Lean times have returned to investment banking like a forgotten winter’s chill. Barclays PLC and Credit Suisse, to name just two, have each imposed substantial job cuts, largely because of a decline in trading income. Yet one investment bank stands out for growing its trading business, even after larger rivals began slimming down.
In fact, Jefferies Group Inc. has gone from strength to strength as a full service, independent investment bank, one with growing ambitions to join its bulge-bracket brethern.“There is going to be a continuing need for companies to raise capital and do M&A and reshape their balance sheets,” says Richard Handler, Jefferies’ CEO since 2002. “I don’t think that model is broken.”
In fact, Jefferies has been on a growth spurt. Its headcount has gone from 2,200 two years ago to about 3,600 today. Net revenues in the second quarter were $727 million, up from $465 million in the like period in 2007; earnings were $81 million compared with $62 million.
“If you look at the years since Handler has been CEO, Jefferies has been the best-performing investment bank out there in terms of total return to shareholders,” says Oppenheimer banking analyst Christopher Kotowski. “It’s the one company where you would say they came out of the crisis bigger and stronger and broader than they went into it.”
Jefferies has been through crises before. A high-flying third-market player catering to corporate raiders and arbitrageurs in the 1980s, the then-Los Angeles firm was rattled by the 1987 stock market convulsion which rudely ended that brazen era. (Founder Boyd Jefferies was fined, put on probation and banned from the securities industry for parking stock for Ivan Boesky and other peccadillos.) The firm’s salvation proved to be junk bonds, high tech and corporate finance under then-CEO Frank Baxter. As if to emphasize how much Jefferies had changed, it moved lock, stocks and barrel to New York a decade ago.
Handler and his executives are today at pains to remind you that Jefferies is no longer a boutique firm. Not without reason. One standout success has been the firm’s expansion of fixed-income trading. Once confined largely to leveraged finance and high-yield, and generating $177 million in revenues in 2007, the operation is now omnibus in trading and omnipresent in global markets, and brings in more than $1 billion annually (though fixed income suffered a setback in the second quarter’s market slump).
Handler brought in William Jennings from RBS Greenwich Capital in 2008 as global co-head of fixed income, along with Johan Eveland, to build a substantial international trading operation for mortgages and other asset-backed securities.
In March 2009 Jefferies acquired the U.S. municipal bond business of Depfa First Albany Securities from Germany’s bankrupt Depfa Bank. “It’s become a significant business for us,” says Brian P. Friedman, chairman of Jefferies executive committee and president of its private equity arm, Jefferies Capital Partners, who runs the firm alongside Handler.
Strikingly, Friedman, a lawyer who used to be head of investment banking for Furman Selz, occupies a large executive suite in the bank’s Madison Avenue offices, while Handler, who also holds the title of chairman of the board, seems to feel more comfortable in a small, inconspicuous office next to the trading floor. But then, he used to be managing director of Jefferies’ high-yield capital markets operation.
In the financial crisis-inspired turmoil that led to Merrill Lynch’s merging with Bank of America, Jefferies hired a team of the broker’s U.S.-government-bond traders and in 2009 became a primary dealer in Treasuries. It followed that up by hiring a European bond team from Dresdner Kleinwort ,which was then being acquired by Commerzbank, becoming a primary dealer in government debt in Austria, Germany, the the Netherlands and the U.K.
On the equity side (22 percent of revenues), Jefferies has also expanded rapidly. Jason Griffith, head of equity trading, says it now offers a full complement of cash equities, convertible bonds, equity derivatives, exchange-traded funds, prime brokerage services for hedge funds and algorithmic trading. In the last year alone, the firm has added 100 people in Hong Kong, Mumbai, Singapore and Tokyo.
Jefferies has also vastly expanded its equity research operation, adding 85 staffers and covering an additional 400 stocks worldwide. “The ultimate objective is to be truly diversified globally and provide our investor base with great ideas not just in the U.S. but the U.K., Europe as well as Asia,’ says Steven R. Black, head of research.
Jefferies makes no secret that it aspires to join the bulge bracket. Its investment banking revenues were up 28 percent, to $328 million, in the second quarter, compared with the like period in 2010, thanks to the 634 investment bankers the firm has systematically stationed around the globe. An impressive 100 debt deals during the quarter bolstered the capital markets business. What’s more, Jefferies has managed to almost double its M&A fees, to $144 million in the second quarter, over the past 12 months by luring a slew of bankers away from Credit Suisse, Citigroup and Barclays. Investment banking accounts in toto for around 40 percent of its revenue stream. Yet the Dealogic rankings show Jefferies still has considerable distance to go to join the ranks of its former “boutique” rivals Evercore and Greenhill and even Moelis & Co in sheer M&A volume, though not in fees.
In real estate finance, Jefferies thinks it can succeed where others (Lehman, Bear Stearns) have failed. It recently formed a commercial real estate finance venture as an equal partner with the Singapore Investment Corp. Initial equity commitment; $600 million. “We’ve studied carefully where others have erred, and it comes down to liquidty and risk,” contends Friedman. “We believe that commercial real estate is at the beginning of a turnaround that can be financed smartly.” The commercial real estate operation will securitize and syndicate all of its underwritings to reduce the risk, he adds.
Similarly, Jefferies has formed a joint venture called Jefferies Finance with insurer Mass Mutual to lend to corporate borrowers looking to make acquisitions or restructure their balance sheets. Those loans are also syndicated immediately.
To help finance the $430 million purchase of Prudential Bache Securities, which should close in July, Jefferies raised $1.3 billion. This will give it entree to commodities trading, financial futures and foreign exchange trading. The unit will operate as a distinct division, Jefferies Bache, and be headed by Patrice Blanc, former CEO of multi-asset brokerage Newedge Group.
All of this expansion has been costly. Firmwide compensation alone is up 38 percent in the past year. Handler collected $15 million, along with the promise of very generous bonuses for meeting future performance targets. Friedman acknowledges that “we obviously sacrifice some near-term profitability for what we think is a much greater long-term value.”
The danger, of course, is that not that Jefferies will make the kind of bets that sank Bear Stearns or Lehman Brothers, but that its growth will turn out to be too ambitious for a low-growth era. If investment banking slows markedly because the economy stalls, for example, all those new hires may be burdensome for Jefferies’ balance sheet. The firm got a taste of the new austerity in the second quarter, when its fixed income revenues fell 30 percent from the prior quarter, in line with a market decline. Like its rival Lazard, however, Jefferies has a restructuring operation that can help bolster its business during economic downturns.
What Handler and Friedman are trying to accomplish is in some ways a throwback to the ‘80s and ‘90s: Pure Wall Street versus universal, all-things-to-all-customers banks. The big banks serve too many masters, they say, and must contend with too much regulation from Washington. Jefferies doesn’t have to worry about these intrusions nearly as much.Jefferies may scale back its hiring now that it has staffed up globally, but it still has ambitions to eat its larger rivals’ lunch.
“This is good, old-fashioned smart investment banking,” Friedman declares. So far, it seems to be working.
