I admit I never paid too much attention to Jefferies, since in the grand scheme of things, this bank is a relatively marginal player in the global financial system. I was fully aware, though, that their strategy to climb Wall Street league tables mostly relied on dealing with assets and companies many banks wouldn’t touch with a 10-foot pole (usually because of too many compliance red flags).
The recent and “sudden” bust of First Brands Group brought Jefferies and its dealings under the spotlight, so out of curiosity, I started to look into their financials to gauge the health of this investment bank. Frankly speaking, considering there are many analysts out there who did this before me, I wonder how no one noticed the overwhelming number of red flags sitting in plain sight on Jefferies’ SEC filings.
Let’s start by taking a look at Jefferies’ assets and liabilities. As you can see from the table here:
- Net REPO financing (Securities sold or purchased under REPO agreements) is ~$4 billion NEGATIVE
- Receivables minus Payables is ~$1.5 billion NEGATIVE
- Short-term borrowings jumped to ~$1.2 billion, or 3 times in the last 9 months
- Other secured financing is ~$2.7 billion
- Accrued expenses and Other Liabilities are ~$3.1 billion
The total is: ~$12.5 billion of short-term financing
How much cash and cash equivalents does Jefferies have on its books? ~$11.5 billion. Putting it all together, without all these forms of very short-dated (and by definition unreliable) financing, Jefferies’ cash position would be ~$1 billion NEGATIVE. If this isn’t a massive red flag, I don’t know what is.
Another interesting thing about Jefferies’ numbers is: “Financial Instruments Sold, not yet purchased, at fair value”. What’s this about? These are SHORT POSITIONS Jefferies has, for a total of ~$12.3 billion, that are effectively another form of very unstable short-term financing. Second massive red flag here.
Adding these to the previous calculation, the total is a theoretical NEGATIVE cash position of ~$13.3 billion.
Considering ~$4.4 billion of shorts are in equity, and that stocks are trading at all-time highs, how large are the losses Jefferies is hiding here? They forgot to share details about this.
At this point, someone might argue that Jefferies owns ~$26 billion of financial instruments; however, digging deeper, it doesn’t take long to find out ~$20.5 billion of these have already been pledged as collateral that isn’t part of REPO transactions. Collateral against what exactly? I smell big losses on derivative positions and guarantees here.
The last interesting thing in Jefferies’ balance sheet assets before we move forward is ~$1.5 billion of “loans and investments to related parties”. What are these exactly? This is capital and liquidity that Jefferies injected into its off-the-books VIE vehicles used to repackage and sell toxic assets. Let’s take a closer look at these.
As you can see in the table here, VIE vehicles sponsored by Jefferies piled up ~$49 billion of CLOs, ABS, Private Equity, and “other investment vehicles”. All these assets are NOT CONSOLIDATED in Jefferies’ financials. In order to sell these assets and pocket large commissions in the process, which make up a good chunk of Jefferies’ revenues, the bank clearly extended guarantees, considering the bank itself declares a “Maximum exposure to loss” of ~$10.4 billion.
Here is how Jefferies explains their “maximum exposure to loss” risk:
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 our 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.
How much is Jefferies’ total shareholders’ equity? ~$10.5 billion. Clearly, if we consider this direct exposure to losses and the hidden losses on equity short positions (without considering anything else, not to make things look even worse), Jefferies does stand a high risk of quickly becoming INSOLVENT.
It should not come as a surprise that Jefferies executives have already started to “control the damage,” stating the bank is solid. Kind of reminds me of Credit Suisse a few years ago.
However, clients have seen enough and are already flooding Jefferies with redemption requests to get their money back as soon as possible. I wonder if, after avoiding doing due diligence, they figured out how precarious Jefferies’ liquidity and capital positions are.
Clearly, it is only a matter of time before things turn from bad to worse for Jefferies. My bet is we will see a Fed-orchestrated bailout where Wells Fargo takes over its operations and avoids a dangerous contagion to other institutions that have been involved in similar repackaging and distribution of toxic assets over the years. Why Wells Fargo? Because it’s the only bank with a “free capital” buffer that can be deployed against Jefferies’ books after the bank has been released from the “penalty box” it stood in for several years due to the mortgage scandal it was previously involved in. Don’t worry, though, Jefferies isn’t a systemic bank, and even if steep losses from its activities can surface all around the global financial system, the total amount will still be manageable thanks to the endless amount of liquidity central banks keep injecting into the system. However, this situation is a big warning sign that problems are set to increase in the future, especially when the Fed itself helped banks to hide them in the last round of stress tests, as I flagged in my report: “2025 FED STRESS TEST REVEALS HOW TODAY’S FED IS COMPLICIT IN HIDING BANKS’ PROBLEMS“.
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