Finance and economics ı June 30th 2012
Jefferies ı From Boyd to men
A 50-year-old upstart makes striking progress on Wall Street
I
T IS a year of anniversaries for the world’s financial institutions. Never mind that they almost failed to make it: Citigroup’s 200th birthday is being widely trumpeted; UBS is marking
its 150th year. The 50th anniversary of Jefferies
Group, an American investment bank, hardly has
the same resonance, but in its own way it has most
to celebrate.
Quietly, Jefferies has been building up an impressive head of steam. It employs 3,800 people (up
threefold in the past decade). It has $35 billion in assets; a sizeable London office after the acquisition
of a British broker, Hoare Govett, from the Royal
Bank of Scotland in February; and operations in
Asia. It is winning mandates on ever-more prominent deals, including a rumoured lead role raising
equity for Manchester United, a football team with
wonderful assets (its fans around the world) and
big liabilities (debt, and Ashley Young). As the investment-banking industry as a whole slims down,
Jefferies has increased market share in recent years.
Set alongside the industry’s behemoths, with their hundreds of
thousands of employees, trillions of dollars in assets and ubiquitous retail branches, Jefferies is still a tiddler with aspirations. It is
certainly not too big to fail, which means it must rely on its wits and
a market that at the moment is not entirely co-operative. Jefferies
pays more than larger rivals to fund itself, and lacks the comfort of
lots of sticky, insured deposits. So it has little choice but to build in
layers of protection: the average maturity on Jefferies’s debt is nine
years. In November, in the aftermath of MF Global’s implosion,
Jefferies still had to act fast to stop a run tied to concern over its
holdings of European debt.
But being small has its benefits, too. Jefferies resisted the forces that
brought bigger firms into the government’s clammy embrace during the crisis. It did not take TARP money, and did not become a
bank-holding company with access to the Federal Reserve’s funding
spigot. Although heavily regulated, like all securities firms, it does
not have to undergo the stress tests that big banks are subjected to,
nor put together “living wills” to prepare for its own demise. It need
not go through the government if it wants to buy back shares, pay
dividends or tweak its capital structure.
Its core shareholder group is comprised of employees and board
members (24%); Leucadia, an investment firm which bought a
big stake when Jefferies raised money in March 2008 (29%); and
MassMutual, an insurer. The owners have reason to be content,
if not euphoric. Over the past four years, Jefferies’s results have
been “decent”, says Richard Handler, its chief executive. That’s
fair. The bank suffered losses in 2008. Return on equity hovers
in the high-single, low-double-digit realm. In another era, that
would be reason to change management; in this, it is almost
came from a man then considered an insightful source on trading,
one Bernard Madoff.
Jefferies always contended that by settling charges himself, he
spared his namesake firm a wrenching examination and possible
death. Perhaps so, but it was hardly clear that a company of several
hundred people focused on trading shares had much of a future to
live for in an increasingly automated world. Ironically, a new path
opened up in part because of the implosion of Mr Milken’s old
firm, Drexel Burnham Lambert.
Mr Handler himself came to Jefferies from Drexel in 1990, with an
expertise and a client roster in high-yield debt. Colleagues came
along too, including people experienced in distressed debt thanks
to the overleveraging of many Drexel clients. His first assignment
was valuing the portfolio of First Executive Life, an insurance company with ties to Drexel, on behalf of Apollo Group, an investment
company run by another person from Drexel. Then came a small
underwriting mandate for a Montana-based supermarket chain,
sold to former Drexel clients who remain clients of Jefferies today.
heroic. “We are”, says Mr Handler, “the nicest property in a devastated neighbourhood.”
It is in better shape now than a decade ago, by any number of measures: range of clients, transaction size, revenue and, most important,
income (see chart 1). In what now counts as an endorsement, Jefferies’s shares trade a bit above book value, a theoretically easy benchmark to meet but one failed by most competitors. Its shares have
outperformed the rest of the sector since the crisis (see chart 2).
It was not always like this. Just over two decades ago, the very
survival of Jefferies was in doubt. The firm was founded in 1962 in
Los Angeles by Boyd Jefferies, a charismatic securities salesman, in
an era when trading of all big companies took place on or through
the New York Stock Exchange. Jefferies, who died in 2001, found
a niche in what was known as the “third market”—non-exchange
trading of shares.
For the most part, this was a harmless way for large institutions to
avoid having a big impact on price when they carried out transactions—a forerunner of today’s off-exchange “dark pools”. But
there was a seamier side. Jefferies left his eponymous firm in the
late 1980s after being implicated in a complex network of insidertrading activities that tied together such high-profile names as Ivan
Boesky and Michael Milken. His particular offence was “stock parking”, a charge not used before or since, that was tied to his willingness to “warehouse” shares for investors, often in advance of
hostile takeovers, enabling them to evade reporting requirements.
As part of a guilty plea, Jefferies assisted in various prosecutions
and was allowed to forgo a prison sentence. In a generally laudatory obituary in the New York Times on August 25th 2001, praise
In retrospect, Jefferies had hit on an abundant resource that has
served it well since: refugees. After moving its headquarters to New
York, Jefferies has picked up the pieces from the disappearance of
all sorts of Wall Street names, from Donaldson, Lufkin & Jenrette
to Bear Stearns. All of them had some superb people but were
dragged down by mistakes elsewhere, or squashed by mergers. Jefferies wants “to hire people who are not leaving their firms, but
whose firms have left them,” says Mr Handler. Ideally, they come,
like Mr Handler did, with expertise and clients. Some are hired one
at a time. Recently, entire teams have been given shelter—one covering mortgages from Lehman, for example; another covering health
care from UBS. Bit by bit, critical pieces of a broad-based investment
bank have been put in place.
This strategy is in some ways low-risk: none of these acquisitions
is, by itself, a giant leap. But building in small steps is not cheap,
nor is creating the kind of firm Jefferies aspires to be. The ratio of
compensation to revenue, obsessively cited by consultancies opining on Wall Street, is 60% for Jefferies, well above the 40% mark
now widely regarded as efficient. Some of this extra cost is transitory, a result of signing bonuses and replacing shares held in former
employers. But some of the expense is structural. Jefferies has none
of the high-volume, low-margin, commodity businesses of the big
commercial banks; it has resisted the lure of massive amounts of
leverage. Its model depends on highly motivated people.
It doesn’t hurt to have competition that is hobbled. That is certainly
the case for the large banks, but it is also, to a disturbing extent, true
of would-be competitors. A few boutique investment banks have
been created in recent years, but they have been very careful to restrict their operations to the kind of advisory work that steers clear
of regulators, meaning they want little to do with retail customers
or anything involving the use of a balance-sheet. The success of
Jefferies suggests that Wall Street is a place where the best part of
failing firms can be reassembled in a compelling form. But whether
a new entrant could replicate its rise is less clear. n
Reprinted with permission from The Economist, June 30th, 2012. On the web at www.economist.com.
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