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| JEF > SEC Filings for JEF > Form 10-Q on 6-Aug-2009 | All Recent SEC Filings |
6-Aug-2009
Quarterly Report
• the discussion of our analysis of financial condition and results of operations contained in this report under the caption "Management's Discussion and Analysis of Financial Condition and Results of Operations";
• the notes to the consolidated financial statements contained in this report; and
• cautionary statements we make in our public documents, reports and announcements.
Any forward-looking statement speaks only as of the date on which that statement
is made. We will not update any forward-looking statement to reflect events or
circumstances that occur after the date on which the statement is made.
Critical Accounting Policies
The consolidated financial statements are prepared in conformity with U.S.
generally accepted accounting principles, which require management to make
estimates and assumptions that affect the amounts reported in the consolidated
financial statements and related notes. Actual results can and will differ from
estimates. These differences could be material to the financial statements.
We believe our application of accounting policies and the estimates required
therein are reasonable. These accounting policies and estimates are constantly
re-evaluated, and adjustments are made when facts and circumstances dictate a
change. Historically, we have found our application of accounting policies to be
appropriate, and actual results have not differed materially from those
determined using necessary estimates.
We believe our critical accounting policies (policies that are both material to
the financial condition and results of operations and require our most
subjective or complex judgments) are our valuation of financial instruments,
assessment of goodwill and our use of estimates related to compensation and
benefits during the year. For further discussion of these and other significant
accounting policies, see Note 1, "Organization and Summary of Significant
Accounting Policies," in our consolidated financial statements.
June 30, 2009 December 31, 2008
Financial Financial
Instruments Instruments
Financial Sold, Financial Sold,
Instruments Not Yet Instruments Not Yet
Owned Purchased Owned Purchased
Corporate equity securities $ 1,163,078 $ 1,308,676 $ 945,747 $ 739,166
Corporate debt securities 2,115,462 1,819,590 1,851,216 1,578,395
Government, federal agency and other
sovereign obligations 1,613,552 1,240,843 447,233 211,045
Mortgage- and asset-backed securities
(1) 2,721,545 - 1,035,996 -
Loans and other receivables 446,733 229,438 34,407 -
Derivatives 220,043 188,019 298,144 220,738
Investments 73,441 - 75,059 -
Other - 4,288 - 223
$ 8,353,854 $ 4,790,854 $ 4,687,802 $ 2,749,567
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(1) A portion of
our mortgage-
and
asset-backed
securities
inventory has
been
economically
hedged through
the forward
sale of such
securities with
the execution
of
to-be-announced
("TBA")
securities with
a notional
amount
outstanding of
$2,201 million
and
$534 million at
June 30, 2009
and
December 31,
2008,
respectively.
TBA securities
had a net fair
value of
$2.0 million
and
$1.7 million at
June 30, 2009
and
December 31,
2008,
respectively,
and are
included in
Financial
Instruments
Owned and
Financial
Instruments
Sold, Not Yet
Purchased in
our
Consolidated
Statement of
Financial
Condition.
Fair Value Hierarchy - FASB 157 defines fair value, establishes a framework for
measuring fair value, establishes a fair value hierarchy based on the inputs
used to measure fair value and enhances disclosure requirements for fair value
measurements. FASB 157 maximizes the use of observable inputs and minimizes the
use of unobservable inputs by requiring that the observable inputs be used when
available. Observable inputs are inputs that market participants would use in
pricing the asset or liability based on market data obtained from independent
sources. Unobservable inputs reflect our assumptions that market participants
would use in pricing the asset or liability developed based on the best
information available in the circumstances. The hierarchy is broken down into
three levels based on the transparency of inputs as follows:
Level 1: Quoted prices are available in active markets for identical assets or
liabilities as of the reported date.
Level 2: Pricing inputs are other than quoted prices in active markets, which
are either directly or indirectly observable as of the reported date.
The nature of these financial instruments include cash instruments for
which quoted prices are available but traded less frequently,
derivative instruments whose fair value have been derived using a model
where inputs to the model are directly observable in the market, or can
be derived principally from or corroborated by observable market data,
and instruments that are fair valued using other financial instruments,
the parameters of which can be directly observed.
Level 3: Instruments that have little to no pricing observability as of the
reported date. These financial
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The availability of observable inputs can vary for different products. Fair
value is a market-based measure; therefore, when market observable inputs are
not available, our judgment is applied to reflect those judgments that a market
participant would use in valuing the same asset or liability. We use prices and
inputs that are current as of the measurement date even in periods of market
disruption or illiquidity. Greater judgment in valuation is required when inputs
are less observable or unobservable in the marketplace and judgment must be
applied in determining the appropriateness of available prices, particularly in
assessing whether available data reflects current prices and/or reflects the
results of recent market transactions. The valuation of financial instruments
classified in Level 3 of the fair value hierarchy involves the greatest amount
of management judgment.
In April 2009, the FASB issued FASB Staff Position No. FAS 157-4 ("FSP FAS
157-4"), "Determining Whether a Market is Not Active and a Transaction Is Not
Distressed," which indicates that greater use of management judgment will be
required in determining fair value when the volume or level of trading activity
for a financial instrument has decreased and when certain factors suggest that
observed transactions may not be reflective of orderly market transactions. FSP
FAS 157-4 provides that prices or quotes should be weighed when estimating fair
value with greater reliability placed on information from transactions that are
considered to be representative of orderly market transactions. We adopted FSP
FAS 157-4 in the second quarter of 2009. Our fair value measurement policies
have been consistent with the guidance in FSP FAS 157-4 and the adoption of FSP
FAS 157-4 did not have a material impact on our fair value estimates.
Valuation Process for Financial Instruments - Financial instruments are valued
at quoted market prices, if available. For financial instruments that do not
have readily determinable fair values through quoted market prices, the
determination of fair value is based upon consideration of available
information, including current financial information, restrictions on
dispositions, fair values of underlying financial instruments and quotations for
similar instruments. Certain financial instruments have bid and ask prices that
can be observed in the marketplace. For financial instruments whose inputs are
based on bid-ask prices, mid-market pricing is applied and adjusted to the point
within the bid-ask range that meets our best estimate of fair value. For
offsetting positions in the same financial instrument, the same price within the
bid-ask spread is used to measure both the long and short positions.
The valuation process for financial instruments may include the use of valuation
models and other techniques. Adjustments to valuations derived from valuation
models may be made when, in management's judgment, either the size of the
position in the financial instrument in a nonactive market or other features of
the financial instrument such as its complexity, or the market in which the
financial instrument is traded require that an adjustment be made to the value
derived from the models. An adjustment may be made if a financial instrument is
subject to sales restrictions that would result in a price less than the quoted
market price. Adjustments from the price derived from a valuation model reflect
management's judgment that other participants in the market for the financial
instrument being measured at fair value would also consider in valuing that same
financial instrument and are adjusted for assumptions about risk uncertainties
and market conditions. Results from valuation models and valuation techniques in
one period may not be indicative of future period fair value measurements.
Cash products - Where quoted prices are available in an active market, cash
products are classified in Level 1 of the fair value hierarchy and valued based
on the quoted exchange price, which is generally obtained from pricing services.
Level 1 cash products are highly liquid instruments and include listed equity
and money market securities and G-7 government and agency securities. Cash
products classified within Level 2 of the fair value hierarchy are based
primarily on broker quotations, pricing service data from external providers and
prices observed for recently executed market transactions. If quoted market
prices are not available for the specific security, then fair values are
estimated by using pricing models, quoted prices of cash products with similar
characteristics or discounted cash flow models. Examples of cash products
classified within Level 2 of the fair value hierarchy are corporate, convertible
and municipal bonds, agency and non-agency mortgage-backed securities and
to-be-announced ("TBA") securities. If there is limited transaction activity or
less transparency to observe market-based inputs to valuation models, cash
products presented at fair value are classified in Level 3 of the fair value
hierarchy. Fair values of cash products
Financial Instruments Financial Instruments
Valuation Basis Owned Sold, Not Yet Purchased
Exchange closing prices 16 % 31 %
Recently observed transaction prices 3 % -
Data providers/pricing services 51 % 40 %
Broker quotes 16 % 24 %
Valuation techniques 14 % 5 %
100 % 100 %
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Pricing information obtained from external data providers may incorporate a range of market quotes from dealers, recent market transactions and benchmarking model derived prices to quoted market prices and trade data for comparable securities. External pricing data is subject to evaluation for reasonableness using a variety of means including comparisons of prices to those of similar product types, quality and maturities, consideration of the narrowness or wideness of the range of prices obtained, knowledge of recent market transactions and an assessment of the similarity in prices to comparable dealer offerings in a recent time period.
JEFFERIES GROUP, INC. AND SUBSIDIARIES
Certain cash products and derivative products trade infrequently and therefore
have little price transparency. As a result, we may use alternative valuation
techniques or valuation models as methods for determining fair value. When using
alternative valuation techniques or valuation models, the following techniques
are applied to different financial instruments classes:
Financial Instrument Classes Valuation Techniques
Equity securities and convertible Valuations based on pending transactions
bonds involving the issuer or comparable
companies, subsequent financings or
recapitalizations, changes in financial
ratios and cash flows of the underlying
issuer and prices of comparable
securities
High-yield corporate bonds Valuations based on pending transactions
involving the issuer or comparable
companies, subsequent financings or
recapitalizations, changes in financial
ratios and cash flows of the underlying
issuer and prices of comparable
securities
Non-agency mortgage-backed and other Benchmarked to yields from market prices
asset-backed securities for comparable securities and calibrated
based on expected cash flow
characteristics of the underlying assets
Auction rate securities Benchmarked to transactions and market
prices of comparable securities and
adjusted for projected cash flows and
security structure, where appropriate *
Corporate bank and other commercial References to prices for other debt
loans and other receivables instruments of the same issuer;
estimates of expected future cash flows
incorporating assumptions regarding
creditor default and/or recovery
Investments in hedge funds, funds of Net asset values, as adjusted for any
funds and certain private equity redemption restrictions
funds
Investments in certain private equity Discounted cash flow techniques
funds
OTC equity and commodity options and Black-Scholes and comparable simulation
equity warrants models
Interest rate, credit default, Modeling, primarily involving discounted
commodity and total return swaps and cash flows, which incorporate observable
foreign exchange forward contracts inputs related to interest rate curves,
commodity indices, equity prices and
volatilities, foreign currency spot
curves and credit spreads of the
underlying credit
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* Prior to the second quarter of 2009, a valuation technique utilizing an internal methodology based on projected cash flows discounted for lack of liquidity was applied in determining fair value.
JEFFERIES GROUP, INC. AND SUBSIDIARIES Level 3 Assets and Liabilities - Level 3 assets were $661.3 million and $469.4 million as of June 30, 2009 and December 31, 2008, respectively, and represented approximately 8% and 10%, respectively, of total assets measured at fair value. Level 3 liabilities were $241.8 million and $11.7 million as of June 30, 2009 and December 31, 2008, respectively, and represented approximately 5% and 0.4%, respectively, of total liabilities measured at fair value. While our financial instruments sold, not yet purchased, which are included within liabilities on our Consolidated Statement of Financial Condition, are accounted for at fair value, we do not account for any of our other liabilities at fair value. At June 30, 2009 and December 31, 2008, Level 3 financial instruments were comprised of the following asset and liability classes:
Financial Instruments Sold,
Financial Instruments Owned Not Yet Purchased
June 30, December 31, June 30, December 31,
(in thousands) 2009 2008 2009 2008
Loans and other receivables $ 275,694 $ 107,929 $ 229,438 $ -
Corporate bonds 104,504 165,248 4,802 3,515
Mortgage and asset-backed securities 119,182 65,154 - -
Investments in hedge funds, fund of
funds, and private equity funds 73,441 75,059 - -
Auction rate securities 59,772 10,579 - -
Equity securities and warrants 20,297 43,227 - -
Derivatives 5,499 - 7,538 8,197
Collateralized loan obligations 2,119 2,179 - -
Emerging market bonds 777 - - -
Total Level 3 financial instruments 661,285 469,375 241,778 11,712
Level 3 financial instruments for which
the firm bears no economic exposure (251,268 ) (146,244 ) - -
Level 3 financial instruments for which
the firm bears economic exposure $ 410,017 $ 323,131 $ 241,778 $ 11,712
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During the three and six months ended June 30, 2009, we had transfers of assets of $89.5 million and $115.0 million, respectively, from Level 2 to Level 3 and transfers of $77.3 million and $89.8 million, respectively, from Level 3 to Level 2. Transfers of assets from Level 2 to Level 3 during the three and six months ended June 30, 2009 were primarily related to residential mortgage-backed securities as observable transaction data became less available for the specific class of securities in inventory that were transferred. Additionally during the six months ended June 30, 2009, transfers of assets from Level 2 to Level 3 were related to some high yield corporate bond positions as market quotes became less observable throughout the quarter due to less frequent or nominal market activity and the opaqueness of observable credit spreads. Transfers of assets from Level 3 to Level 2 for the three and six months ended June 30, 2009 were primarily related to high yield corporate bonds where pricing information, trading activity observed and recently executed transactions provided transparency for purposes of determining fair values and related to residential mortgage-backed securities. During the three and six months ended June 30, 2009, we had transfers of liabilities of $3.0 million and $3.0 million, respectively, from Level 2 to Level 3 and transfers of liabilities of $-0- and $3.5 million from Level 3 to Level 2. Net losses on Level 3 assets of $2.6 million and $45.3 million for the three and six months ended June 30, 2009, respectively, are attributed primarily to equity warrants and certain equity securities due to declining underlying equity prices and increased market volatility, and declines in loan positions due to widening of pricing due to increasing default probabilities for particular credits during the quarter, partially offset by increases in fair value for certain mortgage-backed securities due to increased market transactions observed for comparable positions and net gains on credit derivative positions. Additionally, for the three months ended June 30, 2009, net losses on Level 3 assets were also attributed to net writedowns on auction rate securities as market-based pricing levels and redemptions have dampened during the second quarter of 2009. Net losses on Level 3 liabilities were $3.7 million for the three months ended June 30, 2009 primarily attributed to writedowns on certain written equity options
. . .
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