Jefferies: From One Challenge to the Next

By David Reilly, Wall Street Journal

Jefferies Group has to show it has gotten back to business.

For much of November, the midtier investment bank was in crisis mode, trying to quell fears about exposure to Europe and its balance sheet. This led Chief Executive Richard Handler to engage in a spirited defense, publishing information about individual positions while also reducing some holdings to prove the firm was nimble.

While extreme, the approach seems to have reassured investors and customers. Now, as Jefferies on Tuesday reports earnings for its fiscal fourth quarter, which ended in November, Mr. Handler needs to move the firm forward.

Admittedly, that will be difficult, given Europe’s continuing woes. That means investors will remain sensitive to Jefferies’s European exposure—even if it is hedged with offsetting positions rather than derivatives, as the firm has noted—as well as the amount of borrowed money, or leverage, it uses. In addition, the firm will continue to face questions over its reliance on short-term funding.

Still, the danger may be that Jefferies has to pull in its horns too far. That could send the wrong signal about long-term prospects. It’s also an issue because Jefferies, like other banks, faces several head winds. Although markets are somewhat firmer of late, investment banking and trading activity remain weak. So a key question will be whether Jefferies’s fixed-income trading held its own in the most-recent quarter.

Analysts expect Jefferies to report earnings of 16 cents a share, up from 10 cents in the fiscal third quarter, according to FactSet Research. Management has already tried to reassure investors, saying in a Nov. 21 letter, “We expect to record operating results for our fourth quarter that, although not where we want them to be, will be profitable and stronger than our third quarter,” excluding acquisition-related items.

That said, some analysts believe Jefferies, like other investment banks, will struggle to generate returns on equity in excess of 10%. This could become even more of an issue if Jefferies is forced by the recent tumult to deleverage sharply.

As it is, investors are questioning whether the business model of investment banking needs to undergo some fundamental changes. That may not be as immediate a concern as the crisis Jefferies has just faced down. But it may ultimately be a more difficult one for the firm and its peers to deal with.


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