contract with the central clearing corporation and not one another individually. Therefore, counterparty credit risk is borne by the central clearing corporation which mitigates the risk through initial margin demands and variation margin calls from repo participants. The comparatively large proportion of Jefferies Group's total repo activity that is eligible for central clearing reflects the high quality
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and liquid composition of the inventory Jefferies Group carries in its trading books. For those asset
classes not eligible for central clearing house financing, Jefferies Group seeks to execute its bi-lateral financings on an extended term basis and the tenor of Jefferies Group's repurchase and reverse repurchase agreements generally exceeds the expected holding period of the assets Jefferies Group is financing. The weighted average maturity of cash and noncash repurchase agreements for non-clearing corporation eligible funded inventory is approximately six months at May 31, 2020.
Jefferies Group's ability to finance its inventory via central clearinghouses and bi-lateral arrangements is augmented by Jefferies Group's ability to draw bank loans on an uncommitted basis under its various banking arrangements. At May 31, 2020, short-term borrowings, which must be repaid within one year or less and include bank loans and overdrafts,
borrowings under revolving credit facilities, floating rate puttable notes and equity-linked notes, totaled $656.9 million. Interest under the bank lines is generally at a spread over the federal funds rate. Letters of credit are used in the normal course of business mostly to satisfy various collateral requirements in favor of exchanges in lieu of depositing cash or securities. Average daily short-term borrowings outstanding for Jefferies Group were $642.9 million and $566.6 million for the second quarter and first half of 2020, respectively.
Our short-term borrowings include the following facilities:
•Credit Facility. One of Jefferies Group's subsidiaries has the Jefferies Group Credit Facility with JPMorgan
Chase Bank, N.A. for a committed amount of $296.0 million. Interest is based on an annual alternative base rate or an adjusted London Interbank Offered Rate ("LIBOR"), as defined in the Jefferies Group Credit Facility. The Jefferies Group Credit Facility contains certain covenants that, among other things, require Jefferies Group LLC to maintain a specified level of tangible net worth. The covenants also require the borrower to maintain specified leverage amounts and impose certain restrictions on the borrower's future indebtedness. At May 31, 2020, we were in compliance with all debt covenants under the Jefferies Group Credit Facility.
•Intraday Credit Facility. The Bank of New York Mellon has agreed to make revolving intraday credit advances ("Jefferies Group Intraday Credit Facility") for an aggregate committed
amount of $150.0 million. The Jefferies Group Intraday Credit Facility is structured so that advances are generally repaid before the end of each business day. However, if an advance is not repaid by the end of any business day, the advance is converted to an overnight loan. Intraday loans accrue interest at a rate of 0.12%. Interest is charged based on the number of minutes in a day the advance is outstanding. Overnight loans are charged interest at the base rate plus 3% on a daily basis. The base rate is the higher of the federal funds rate plus 0.50% or the prime rate in effect at that time. The Jefferies Group Intraday Credit Facility contains financial covenants, which include a minimum regulatory net capital requirement for Jefferies Group's U.S. broker-dealer, Jefferies LLC. At May 31, 2020, we were in compliance with all debt covenants under the Jefferies Group Intraday Credit Facility.
In
addition to the above financing arrangements, Jefferies Group issues notes backed by eligible collateral under a master repurchase agreement, which provides an additional financing source for its inventory ("repurchase agreement financing program"). The notes issued under the program are presented within Other secured financings in the Consolidated Statement of Financial Condition. At May 31, 2020, the outstanding notes were $2.1 billion, bear interest at a spread over LIBOR and mature from June 2020 to May 2022.
Long-Term Debt
Jefferies Group's long-term debt reflected in the Consolidated Statement of Financial Condition at May 31, 2020 is $6.7 billion. Jefferies Group's long-term debt, excluding its revolving credit facility and the secured bank loan, has a weighted average
maturity of approximately 9.5 years.
During the six months ended May 31, 2020, Jefferies Group's 2.375% Euro Medium Term Notes matured and were repaid. Additionally, during the six months ended May 31, 2020, structured notes with a total principal amount of approximately $191.3 million, net of retirements, and an additional $150.0 million principal amount of 5.125% Senior Notes due 2023 were issued by Jefferies Group. At May 31, 2020, all of Jefferies Group's structured notes contain various interest rate payment terms and are accounted for at fair value, with changes in fair value resulting from a change in the instrument specific credit risk presented in Accumulated other comprehensive income (loss) and changes in fair value resulting from non-credit components recognized in
Principal transactions revenue. The fair value of all of Jefferies Group's structured notes at May 31, 2020 was $1,245.5 million
Jefferies Group has a Revolving Credit Facility ("Jefferies Group Revolving Credit Facility") with a group of commercial banks for an aggregate principal amount of $190.0 million. At May 31, 2020, borrowings under the Jefferies Group Revolving Credit Facility amounted to $189.4 million. Interest is based on an annual alternative base rate or an adjusted LIBOR, as defined in the
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Jefferies Group Revolving Credit Facility agreement. The Jefferies Group Revolving
Credit Facility contains certain covenants that, among other things, requires Jefferies Group LLC to maintain specified level of tangible net worth and liquidity amounts, and imposes certain restrictions on future indebtedness of and requires specified levels of regulated capital for certain of its subsidiaries. Throughout the period and at May 31, 2020, no instances of noncompliance with the Jefferies Group Revolving Credit Facility covenants occurred and we expect to remain in compliance given our current liquidity, and anticipated funding requirements given our business plan and profitability expectations.
During 2019, one of Jefferies Group's subsidiaries
entered into a Loan and Security Agreement with a bank for a term loan with a principal amount of $50.0 million ("Jefferies Group Secured Bank Loan"). This Jefferies Group Secured Bank Loan matures on September 27, 2021 and is collateralized by certain trading securities. Interest on the Jefferies Group Secured Bank Loan is 1.25% plus LIBOR. The agreement contains certain covenants that, among other things, restrict lien or encumbrance upon any of the pledged collateral. At May 31, 2020, we were in compliance with all covenants under the Jefferies Group Loan and Security Agreement.
Jefferies Group's long-term debt ratings are as follows:
Rating
Outlook
Moody's Investors Service (1)
Baa3
Stable
Standard and Poor's (2)
BBB
Negative
Fitch Ratings
BBB
Stable
(1) On April 15, 2020, Moody's Investors Service affirmed Jefferies Group's rating of Baa3 and rating outlook of stable.
(2) On
April 14, 2020, Standard and Poor's affirmed Jefferies Group's rating of BBB and revised its rating outlook from stable to negative.
Jefferies Group's access to external financing to finance its day to day operations, as well as the cost of that financing, is dependent upon various factors, including its debt ratings. Jefferies Group's current debt ratings are dependent upon many factors, including industry dynamics, operating and economic environment, operating results, operating margins, earnings trend and volatility, balance sheet composition, liquidity and liquidity management, capital structure, overall risk management, business diversification and market share and competitive position in the markets in which it operates. Deteriorations in any of these factors could impact Jefferies Group's credit ratings. While certain aspects of
a credit rating downgrade are quantifiable pursuant to contractual provisions, the impact on business and trading results in future periods is inherently uncertain and depends on a number of factors, including the magnitude of the downgrade, the behavior of individual clients and future mitigating action taken by us.
In connection with certain over-the-counter derivative contract arrangements and certain other trading arrangements, we may be required to provide additional collateral to counterparties, exchanges and clearing organizations in the event of a credit rating downgrade. At May 31, 2020, the amount of additional collateral that could be called by counterparties, exchanges and clearing organizations under the terms of such agreements in the event of a downgrade of Jefferies Group's
long-term credit rating below investment grade was $81.0 million. For certain foreign clearing organizations, credit rating is only one of several factors employed in determining collateral that could be called. The above represents management's best estimate for additional collateral to be called in the event of a credit rating downgrade. The impact of additional collateral requirements is considered in Jefferies Group's Contingency Funding Plan and calculation of Maximum Liquidity Outflow, as described above.
Ratings issued by credit rating agencies are subject to change at any time.
Net Capital
Jefferies Group operates a broker-dealer, Jefferies LLC, registered with the Securities and Exchange Commission ("SEC") and member firms of the Financial Industry Regulatory Authority ("FINRA"). Jefferies LLC is subject to the SEC
Uniform Net Capital Rule ("Rule 15c3-1"), which requires the maintenance of minimum net capital and has elected to calculate minimum capital requirements using the alternative method permitted by Rule 15c3-1 in calculating net capital. Jefferies LLC, as a dually-registered U.S. broker-dealer and futures commission merchant ("FCM"), is also subject to Rule 1.17 of the Commodity Futures Trading Commission ("CFTC"), which sets forth minimum financial requirements. The minimum net capital requirement in determining excess net capital for a dually-registered U.S. broker-dealer and FCM is equal to the greater of the requirement under Rule 15c3-1 or CFTC Rule 1.17. Jefferies LLC's net capital and excess net capital at May 31, 2020 were $1,507.7 million and $1,430.7 million, respectively.
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FINRA
is the designated examining authority for Jefferies LLC and the National Futures Association is the designated self-regulatory organization for Jefferies LLC as an FCM.
Certain other U.S. and non-U.S. subsidiaries of Jefferies Group are subject to capital adequacy requirements as prescribed by the regulatory authorities in their respective jurisdictions, including Jefferies International Limited which is subject to the regulatory supervision and requirements of the Financial Conduct Authority in the United Kingdom. The Dodd-Frank Wall Street Reform and Consumer Protection Act (the "Dodd-Frank Act") was signed into law on July 21, 2010. The Dodd-Frank Act contains provisions that require the registration of all swap dealers, major swap participants, security-based swap dealers, and/or
major security-based swap participants. While entities that register under these provisions will be subject to regulatory capital requirements, these regulatory capital requirements have not yet been finalized. Jefferies Group expects that these provisions will result in modifications to the regulatory capital requirements of some of its entities, and will result in some of its other entities becoming subject to regulatory capital requirements for the first time, including Jefferies Financial Services, Inc., which registered as a swap dealer with the CFTC during January 2013 and Jefferies Financial Products LLC, which registered during August 2014. The regulatory capital requirements referred to above may restrict Jefferies Group's ability to withdraw capital from its regulated subsidiaries.
The
United Kingdom ("U.K.") formally withdrew from the European Union (“EU”) on January 31, 2020 and entered a transition period that is scheduled to expire on December 31, 2020. During the transition period, existing arrangements between the U.K. and EU will remain in place while the U.K. and EU seek to negotiate a free trade agreement that will govern their future trading relationship. We have taken steps to ensure our ability to provide services to our European clients without interruption. As such, we have established a wholly-owned subsidiary of our U.K. broker-dealer in Germany, which has been approved as an authorized MiFID investment firm by the German regulator and which will enable us to conduct business across all of our European investment banking, fixed income and equity platforms. The new entity started trading in 2019 with EU clients with further
clients migrating throughout 2020, and our plans contemplate providing sufficient capital pursuant to the regulatory requirements for the planned operations as well pursuant to requirements of relevant clearing organizations.
Some of our other consolidated subsidiaries also have credit agreements which may restrict the payment of cash dividends, or the ability to make loans or advances to the parent company.
Off-Balance Sheet Risk
Jefferies Group has contractual commitments arising in the ordinary course of business for securities loaned or purchased under agreements to resell, repurchase agreements, future purchases and sales of foreign currencies, securities transactions
on a when-issued basis and underwriting. Each of these financial instruments and activities contains varying degrees of off-balance sheet risk whereby the fair values of the securities underlying the financial instruments may be in excess of, or less than, the contract amount. The settlement of these transactions is not expected to have a material effect upon our consolidated financial statements.
In the normal course of business, we engage in other off-balance sheet arrangements, including derivative contracts. Neither derivatives' notional amounts nor underlying instrument values are reflected as assets or liabilities in the Consolidated Statements of Financial Condition. Rather, the fair values of derivative contracts
are reported in the Consolidated Statements of Financial Condition as Financial instruments owned, at fair value or Financial instruments sold, not yet purchased, at fair value, as applicable. Derivative contracts are reflected net of cash paid or received pursuant to credit support agreements and are reported on a net by counterparty basis when a legal right of offset exists under an enforceable master netting agreement.
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Cautionary Statement for Forward-Looking Information
This report contains or incorporates by reference "forward-looking statements" within
the meaning of the safe harbor provisions of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements include statements about our future and statements that are not historical facts. These forward-looking statements are usually preceded by the words "will,""could,""estimates,""expects,""anticipates,""believes,""plans,""intends" and variations of such words or similar expressions. Forward-looking statements may contain expectations regarding revenues, earnings, operations and other results, and may include statements of future performance, plans and objectives. Forward-looking statements include statements pertaining to our strategies for future development of our businesses and products. Forward-looking statements represent only our belief regarding future events, many of which by their nature are inherently uncertain. Future events and
actual results could differ, possibly materially, from the anticipated results indicated in these forward-looking statements. Information regarding important factors that could cause actual results to differ, perhaps materially, from those in our forward-looking statements is contained in this report and other documents we file. You should read and interpret any forward-looking statement together with these documents, including the following:
•The description of our business and risk factors contained in our Annual Report on Form 10-K for the fiscal year ended November 30, 2019 and filed with the SEC on January 29, 2020 (the "2019 10-K") and in Part II, Item 1A herein;
•The discussion and
analysis of financial condition and result of operations contained in this report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations" herein;
•The notes to the consolidated financial statements in this report; and
•Cautionary statements we make in our public documents, reports and announcements.
Any forward-looking statement speaks only as of the date on which that statement is made. We will not update any forward-looking statement to reflect events or circumstances that occur after the date on which the statement is made, except as required by applicable law.
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Item
3. Quantitative and Qualitative Disclosures About Market Risk.
The following includes "forward-looking statements" that involve risk and uncertainties. See "Cautionary Statement for Forward-Looking Information" above. Actual results could differ materially from those projected in the forward-looking statements. The discussion of risk is presented separately for Jefferies Group and the balance of our company. Exclusive of Jefferies Group, our market risk arises principally from equity price risk. Information related thereto required under this Item is contained in Item 7A in our 2019 10-K, and is incorporated by reference herein.
Excluding Jefferies
Group, Financial instruments owned, at fair value include corporate equity securities with an aggregate fair value of $215.1 million at May 31, 2020. Assuming a decline of 10% in market prices, the value of these investments could decrease by approximately $21.5 million.
Jefferies Group
Overview
Risk is an inherent part of our business and activities. The extent to which we properly and effectively identify, assess, monitor and manage each of the various types of risk involved in our activities is critical to our financial soundness, viability and profitability. Accordingly, we have a comprehensive risk management approach, with a formal governance structure and processes to identify, assess, monitor and manage risk. Principal risks involved in our business activities
include market, credit, liquidity and capital, operational, legal and compliance, new business and reputational risk.
Risk management is a multifaceted process that requires communication, judgment and knowledge of financial products and markets. Our risk management process encompasses the active involvement of executive and senior management, and also many departments independent of the revenue-producing business units, including Jefferies Group's Risk Management, Operations, Compliance, Legal and Finance Departments. Our risk management policies, procedures and methodologies are flexible in nature and are subject to ongoing review and modification.
In achieving our strategic business objectives, our risk appetite incorporates keeping our clients' interests at the top of our priority list and ensuring
we are in compliance with applicable laws, rules and regulations, as well as adhering to the highest ethical standards. We undertake prudent and conservative risk-taking that protects the capital base and franchise, utilizing risk limits and tolerances that avoid outsized risk-taking. We maintain a diversified business mix and avoid significant concentrations to any sector, product, geography, or activity and set quantitative concentration limits to manage this risk. We consider contagion, second order effects and correlation in our risk assessment process and actively seek out value opportunities of all sizes. We manage the risk of opportunities larger than our approved risk levels through risk sharing and risk distribution, sell-down and hedging as appropriate. We have a limited appetite for illiquid assets and complex derivative financial instruments. We maintain the asset quality of our balance sheet through conducting trading activity in liquid markets and generally
ensure high turnover of our inventory. We subject less liquid positions and derivative financial instruments to oversight and use a wide variety of specific metrics, limits, and constraints to manage these risks. We protect our reputation and franchise, as well as our standing within the market. We operate a federated approach to risk management with risk oversight responsibilities assigned to those areas of the business that have the appropriate knowledge.
For discussion of liquidity and capital risk management, refer to the "Liquidity and Capital Resources" section herein.
Risk Considerations
We apply a comprehensive framework of limits on a variety of key metrics to constrain the risk profile of our business activities.
The size of the limits reflects our risk tolerance for a certain activity under normal business conditions. Key metrics included in our risk management framework include inventory position and exposure limits on a gross and net basis, scenario analysis and stress tests, Value-at-Risk ("VaR"), sensitivities, exposure concentrations, aged inventory, amount of Level 3 assets, counterparty exposure, leverage and cash capital.
Market Risk
Market risk is defined as the risk of loss due to fluctuations in the market value of financial assets and liabilities attributable to changes in market variables.
Our market risk principally arises from interest rate risk, from exposure to changes in the yield curve, the volatility of interest rates, and credit spreads, and from equity
price risks from exposure to changes in prices and volatilities of individual equities, equity baskets and
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equity indices. In addition, commodity price risk results from exposure to the changes in prices and volatilities of individual commodities, commodity baskets and commodity indices, and foreign exchange risk results from changes in foreign currency rates.
Market risk is present in our market-making, proprietary trading, underwriting, specialist and investing activities and is principally managed by diversifying exposures, controlling position sizes, and establishing economic hedges in related securities or derivatives. Due to imperfections in correlations, gains and losses can occur even for positions that are economically
hedged. Position limits in trading and inventory accounts are established and monitored on an ongoing basis. Each day, consolidated position and exposure reports are prepared and distributed to various levels of management, which enable management to monitor inventory levels and the results of its trading businesses.
Value-at-Risk
VaR is a statistical estimate of the potential loss from adverse market movements over a specified time horizon within a specified probability (confidence level). It provides a common risk measure across financial instruments, markets and asset classes. We estimate VaR using a model that simulates revenue and loss distributions on Jefferies Group's trading portfolios by applying historical market changes to the current portfolio. We calculate a one day VaR using a one year look-back period measured at a 95% confidence level.
As
with all measures of VaR, the estimate has inherent limitations due to the assumption that historical changes in market conditions are representative of the future. Furthermore, the VaR model measures the risk of a current static position over a one day horizon and might not capture the market risk over a longer time horizon where moves may be more extreme. Previous changes in market risk factors may not generate accurate predictions of future market movements. While we believe the assumptions and inputs in our risk model are reasonable, we could incur losses greater than the reported VaR. Consequently, this VaR estimate is only one of a number of tools we use in our daily risk management activities.
Average daily VaR increased to $9.16 million for the second quarter of 2020 from $7.39 million for the first quarter of 2020. The VaR increase was primarily driven by increased market volatility due to the rapid spread of the global
COVID-19 outbreak, partially offset by an increase in the diversification benefit across asset classes and business divisions. Interest rate VaR was higher due to increased market volatility, while equity price VaR was lower as de-risking and hedging more than offset the impact of increased market moves.
The following table illustrates each separate component of VaR for each component of market risk by interest rate, equity, currency and commodity products, as well as for Jefferies Group's overall trading positions using the past 365 days of historical data.
(1)For
the VaR numbers reported above, a one day time horizon, with a one year look-back period, and a 95% confidence level were used.
(2)The diversification effect is not applicable for the maximum and minimum VaR values as Jefferies Group's firmwide VaR and VaR values for the four risk categories might have occurred on different days during the period.
The aggregated VaR presented here is less than the sum of the individual components (i.e., interest rate risk, foreign exchange rate risk, equity risk and commodity price risk) due to the benefit of diversification among the four risk categories. Diversification benefit equals the difference between aggregated VaR and the sum of VaRs for the four risk categories and arises because the market risk categories are not perfectly correlated.
The
primary method used to test the efficacy of the VaR model is to compare actual daily net revenue for those positions included in the VaR calculation with the daily VaR estimate. This evaluation is performed at various levels of the trading portfolio, from the overall level
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down to specific business lines. For the VaR model, trading related revenue is defined as principal transactions revenues, trading related commissions, revenue from securitization activities and net interest income.
For a 95% confidence one day VaR model (i.e., no intraday trading), assuming current changes in market value are consistent with the historical changes used in the calculation, net trading losses would not be expected to exceed the VaR estimates
more than twelve times on an annual basis (i.e., once in every 20 days). During the second quarter of 2020, results of the evaluation at the aggregate level demonstrated eight days when the net trading loss exceeded the 95% one day VaR, as the rapid spread of the global COVID-19 outbreak resulted in extreme market volatility across asset classes. There were 11 days with trading losses out of a total of 63 trading days in the second quarter of 2020.
Other Risk Measures
Certain positions within financial instruments are not included in the VaR model because VaR is not the most appropriate measure of risk. Accordingly, Jefferies Group's Risk Management has additional procedures in place to assure that the level of potential loss that would arise from market movements are within acceptable levels. Such procedures include performing stress tests,
monitoring concentration risk and tracking price target/stop loss levels. The table below presents the potential reduction in net income associated with a 10% stress of the fair value of the positions that are not included in the VaR model at May 31, 2020 (in thousands):
10% Sensitivity
Investments in funds (1)
$
94,507
Private investments
21,680
Corporate
debt securities in default
7,201
Trade claims
3,242
(1) Includes investments in hedge funds, fund of funds and private equity funds. For additional information on these investments, see Note 3 in our consolidated financial statements.
VaR also excludes the impact of changes in our own credit spreads on our structured notes for which the fair value option was elected. The estimated credit spread risk sensitivity for each one basis point widening in our own credit spreads on financial liabilities for which the fair value option was elected was an increase in value of approximately
of $1.7 million at May 31, 2020, which is included in Accumulated other comprehensive income (loss).
Stress Tests and Scenario Analysis
Stress tests are used to analyze the potential impact of specific events or extreme market moves on the current portfolio both firm-wide and within business segments. Stress testing is an important part of our risk management approach because it allows us to quantify our exposure to tail risks, highlight potential loss concentrations, undertake risk/reward analysis, set risk controls and overall assess and mitigate its risk.
We employ a range of stress scenarios, which comprise both historical market price and rate changes and hypothetical market environments, and generally involve simultaneous changes of many risk factors. Indicative market changes in our
scenarios include, but are not limited to, a large widening of credit spreads, a substantial decline in equities markets, significant moves in selected emerging markets, large moves in interest rates and changes in the shape of the yield curve.
Unlike VaR, which measures potential losses within a given confidence interval, stress scenarios do not have an associated implied probability. Rather, stress testing is used to estimate the potential loss from market moves that tend to be larger than those embedded in the VaR calculation. Stress testing complements VaR to cover for potential limitations of VaR such as the breakdown in correlations, non-linear risks, tail risk and extreme events and capturing market moves beyond the confidence levels assumed in the VaR calculations.
Stress testing is performed and reported at least weekly as part of our risk management process and on an ad
hoc basis in response to market events or concerns. Current stress tests provide estimated revenue and loss of the current portfolio through a range of both historical and hypothetical events. The stress scenarios are reviewed and assessed at least annually so that they remain relevant and up to date with market developments. Additional hypothetical scenarios are also conducted on a sub-portfolio basis to assess the impact of any relevant idiosyncratic stress events as needed.
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Counterparty Credit Risk and Issuer Country Exposure
Counterparty Credit Risk
Credit risk is the risk of loss due to adverse changes in a counterparty's credit worthiness or its ability
or willingness to meet its financial obligations in accordance with the terms and conditions of a financial contract. We are exposed to credit risk as a trading counterparty to other broker-dealers and customers, as a direct lender and through extending loan commitments, as a holder of securities and as a member of exchanges and clearing organizations. Credit exposure exists across a wide-range of products, including cash and cash equivalents, loans, securities finance transactions and over-the-counter derivative contracts. The main sources of our credit risk are:
•Loans and lending arising in connection with our investment banking and capital markets activities, which reflects our exposure at risk on a default event with no
recovery of loans. Current exposure represents loans that have been drawn by the borrower and lending commitments that are outstanding. In addition, credit exposures on forward settling traded loans are included within our loans and lending exposures for consistency with the balance sheet categorization of these items. Loans and lending also arise in connection with our portion of Jefferies Group's Secured Revolving Credit Facility that is with Jefferies Group and Massachusetts Mutual Life Insurance Company, to be funded equally, to support loan underwritings by Jefferies Finance. See Note 8 for additional information on this facility. In addition, Jefferies Group has loans outstanding to certain of its officers and employees (none of whom are executive officers or directors). See Note 22 for additional information on these employee loans.
•Securities and margin financing transactions, which reflect
our credit exposure arising from reverse repurchase agreements, repurchase agreements and securities lending agreements to the extent the fair value of the underlying collateral differs from the contractual agreement amount and from margin provided to customers.
•Over-the-counter derivatives, which are reported net by counterparty when a legal right of setoff exists under an enforceable master netting agreement. Over-the-counter derivative exposure is based on a contract at fair value, net of cash collateral received or posted under credit support agreements. In addition, credit exposures on forward settling trades are included within our derivative credit exposures.
•Cash and cash equivalents, which includes both interest-bearing and non-interest-bearing
deposits at banks.
Credit is extended to counterparties in a controlled manner and in order to generate acceptable returns, whether such credit is granted directly or is incidental to a transaction. All extensions of credit are monitored and managed as a whole to limit exposure to loss related to credit risk. Credit risk is managed according to the Credit Risk Policy, which sets out the process for identifying counterparty credit risk, establishing counterparty limits, and managing and monitoring credit limits. The policy includes our approach for:
•Client on-boarding and approving counterparty credit limits;
•Negotiating, approving and monitoring credit terms in legal and master documentation;
•Determining
the analytical standards and risk parameters for ongoing management and monitoring credit risk books;
•Actively managing daily exposure, exceptions and breaches; and
•Monitoring daily margin call activity and counterparty performance.
Counterparty credit exposure limits are granted within our credit ratings framework, as detailed in the Credit Risk Policy. Jefferies Group's Credit Risk Department assesses counterparty credit risk and sets credit limits at the counterparty master agreement level. Limits must be approved by appropriate credit officers and initiated in our credit and trading systems before trading commences. All credit exposures are reviewed against approved limits on a daily basis.
Jefferies Group's
Secured Revolving Credit Facility, which supports loan underwritings by Jefferies Finance, is governed under separate policies other than the Credit Risk Policy and is approved by Jefferies Group's Board of Directors. The loans outstanding to certain of Jefferies Group's officers and employees are extended pursuant to a review by its most senior management.
Current counterparty credit exposures are summarized in the tables below and provided by credit quality, region and industry. Credit exposures presented take netting and collateral into consideration by counterparty and master agreement. Collateral taken into consideration includes both collateral received as cash as well as collateral received in the form of securities or other arrangements. Current exposure is the loss that would be incurred on a particular set of positions in the event of default by the counterparty, assuming no recovery. Current exposure equals the fair
value of the positions less collateral. Issuer risk is the credit risk arising from inventory positions (for example, corporate debt securities and secondary bank loans). Issuer risk is included in our country risk exposure tables below.
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The amounts in the tables below are for amounts included in the Consolidated Statements of Financial Condition at May 31, 2020 and November 30, 2019 (in millions).
For
additional information regarding credit exposure to over-the-counter derivative contracts, see Note 4 in the consolidated financial statements.
Country Risk Exposure
Country risk is the risk that events or developments that occur in the general environment of a country or countries due to economic, political, social, regulatory, legal or other factors, will affect the ability of obligors of the country to honor their obligations. We define the country of risk as the country of jurisdiction or domicile of the obligor, and monitor country risk resulting from both trading positions and counterparty exposure.
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The
following tables reflect our top exposures to the sovereign governments, corporations and financial institutions in those non-U.S. countries in which we have a net long issuer and counterparty exposure, as reflected in the Consolidated Statements of Financial Condition (in millions):
At
May 31, 2020, we have no material exposure to countries where either sovereign or non-sovereign sectors pose potential default risk as the result of liquidity concerns.
Operational Risk
Operational risk refers to the risk of loss resulting from operations, including, but not limited to, improper or unauthorized execution and processing of transactions, deficiencies in operating systems, business disruptions and inadequacies or breaches in internal control processes. Our businesses are highly dependent on our ability to process, on a daily basis, a large number of transactions across numerous and diverse markets in many currencies. In addition, the transactions we process have become increasingly complex. If our financial, accounting or other data processing
systems do not operate properly or are disabled or if there are other shortcomings or failures in our internal processes, people or systems, we could suffer an impairment to our liquidity, financial loss, a disruption of our businesses, liability to clients, regulatory intervention or reputational damage.
These systems may fail to operate properly or become disabled as a result of events that are wholly or partially beyond our control, including a disruption of electrical or communications services or the inability to occupy one or more of our buildings. The inability of our systems to accommodate an increasing volume of transactions could also constrain our ability to expand our businesses.
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We
also face the risk of operational failure or termination of any of the clearing agents, exchanges, clearing houses or other financial intermediaries we use to facilitate our securities transactions. Any such failure or termination could adversely affect our ability to effect transactions and manage exposure to risk. In addition, despite the contingency plans we have in place, our ability to conduct business may be adversely impacted by a disruption in the infrastructure that supports our businesses and the communities in which they are located. This may include a disruption involving electrical, communications, transportation or other services used by us or third parties with which we conduct business.
Our operations rely on the secure processing, storage and transmission of confidential and other information in our computer systems and networks. Although we take protective measures and
endeavor to modify them as circumstances warrant, our computer systems, software and networks may be vulnerable to unauthorized access, computer viruses or other malicious code, and other events that could have a security impact. If one or more of such events occur, this potentially could jeopardize our or our clients' or counterparties' confidential and other information processed and stored in, and transmitted through, our computer systems and networks, or otherwise cause interruptions or malfunctions in our, our clients', our counterparties' or third parties' operations. We may be required to expend significant additional resources to modify our protective measures or to investigate and remediate vulnerabilities or other exposures, and may be subject to litigation and financial losses that are either not insured against or not fully covered through any insurance maintained by us.
Our
Operational Risk framework includes governance, collection of operational risk incidents, proactive operational risk management, and periodic review and analysis of business metrics to identify and recommend controls and process-related enhancements. Each revenue producing and support department is responsible for the management and reporting of operational risks and the implementation of the Operational Risk policy and processes within the department. Operational Risk policy, framework, infrastructure, methodology, processes, guidance and oversight of the operational risk processes are centralized and consistent firm wide and also subject to regional operational risk governance.
Our leadership is continuously monitoring circumstances around COVID-19, as well as economic and capital market conditions, and providing frequent communications to both our clients and our employees. We have
adopted enhanced cleaning practices across our offices, have restricted business travel, and have monitored the health and welfare of our employees and worked actively with many individuals diagnosed with COVID-19. We implemented our Business Continuity Planning plan and have largely moved to a remote working environment across all functions without any significant disruptions to our business or control processes. Additionally, we are working continuously with all of our critical vendors regarding their own pandemic responses to ensure there is minimal impact on our business operations.
Model Risk
Model risk refers to the risk of losses resulting from decisions that are based on the output of models, due to errors or weaknesses in the design and development, implementation, or improper use of models.
We use quantitative models primarily to value certain financial assets and liabilities and to monitor and manage our risk. Model risk is a function of the model materiality, frequency of use, complexity and uncertainty around inputs and assumptions used in a given model. Robust model risk management is a core part of our risk management approach and is overseen through our risk governance structure and risk management controls.
Legal and Compliance Risk
Legal and compliance risk includes the risk of noncompliance with applicable legal and regulatory requirements. We are subject to extensive regulation in the different jurisdictions in which we conduct our business. We have various procedures addressing issues such as regulatory capital requirements, sales and trading practices, use of and safekeeping
of customer funds, credit granting, collection activities, anti-money laundering and record keeping. These risks also reflect the potential impact that changes in local and international laws and tax statutes have on the economics and viability of current or future transactions. In an effort to mitigate these risks, we continuously review new and pending regulations and legislation and participate in various industry interest groups. We also maintain an anonymous hotline for employees or others to report suspected inappropriate actions by us or by our employees or agents.
New Business Risk
New business risk refers to the risks of entering into a new line of business or offering a new product. By entering a new line of business or offering a new product, we may face risks that we are unaccustomed to dealing
with and may increase the magnitude of the risks we currently face. The New Business Committee reviews proposals for new businesses and new products to determine if we are prepared to handle the additional or increased risks associated with entering into such activities.
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Reputational Risk
We recognize that maintaining our reputation among clients, investors, regulators and the general public is an important aspect of minimizing legal and operational risks. Maintaining our reputation depends on a large number of factors, including the selection of our clients and the conduct of our business activities. We seek to maintain our reputation by screening
potential clients and by conducting our business activities in accordance with high ethical standards. Our reputation and business activity can be affected by statements and actions of third parties, even false or misleading statements by them. We actively monitor public comment concerning us and are vigilant in seeking to assure accurate information and perception prevails.
Item 4. Controls and Procedures.
Evaluation of disclosure controls and procedures
The Company's management evaluated, with the participation of the Company's
principal executive and principal financial officers, the effectiveness of the Company's disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the "Exchange Act")), as of May 31, 2020. Based on their evaluation, the Company's principal executive and principal financial officers concluded that the Company's disclosure controls and procedures were effective as of May 31, 2020.
Changes in internal control over financial reporting
There has been no change
in the Company's internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the Company's fiscal quarter ended May 31, 2020, that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
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PART
II – OTHER INFORMATION
Item 1. Legal Proceedings.
The information set forth in response to this Item 1 is incorporated by reference from the "Contingencies" section in Note 19, Commitments, Contingencies and Guarantees, in the Notes to consolidated financial statements in Item 1 of Part I of this Quarterly Report, which is incorporated herein by reference.
Item 1A. Risk Factors.
The
effects of the outbreak of the novel coronavirus (COVID-19) have negatively affected the global economy, the United States economy and the global financial markets, and may disrupt our operations and our clients' operations, which could have an adverse effect on our business, financial condition and results of operations. The ongoing COVID-19 global and national health emergency has caused significant disruption in the international and United States economies and financial markets. On March 11, 2020, the World Health Organization declared the COVID-19 outbreak a pandemic. The spread of COVID-19 has caused illness, quarantines, cancellation of events and travel, business and school shutdowns, reduction in business activity and financial transactions, labor shortages, supply chain interruptions and overall economic and financial market instability. The United States now has the world's most reported
COVID-19 cases, and all 50 states and the District of Columbia have reported cases of infected individuals. Several states, including New York, where we are headquartered, have declared states of emergency. Similar impacts have been experienced in every country in which we do business. Impacts to our business could be widespread and global, and material impacts may be possible, including the following:
•Employees contracting COVID-19
•Reductions in our operating effectiveness as our employees work from home or disaster-recovery locations
•Unavailability of key personnel necessary to conduct our business activities
•Unprecedented volatility in global financial markets
•Reductions
in revenue across our operating businesses
•Delay in planned entry into, or expansion of, investments or projects in China and surrounding areas
•Closure of our offices or the offices of our clients
•De-globalization
We are taking precautions to protect the safety and well-being of our employees and customers. However, no assurance can be given that the steps being taken will be deemed to be adequate or appropriate, nor can we predict the level of disruption which will occur to our employee's ability to provide customer support and service.
The ongoing COVID-19 pandemic has resulted in meaningfully lower
stock prices for many companies, as well as the trading prices for our own securities. The further spread of the COVID-19 outbreak may materially disrupt banking and other financial activity generally and in the areas in which we operate. This would likely result in a decline in demand for our products and services, which would negatively impact our liquidity position and our growth strategy. Any one or more of these developments could have a material adverse effect on our and our consolidated subsidiaries' business, operations, consolidated financial condition, and consolidated results of operations.
We may incur losses as a result of unforeseen or catastrophic events, including the emergence of a pandemic, terrorist attacks, extreme weather events or other natural disasters. The
occurrence of unforeseen or catastrophic events, including the emergence of a pandemic, such as COVID-19, or other widespread health emergency (or concerns over the possibility of such an emergency), terrorist attacks, extreme terrestrial or solar weather events or other natural disasters, could create economic and financial disruptions, and could lead to operational difficulties (including travel limitations) that could impair our ability to manage our businesses.
Abrupt changes in market and general economic conditions have in the past adversely affected, and may in the future adversely affect, our business and profitability and cause volatility in our results of operations. Economic and market conditions have had, and will continue to have, a direct and material impact on our results of operations and financial condition because performance in the financial
services industry is heavily influenced by the overall strength of general economic conditions and financial market activity.
Our investment banking revenue, in the form of advisory services and underwriting, is directly related to general economic conditions and corresponding financial market activity. When the outlook for such economic conditions is uncertain or negative, financial market activity generally tends to decrease, which reduces our investment banking revenues. Reduced expectations of United States economic growth or a decline in the global economic outlook could cause financial market activity to decrease and negatively affect our investment banking revenues.
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A
sustained and continuing market downturn could lead to or exacerbate declines in the number of securities transactions executed for customers and, therefore, to a decline in the revenues we receive from commissions and spreads. Correspondingly, a reduction of prices of the securities we hold in inventory or as investments would lead to reduced revenues.
Revenues from our asset management businesses have been and may continue to be negatively impacted by declining securities prices, as well as widely fluctuating securities prices. Because our asset management businesses hold long and short positions in equity and debt securities, changes in the prices of these securities, as well as any decrease in the liquidity of these securities, may materially and adversely affect our revenues from asset management.
Similarly,
our merchant banking businesses may suffer from the above-mentioned impacts of COVID-19 including employee and customer illnesses and quarantines, cancellations of events and travel, reductions in business activity and financial transactions, labor shortages, supply chain interruptions and overall economic and financial market instability. As an example, an overall reduction in business activity has led to a decrease in global demand for oil and natural gas thereby causing historically low prices for these commodities. Such dramatic price decreases may have a material adverse effect on our investments in Vitesse Energy Finance and JETX Energy.
In addition, global economic conditions and global financial markets remain vulnerable to the potential risks posed by certain events, which could include, among other things, political and financial uncertainty in the United States and the
European Union, renewed concern about China's economy, complications involving terrorism and armed conflicts around the world, or other challenges to global trade or travel, such as might occur in the event of a wider pandemic involving COVID-19. More generally, because our business is closely correlated to the general economic outlook, a significant deterioration in that outlook or realization of certain events would likely have an immediate and significant negative impact on our business and overall results of operations.
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Item 2. Unregistered Sale of Equity Securities and Use of Proceeds.
(c)
Issuer Purchases of Equity Securities
The following table presents information on our purchases of our common shares during the second quarter of 2020 (dollars in thousands, except per share amounts):
(a) Total Number of Shares Purchased
(b)
Average Price Paid per Share
(c) Total Number of Shares Purchased as Part of Publicly Announced Plans or Programs (1)
(d) Approximate Dollar Value of Shares that May Yet Be Purchased Under the Plans or Programs (1)
(1)In
January 2020, the Board of Directors approved an additional $250 million share repurchase authorization. In March 2020, having completed the repurchase of shares under the previous authorization, the Board of Directors approved an additional share repurchase authorization of $100 million. At May 31, 2020, $73.3 million remains available for future purchases. In June 2020, the Board of Directors increased the share repurchase authorization to $250 million, including the $73.3 million.
Financial statements from the Quarterly Report on Form 10-Q of Jefferies Financial Group
Inc. for the quarter ended May 31, 2020, formatted in Inline Extensible Business Reporting Language (iXBRL): (i) the Consolidated Statements of Financial Condition, (ii) the Consolidated Statements of Operations, (iii) the Consolidated Statements of Comprehensive Income (Loss), (iv) the Consolidated Statements of Cash Flows, (v) the Consolidated Statements of Changes in Equity and (vi) the Notes to Consolidated Financial Statements.
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Cover Page Interactive Data File, formatted in iXBRL (included in Exhibit 101)
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SIGNATURES
Pursuant
to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
