November 21, 2011
To Our Clients, Shareholders, Bondholders, Employees and Friends:
We are writing so that every one of our key constituencies receive the facts and reality directly from us, instead of being misled by half-truths, false rumors and lies being disseminated with malice by a group whose interests are absolutely opposed to yours and ours. With the exception of facts that are referenced as of today, the information summarized below is further detailed in our Form 10-Q for the quarterly period ended August 31, 2011, filed with the Securities and Exchange Commission and available on our website.
Our Strategic Goals. For nearly 50 years, Jefferies has consistently thrived and built our business through good times and bad. After each period of financial difficulty or crisis, we have emerged stronger and better positioned to serve our clients. During this half-century of serving an ever-growing group of clients with an expanding array of our capabilities, our focus has been on achieving straightforward, strategic goals: protect our platform; maintain our core capabilities and capacity to best serve our clients; be as profitable as reasonably possible while achieving those goals; and take advantage of attractive opportunities that fit our model.
Our Liquidity and Funding Model. One of the fundamental reasons we have been able to achieve those goals is a liquidity and funding model that is based on five core principles, which we discuss below:
enter into partnerships and joint ventures with complementary long-term partners to pursue business opportunities that otherwise might exceed our capital capacity or risk tolerance.
Sound Capital Base. Jefferies navigated the 2008-09 financial meltdown without any government support or “bail out” from taxpayers. Seeing events unfold, Jefferies acted in April 2008, raising $430 million of equity as a buffer against the ongoing crisis.
Similarly, a few years later on April 7, 2011, when we announced our $422 million acquisition of Prudential Bache’s Global Commodities Group, that very same day we raised $500 million of equity and the next day we raised $800 million of long-term debt. We also established a three-
maintain a sound long-term capital base and reasonable leverage relative to our business activity,
own inventory composed of liquid assets that turn over regularly, with a minimal amount of Level 3 inventory,
employ secured funding that is readily and consistently available through clearing houses, or fixed for periods of time that exceed the expected holding period of the inventory being funded,
assess capital reserves and maintain liquidity to withstand adverse changes in the trading or financing markets, and
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year committed $950 million senior secured revolving credit facility with a group of commercial banks. The sum of these long-term capital raises and funding facility well exceeds the needs of Jefferies Bache and provides extra liquidity to Jefferies.
As a result of these and earlier capital raises, as well as ongoing retained earnings, Jefferies maintains a liquid balance sheet supported by over $8.2 billion of long-term capital. As of August 31, 2011, the date of our last published financial information, this capital was composed of $3.5 billion of shareholders equity, $438 million of preferred equity and $4.3 billion of long- term debt. The $4.3 billion of long-term debt does not include our 7.75% senior notes due in 2012, our only funded debt that matures in the next two years. During the crisis of 2009, and again in the last three weeks, we repurchased a significant amount of these 2012 notes at attractive prices in the open market. There remain outstanding today $255 million principal amount of these notes, which will be repaid at maturity out of our available funds, including if needed the proceeds of our long-term capital raises earlier this year. Aside from these 2012 notes, our long-term debt has an average maturity exceeding nine years.
Liquid Inventory. We never forget that we are, in a manner of speaking, in the moving business and not the storage business. Thus, Jefferies’ balance sheet is highly liquid, with Level 3 assets for which the firm bears economic exposure equaling only approximately 3% of our inventory and less than 7% of long-term capital, substantially less – both absolutely and relatively – than most of our larger competitors. At August 31, 2011, Jefferies’ total financial instruments owned, or “long inventory,” was $18.1 billion and total financial instruments sold, not yet purchased, or “short inventory,” was $10.3 billion. We finance our inventory with our own funds and by borrowing against our inventory in the secured funding market.
Secured and Readily Available Funding. To be clear at the outset, we do not use or rely on “wholesale funding,” a catch-all term typically used to refer to funding other than core deposits, such as brokered deposits, foreign deposits or commercial paper. We do not have any unsecured overnight borrowings, and other than the previously mentioned $255 million of debt maturing in March 2012, we do not have any short term unsecured debt.
Our liquid inventory is readily financed. Approximately 77% of our total long inventory at August 31, 2011, was readily financeable at haircuts of 10% or less, meaning we could readily borrow over 90% of the fair market value of this inventory. Those low haircut levels directly reflect the high quality and liquid nature of our inventory.
We finance a portion of our long inventory and cover some of our short inventory by pledging and borrowing securities in the form of repurchase or reverse repurchase agreements, respectively. About 87% of all our repo activities use collateral (or inventory) that is eligible for repo transactions with clearing utilities. Because central clearing corporations or utilities sit between participating members who borrow cash and lend securities (or vice versa), repo participants contract with the clearing utility and not one another individually. Therefore, counterparty credit risk is borne by the clearing utility, which risk it mitigates through initial margin demands and variation margin calls from repo participants. Put differently, 87% of our repos end up with clearing utility counterparties who are blind to the Jefferies’ name in the same way that we are blind to their names. The comparatively large proportion of our total repo
activity that is eligible for central clearing is further testimony to the very high quality and liquid composition of the inventory we carry in our trading books.
The remaining 13% of our repo activity is currently contracted for a term that, on average, exceeds 80 days. The tenor of our repos generally exceeds the expected holding period of the assets we are financing.
Although the liquidity and quality of the relevant inventory is the overriding determinant of applicable repo margin and haircuts, were our credit rating to revert to the lowest rating at the time of the 2008-09 crisis, we would be obligated to post an immaterial amount of incremental cash (estimated at under $100 million).
Finally, at any time we are concerned about our inventory funding rollover, we obviously have the alternative of reducing inventory through sales in the market. Given the mix of inventory we carry, this is a straightforward exercise, as evidenced by the actions we took two weeks ago and since then in respect of our European sovereign inventory book.
Capital Reserves and Liquidity Maintenance. As of the close of business Friday, Jefferies had in excess of $2.2 billion in cash on hand, nearly $1 billion of unpledged quality