Wall Street Faces ‘Brutal’ Fixed-Income Results After Jefferies Decline

By Donal Griffin - Sep 21, 2011 2:34 AM GMT+0700
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Jefferies Group, run by CEO Richard Handler, has been adding staff since the 2008 credit crisis. Photographer: F. Carter Smith/Bloomberg

Jefferies Group Inc. (JEF) posted a 79 percent plunge in fixed-income trading revenue that may show the extent of the damage August’s market turmoil caused for its bigger Wall Street competitors.

Revenue from trading bonds for the three months through Aug. 31 dropped to $33.1 million from $161 million a year earlier at New York-based Jefferies, which is led by Chief Executive Officer Richard “Rich” Handler. Profit excluding an acquisition was 10 cents a share, the investment firm said today in a statement, half analysts’ estimates in a Bloomberg survey.

The biggest Wall Street firms will start reporting third- quarter results next month showing how they weathered a market grappling with fallout from Standard & Poor’s downgrade of the U.S. credit rating and concern Greece would default. August was “outright brutal,” Handler told analysts on a conference call. JPMorgan Chase & Co. (JPM) and Morgan Stanley (MS) both warned investors this month that trading revenue may suffer.

“This is a function of the environment, not something specific to Jefferies,” said Lauren Smith, an analyst with New York-based KBW Inc. who predicted the bank would post fixed- income revenue of $195 million. “June and July were fairly muted trading on the part of clients, that was across the board. But August the wheels came off the cart.”

Credit Markets

Handler, 50, said some fixed-income markets at the end of August had tumbled by as much as 15 percent from the end of May, leading to the third-worst month for U.S. credit markets after September and October in 2008. This caused “broad-based writedowns” of some trading assets held by the bank, he said.

“Our results for the quarter substantially reflect the challenging trading conditions across global markets,” Handler said on the call. The problems were “particularly pronounced in August and led to significant declines in certain inventory and hedge values during the quarter,” he said.

Handler and his fellow executives thought the bank was on course for a “satisfactory” quarter at the end of July, he said. The European sovereign debt crisis and investor concern that some banks could struggle to fund their operations ended such hopes in August, he told analysts.

Markets were roiled in August amid investor fear that Europe was struggling to contain its sovereign-debt crisis and that lenders would suffer if a country such as Greece defaulted. Shares in BNP Paribas (BNP) SA, Credit Agricole SA (ACA) and Societe Generale (GLE) SA, the three biggest French banks, fell more than 20 percent during the month. The KBW Bank Index (BKX), which tracks the performance of 24 U.S. banks, fell 13 percent.

Trading Assets

The crisis drove a period of trading volatility and caused a widening of so-called credit spreads, the extra yield that investors demand to own a corporate bond rather than U.S. Treasury notes, Handler said. This caused significant writedowns in some of the bank’s trading assets tied to high-yield bonds, distressed debt and some mortgage bonds, he said.

Trading results at Morgan Stanley, owner of the world’s biggest brokerage, could be affected for the same reason, Chief Financial Officer Ruth Porat said this month. Citigroup Inc. (C), the third-biggest U.S. bank, could post a 31 percent decline in fixed-income revenue compared with the same quarter last year tied to the rout, according to Gerard Cassidy, an analyst with Royal Bank of Canada.

Analysts have reduced their third-quarter profit estimates for firms including Morgan Stanley, Citigroup, JPMorgan and Goldman Sachs Group Inc. (GS) in the past four weeks, according to Bloomberg data. The KBW Bank Index has declined about 5.7 percent since the end of August.

“When credit spreads dislocate as they have, there is a risk that market makers got caught with adverse inventory positions that cause losses,” Chris Kotowski, a New York-based analyst with Oppenheimer & Co., wrote in a Sept. 6 note to clients. “That is clearly what the stock market is fearing.”

To contact the reporter on this story: Donal Griffin in New York at dgriffin10@bloomberg.net

To contact the editor responsible for this story: David Scheer at dscheer@bloomberg.net.