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Holly LaFon
Holly LaFon
Articles (10163)  | Author's Website |

Jefferies' 2018 Annual Letter

Discussion of markets and investing

June 11, 2019 | About:

January 10, 2019

Dear Fellow Shareholders,

By most measures, 2018 was a year of meaningful accomplishment at Jefferies Financial Group, as we achieved our overriding priorities identified in last year’s letter. We delivered consistent and solid results at Jefferies Group LLC, completed significant and very profitable transactions involving two of our Merchant Banking portfolio companies and drove solid progress across much of the rest of our principal investments. This was a lot of work and we are incredibly proud of everyone at Jefferies Financial Group for getting so many difficult jobs done so well.

In our fiscal year ended November 30, 2018, Jefferies Financial Group recorded net income attributable to common shareholders of $1.0 billion, or $2.90 per diluted share, and paid $0.45 per share in dividends. Fully diluted tangible equity per share increased by 22% from $20.48 at the beginning of the fiscal year to $24.90 on November 30.

There have been several periods in our careers when our stock price has been out of sync with our operating performance and future prospects. Since this mis-alignment evolved to such a material extent in 2018, it was as if we were “getting the call” from our own company about a compelling new investment opportunity and, in 2018, JEF was our single largest investment. We repurchased 50 million shares, representing 13% of our fully diluted shares outstanding at the beginning of the year and including 24 million shares repurchased in October and November, at an average price per share of $22.86, a material discount to both tangible and intrinsic values, or a total of $1.14 billion. We believe this buyback is highly accretive and rewarding to all our long-term shareholders. In our experience, perception does eventually reflect reality, particularly when the investment story is becoming more focused and straightforward.

Combining the share buyback with the dividends paid in the eleven-month period of 2018, we returned to our shareholders an aggregate of $1.3 billion, or 17% of our beginning of year tangible common shareholders’ equity. Even after this return of capital to our shareholders and our $400 million of investments to expand Vitesse Energy Finance and Leucadia Asset Management, we ended fiscal 2018 with an increase of $300 million in parent company liquidity, which now totals $1.6 billion. This leaves us continuing in a strong position to defend against adversity and to take advantage of new opportunities, whether to acquire businesses or investments, expand our existing franchise or return additional capital to shareholders.

Perhaps even more important than the strong results, we believe the strategic changes made in 2018 will become more apparent and productive starting in fiscal 2019. Despite the many benefits and opportunities that arose from the combination, the merger of Leucadia and Jefferies was confusing to investors and others to understand. The full consolidation of National Beef’s results, given Beef’s high revenues and relatively low operating margin, made it very difficult to comprehend our consolidated income statement. With the deconsolidation of National Beef, we simplified our story considerably and marked this increased focus by changing the name of our parent company to Jefferies Financial Group Inc., a financial services holding company focused on investment banking and capital markets, asset management and principal investing.

Jefferies Financial Group Inc. Annual Report 2018

1

Furthering this simplification, on October 1, we transferred into Jefferies Group our 50% interest in Berkadia and our Leucadia Asset Management seed investments, thereby amalgamating our long-term financial services operating businesses into one platform. Our merchant banking efforts will be presented separately in semi-annual disclosures of the estimated fair market value of this portfolio.

The final and equally necessary simplification was the alignment of our two previously distinct fiscal year ends. There is historical rationale for how we got there, but two different year ends made it more difficult to follow our financial performance. With this alignment to a year ending on November 30, we will provide timely financial information four times a year in a comprehensive, consistent and transparent format.

2019 should be our most straightforward and readily understandable financial reporting period in a long time, and we believe this should help narrow substantially the gap between perception of value and the reality of stock price. We are realists who care passionately about our responsibilities and obligations to all our stakeholders. As long-term, large shareholders, we are fully aligned with all shareholders and committed to not only creating value, but having it recognized.

Looking forward, our top priority is growth and margin improvement at Jefferies Group driven by continued expansion of our Investment Banking effort, continuing market share gains in Equities, recovery in Fixed Income and better results in Asset Management. We expect our Merchant Banking portfolio will yield several further monetization events in the next couple of years. We will continue to review opportunities for further direct investment, and will act when we find solid value that can accrue for our shareholders. We enter 2019 in as strong a position as ever to build upon our solid foundation.

Investment Banking, Capital Markets and Asset Management

We recorded net revenues at Jefferies Group of almost $3.2 billion, pre-tax income of $410 million and adjusted return on tangible equity of 8.7%. There is never a good excuse for missing our double digit goal, but our lower than targeted adjusted ROTE primarily reflects the challenging markets of the fourth quarter. However, despite heightened volatility, a significant decline in oil prices and a severe backup in leveraged finance and all risk classes, all our businesses held up well, albeit, in a few cases, at more moderate levels, but meaningfully better than in similar conditions in 2015 and early 2016. Jefferies Group’s quarter end gross assets have remained at approximately $40 billion since the balance sheet de-leveraging and de-risking we undertook in late 2015 and early 2016. Maintaining consistently lower levels of risk and balance sheet for the last few years has helped limit the downside during times of market stress.

Our competitive position strengthened further over the course of the year. Several of our primary competitors continue to experience challenges, which may lead to further industry consolidation and create additional market share growth opportunities.

Investment Banking. Our Investment Banking net revenues were $1.9 billion in 2018, or 60% of Jefferies Group’s total net revenues, driven by record performance in our advisory and equity capital markets businesses. We believe we are benefitting from our flat structure, our entrepreneurial culture, our focus on prioritizing insight rather than balance sheet, and our approach to client service that emphasizes partnership and the long-term. This has led to over 74% of 2018 Investment Banking net revenues being from existing clients.

Over the last five years, our Investment Banking net revenues have grown at the highest annual rate of all major global investment banks. In the U.S., our home market and the largest market for our services, our overall fee market share increased considerably and, for the twelve months ended November 30, 2018,

2 Jefferies Financial Group Inc. Annual Report 2018

we ranked 7th in mergers and acquisitions, 6th in equity capital markets and 6th in leverage finance, all as measured by Dealogic. The table below is testament to decades of effort by many people, perseverance in our strategy and execution, and Jefferies Group’s good fortune to be the only full service investment banking firm to survive the upheaval and challenges of the past 20+ years and break into the top ranks in all relevant lines of business.

We continue to believe we are experiencing an inflection point in the scale and momentum of our Investment Banking business, driven by our efforts to enter a large number of new industry sectors, significantly expand our product capabilities and increase productivity from our senior investment bankers as they become more tenured at Jefferies Group. We are growing our M&A franchise in larger transactions, with transactions over $1 billion in size now accounting for over 50% of our M&A revenue, while at the same time we remain a leader and continue to build our footprint in the middle market M&A business. Finally, we are monetizing the large M&A and equity capital markets revenue opportunities embedded in the incumbent corporate relationships that we have established as one of the largest providers of U.S. leveraged buyout financing.

Net revenues and pre-tax income of Jefferies Finance, our corporate lending 50/50 joint venture with MassMutual Life Insurance Company, were a record $438 million and $205 million, respectively, in 2018. Jefferies Finance originated a record $44 billion in corporate loans in 2018.

Established in 2004, Jefferies Finance has demonstrated growth and resilience across multiple market cycles and has lead arranged over $195 billion in financing. In addition to its syndication business, Jefferies Finance is an asset manager and also provides direct lending to middle market companies. Jefferies Finance completed three new CLOs this year and manages over $7.5 billion of assets, a portion of which are retained from Jefferies Finance-arranged transactions. Jefferies Finance’s strategy will remain focused on growing market share in its core U.S. and European loan syndication business, as well as further expanding into middle market direct lending (both origination and asset management), which represents a significant growth opportunity.

Since we may be late in the credit cycle, it is important to note that Jefferies Finance ended the year in a strong position in terms of risk exposure, having successfully syndicated all deals we brought to market during the year. Our commitments outstanding at year end were all of good quality, with terms consistent with current market conditions, and should be fully syndicated readily in the near-term. We remain vigilant in our underwriting process, while continuing to serve our clients and maintain our market position.

Real Estate Finance. Berkadia, our commercial real estate finance and investment sales 50/50 joint venture with Berkshire Hathaway, delivered a record $222 million of pre-tax income and a record $166 million of cash earnings for the eleven months ended November 30, 2018, up 37% and 12%, respectively from last year’s first eleven months. Strong debt origination and additional third party loan servicing arrangements increased our servicing portfolio to $234.7 billion. Our servicing portfolio has experienced an almost complete turnover since the acquisition of the company in 2009, while the change in mix of the portfolio, coupled with cost compression efforts, have consistently improved revenue and margin. During the year, Berkadia placed a record $23.1 billion of debt for its clients, up over 4% compared to 20171. Similarly, investment sales volumes also set a record, up 6% from the prior year1, totaling $7.5 billion, with 36% of investment sales volume resulting in a debt placement for Berkadia. Berkadia’s improved performance was largely driven by increased productivity of existing mortgage bankers and investment sales advisors, and recruiting of new ones, which bodes well for the future.

Equities. In Equities, we recorded 2018 net revenues of $666 million, relatively flat from the prior year, as growth in our core equities business was offset by losses in certain block positions. The strong performance in our core Equities business reflects continued market share gains driven by intense client focus, enhanced global capabilities and the momentum of the overall Jefferies platform. We have considerably diversified this business, with electronic trading and international markets now representing a significant portion of our Equities net revenues. While absorbing the effects of MiFID II and the increasing market volatility, we have risen to be ranked #5 in the U.S. with large global clients and our overall global market share increased as well.

Fixed Income. Our 2018 Fixed Income net revenues were $560 million, down 9% from the prior year, primarily due to the weakness in the fourth quarter, when our Fixed Income net revenues of $87 million were 45% below the average of the first three quarters of the year. Despite these lower results, Fixed Income is delivering more consistent performance, with increased capital efficiency and lower risk, after further enhancing our team, focusing on our best opportunities and reducing risk, balance sheet and capital utilization.

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About the author:

Holly LaFon
I'm a financial journalist with a Master of Science in journalism from Medill at Northwestern University.

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