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Executives

Richard B. Handler – Executive Chairman, Chief Executive Officer, President

Peregrine C. de M. Broadbent – Chief Financial Officer

Brian P. Friedman Esq. – Director, Chairman of Executive Committee

Analysts

William Tanona – Goldman Sachs

Patrick Dabit – Merrill Lynch

Steve Stelmach – FBR Capital Market

James [Elman] – [Foots]

[Casey Ambrick] – Millenium

Erin Cadell – Hovde Capital

Horst Hueniken – Thomas Wiesel Partners

John Lloyd – Aetna Investment Management

Tony Della Piana – John Hancock

Ryan O’Connell – Citigroup

Michael Lipper – Lipper Advisory Services

Jefferies Group, Inc. (JEF) Q3 2008 Earnings Call October 21, 2008 9:00 AM ET

Operator

Welcome to the Jefferies 2008 third quarter financial results conference call. A question-and-answer period will follow management’s prepared remarks. (Operator Instructions) A press release containing Jefferies 2008 third quarter financial results was distributed via business wire before the market opened today and can be accessed at Jefferies web site www.jefferies.com.

Some of the comments made in this conference call may include forward-looking statements. These forward-looking statements may contain statements about management’s current expectations, strategic objectives, growth opportunities, business and prospects. These forward-looking statements are not statements of historical fact and represent only Jefferies beliefs as to future performance. They usually include the words continue, will, believe, should or similar expressions. Actual results could differ materially from those projected in these forward-looking statements. Please refer to Jefferies annual report on form 10K filed with the Securities and Exchange Commission on February 29, 2008 and in Jefferies forms 10Q and 8K for discussions of important factors that could cause actual results to differ materially from those projected in those forward-looking statements.

I would now like to introduce your host for today’s conference, Mr. Richard Handler, Chairman and CEO of Jefferies. Mr. Handler you may begin your conference.

Richard Handler

Good morning and thank you for joining our discussion of Jefferies’ third quarter results. I am Rich Handler, CEO of Jefferies, and with me on the call today are Brian Friedman, Chairman of our Executive Committee and Peg Broadbent, our Chief Financial Officer.

We are going to spend a little more time than usual on recent events and our strategy while also addressing our recent results and our financial condition. The events of the past days, weeks and nine months have been little short of breathtaking. Our industry, our competitors and to a degree Jefferies have experienced developments and circumstances that are unprecedented and epic in their scope, severity and opportunity.

Jefferies continues to operate successfully and prudently as a client-focused securities and investment banking firm. Over the course of this decade we consistently added to our long-term capital base in anticipation of our needs and with a view to maintaining a margin of safety. We expanded our current capital base earlier this year with the Lucadia Equity investment as we saw the early signs of what has indeed played out in the system.

We effectively have no bank debt today, significant lines of credit available and in fact over $900 million in cash in the bank as recently as this past weekend. We enjoy outstanding strategic relationships with both Lucadia, one of our nation’s savviest value investors, and Mass Mutual, a highly regarded, AAA rated insurance company.

None of this is intended to say we are not feeling our own share of pain and frustration as reflected in our third quarter results. There is no arrogance or hubrus walking around the trading desk or investment banking conference rooms at Jefferies. We have absorbed real losses for several quarters due to a depressed capital market, the extreme dislocation and volatility of the markets, as well as our carrying compensation and operating costs designed to support revenue capabilities in an irrational environment.

Despite all this our loss over the first nine months of this horrific year has been below $100 million, which is less than 5% of shareholders equity and less than a quarter of the incremental fresh equity we raised just six months ago. We are hopeful the decisive government actions of the last two weeks and the moves our competitors have made for their own preservation will lead to more stability in the markets. We don’t need a bull market for our business model to shine. We just need a functioning market.

Turning specifically to our Q3 results, our net revenues for the third quarter were $275 million and we posted a loss of $31 million or negative $0.18 per share. This result included an $11 million or negative $0.06 bad debt reserve relating to amounts owed to us by Lehman Brothers primarily as the result of trading losses incurred in our unwinding securities lending positions with Lehman as our counter-party.

With the exception of Jefferies high yield trading, our business model produces reasonable results particularly in the face of unprecedented market turmoil. The expansion and diversification of both our equity and income platforms has truly paid off as it continues to have steady revenue production from these business lines regardless of the extraordinary market volatility.

Our net revenues X high yield were $336 million, a solid showing in what can be a seasonally slow quarter. Although we are disappointed to report a loss we are not discouraged. Given the unprecedented events in the past nine months and the recent failure or near failure of many of our biggest competitors we are optimistic about Jefferies’ potential and believe our firm has the right mix of businesses and capital to move forward aggressively and return to profitability in the near future.

In last quarter’s call we mentioned Jefferies had adopted a four-prong strategy to deal with the challenges and opportunities of this crisis. We’d like to reiterate our strategy which we are still successfully pursuing during these turbulent times.

The first phase of our strategy is to preserve and protect our capital base and liquidity to ensure long-term viability. Since we have always prudently managed our balance sheet and capital base our firm has never faced liquidity concerns. However, given our largest competitors’ suffered unprecedented losses and faced tremendous uncertainty and even bankruptcy, we acted decisively and preemptively in mid-April this year to enhance our capital base and protect our firm by raising $434 million of equity through our financing with Lucadia.

In further recognition of the need to maintain ample liquidity during this period of exceptional stress, as well as our desire to maintain financial flexibility to capitalize on opportunities we suspended the dividend on our common stock starting with what would have been our second quarter dividend in July. Our capital base liquidity remained rock solid. At the end of the third quarter we had in excess of $900 million of cash, less than $16 million in drawn bank loans and the average life of our long-term debt of over 14 years and no scheduled maturities on our long-term debt until 2012.

The second part of our strategy is to continue and closely monitor and reduce risk and eliminate peripheral businesses that entail risk with limited or delayed up side to our core business. On average, our daily bar in the third quarter was down 38% to $4.9 million compared to an average bar of $8.1 million for 2007. Obviously bars are a risk metric with many limitations but directionally it continues to show that we have been vigilant in reducing risk in this new environment.

The third leg of our strategy is to reserve our long-term value opportunity by retaining our primary asset, our people. We intend to balance carefully the accrual of compensation at levels we think maintain our competitiveness with a keen focus on achieving appropriate levels of profitability.

The fourth and final element of our strategy is to put offense. We want to take advantage of the carnage in our market to enhance our strategic position in our core operating businesses. The consolidation, bankruptcy and financial hardships of many of our largest competitors have afforded us an unprecedented opportunity to build out several businesses. Most notably this has included the addition of 30 professionals who are international [inaudible] and trading capability in London, various clients to our primary brokerage business in New York, as well as a mortgage sales and trading expansion we began earlier this year.

Both our new mortgage camp and our new international equity trading teams have hit the ground running and have had a positive impact on our firm. We have tremendous up side in the firm we are today. We don’t need to enter new businesses with pay offs far down the road. Any additional hires we will make in the next few months will be incremental and relatively near-term in their contribution.

We have three overriding priorities as we face the future at Jefferies. Our first priority is to grow our share of daily sales of trading all securities for which we field; equities, converts, high yield, bank loans, corporate, emerging markets, [inaudible], agencies and mortgage and asset backed securities. The phones are ringing as never before and the barriers to success have never been more penetrable.

In meeting after meeting our customers are making clear that they appreciate our continuing service and want to get closer to us.

Our second priority is to emerge as the leading capital markets firm for growing and mid-size companies. We can tell you with 100% certainty the markets will eventually re-open and more companies will need Jefferies than ever before. We take no pleasure in the pain suffered by the good people at many of our competitors, but the fact is that competitively we have never been in a stronger position. Our story is real and compelling. We want to market our capabilities, build on existing relationships and develop new ones.

Our third priority is to establish the Jefferies brand broadly as one that stands for excellence, expertise and commitment to serving our customers and clients. We can bring exceptional insight, knowledge and ability to our customers and clients in trading and in investment banking. Our brand will be built on the fact that each one of us is delivering on our commitments every day. With the turmoil in the world it is smart for us to drive our brand message publicly at a firm level and we will do so.

We are clearly making progress in executing our priorities. While this unprecedented environment is continuing to take a short-term toll on us we have more than sufficient capital to operate and grow our business and are confident in our long-term future. Moreover, we are committed to restoring profitability in the near term and then growing our bottom line to a strong return on equity.

Now I’d like to turn it over to Peg to discuss our results in greater detail.

Peregrine C. de M. Broadbent

Thank you. Our net revenues for the third quarter were $275 million versus $334 million for the third quarter of 2007. We reported a loss of $31 million or negative $0.18 per share. The 30% decline in our net revenues from the second quarter of 2008 were mainly driven by Jefferies’ high yield trading which recorded revenues of negative $61 million versus a loss of $7.4 million in the third quarter of 2007. Please keep in mind the negative revenues of $61 million and some of the related costs are offset by positive $40 million of minority interests.

Fixed income and commodities revenues were $56 million, 241% higher than the third quarter of 2007 revenues of $17 million. Our corporate bond cash trading effort performed strongly in the quarter as a result of significantly increased market share enabled by increased market volatility and less competition. As a result of the decline a unique, large equity trading opportunity which we benefited from early last year our equities trading revenue was $122 million compared to $140 million in the third quarter of 2007.

Investment banking revenues were $130 million in the third quarter, down 31% compared to the third quarter of 2007. Capital markets revenues were $51 million, down 45% from $92 million in the year-ago quarter while advisory revenues were $79 million which is a decrease of 19% from the third quarter last year.

Our asset management revenue was negative only $3 million despite the nearly impossible environment reflecting our decreased direct capital exposure and better than market performance. Our compensation rate was 90% for the quarter when measured against total net revenues and 73% when calculated against net revenues X the negative high yield revenues.

The non-compensation expenses were $94 million for the quarter excluding $12 million in one-time charges, almost all of which is 100% bad debt reserve for the recently filed claim against Lehman Brothers for losses Rich mentioned were incurred in unwinding our securities lending activities with that firm. The impact of this bad debt reserve was negative $0.06 per share.

The effective $94 million of normalized operating expense for the quarter is the lowest quarterly run rate since the second quarter of 2007 and reflects our ongoing cost reduction efforts. Our effective tax rate for the quarter was 7.8% as compared to 27.8% for the second quarter of 2008. The decrease in tax rate was driven by an overall decrease in the expected tax rate for the full year which in turn was driven by a decrease in forecasted profit before tax for the full year as the result of the first quarter loss.

During the quarter we did not repurchase any shares. The book value per share was $13.38 based upon 163 million shares outstanding. All estimated balance sheet metrics at the end of the third quarter continue to demonstrate its strength and transparency and still sets us apart positively from the norms that prevailed in our industry until last week. We estimate our gross and adjusted leverage ratios of 10.4% and 6.2% respectively. We estimate that at September 30, 2008 our level three assets after accounting for minority interest were $298 million and continue to represent about 1% of our total assets. This indicates the vast majority of our assets are quite transparent and relatively liquid.

Unlike the level three assets of many of our competitors, ours are comprised primarily of public and private corporate stocks, bonds and loans which we own directly or through managed funds.

Of our level three assets only $32 million was mortgage inventory. This represents less than 3% of the total mortgage inventory we held at the end of the quarter which we estimate to be $1.1 billion. Of the $1.1 billion of mortgage inventory we have on our books more than 90% of it is highly liquid, high quality pools of agency securities that we hold to facilitate client activity. We actually turnover this inventory in our daily business. Additionally, $450 million of the inventory has been sold forward through TBA’s that were captured in the derivatives section of our inventory. The TBA forward sales along with other interest rate derivative hedges mean that the mortgage inventory sensitive to interest rate movement is relatively small.

I’d now like to turn it over to Rich to discuss our trading results.

Richard Handler

I’d like to make a few comments about our sales and trading businesses which generated third quarter revenues of $117 million. Our equities business continued to show resiliency and strength in this period. Our equity revenues for the quarter were $122 million which is an increase of 13% compared to the third quarter of 2007. Our customer equities business performed very well. We know we are advancing from investments we made in this certain area of our firm over the past few years. In this regard we are pleased to have recently been ranked number one for both traditional execution and trained expertise and market knowledge by Alpha Magazine.

Our fixed income and commodity revenues performed extremely well during this market turbulence. Revenues were $56 million, up 241% from the $17 million third quarter of 2007. Clearly our expansion efforts in fixed income are paying off. Our sales and trading hires in corporate mortgages and other areas of fixed income are all performing well and demonstrate that we have indeed made additions that quickly added to our results.

Jefferies’ high yield trading suffered from the brutal and unprecedented market volatility. This is one business where we take a capital investment approach and enjoyed many years of success. Jefferies’ high yield trading was down 7% through the month of September and 10% year-to-date. The vast majority of this change was in the form of unrealized mark to market losses. Fortunately, our six year lock up structure combined with the fact that we have not employed leverage in this business will allow us to navigate this painful period.

In fact, we do see value opportunities that are coming from the incredible illiquidity within this market place and we have just called additional third-party capitals to take advantage of the carnage.

I would now like to turn it over to Brian Friedman to discuss investment banking and asset management results.

Brian Friedman

As Peg indicated earlier, investment banking recorded revenues of $130 million for the third quarter as compared to $190 million in the third quarter revenues last year. Capturing in the subdued capital markets environment this was a reasonable banking quarter for Jefferies.

During the quarter and the limited period the capital markets were functioning, Jefferies completed 24 transactions valued at $8 billion with 9 in high yield, five of them serving as the lead or co-lead manager and 15 in equity with ten of those as lead or co-lead manager. These financings include a $149 million notes offering for Caribbean Restaurants, $141 million equity follow-on for GMX Resources, a $440 million registered direct equity offering through two difference trenches for Solution Inc. and a $132 million notes offering for Perkins and Marie Callendar Inc.

Our advisory business, particularly our sector driven merger and acquisition business, continued to operate at a reasonable pace but 19% below the level of last year’s third quarter. We completed 30 advisory assignments valued at over $14 billion during the third quarter. Some transactions to highlight include HLTH Corp. sale of its home note subsidiary VIPS to General Dynamics and HBO Central Europe selling Spectrum TV, the leading documentary channel in Central Europe to Cello Media.

It is also worth noting that as the M&A business has slowed somewhat our corporate restructuring practice has been picking up significantly in this environment. While these types of engagements tend to have longer maturities the counter-cyclical nature is obviously helpful. We have added several well-known senior professionals to our restructuring group and we are leveraging our sector banking teams to market and execute these assignments.

Jefferies Finance, our joint venture with Mass Mutual continues to have a strong and liquid financial position. With the bank loan syndication market very challenging, we completed only six new deals during Q3 all of which were lead managed. Jefferies’ total investment in this joint venture is $84 million of the $250 million total committed. As pricing and covenant packages have become more favorable, we are pleased to have plenty of powder available as we believe valuations are more reasonable and competition has eased.

We believe our unique market position in investment banking will continue to strengthen. Competition from larger banks is lessening as their financial hardships force them to focus their business in other directions. The absorption of Bear Stearns, Lehman Brothers, Merrill Lynch and Wachovia should be very beneficial to Jefferies. In addition, as in the past when Jefferies was able to add significant talent to our platform in times of trouble on Wall Street, we have made some key hires in the past few months with the intention to further enhance our exceptional team and best position our firm for the future.

Our third quarter asset management revenues were negative $3 million. Although this is not a strong performance, given the marketplace we are experiencing this is not a bad result. We remain committed to this business but given the current environment we continue to reduce the amount of our capital at risk. We have reduced the capital invested in our managed funds from $390 million at the end of last year to $184 million at the end of the third quarter of 2008. As we continue to liquidate the remaining positions in one of our closed funds, this investment should decline to about $150 million.

That said, we continue to provide whole operational and marketing support for our remaining funds and are still considering talented management teams to partner with in the asset management space.

I’d like to turn it back to Rich.

Richard Handler

The past nine months have been the most challenging period I have ever experienced in my career. We are disappointed in our overall results but remain optimistic as we start to see payout on the efforts we have taken in building out our platform. We believe the competitive landscape has never been better for our firm. We have a foundation built on our long-term capital, we are comfortable with the inventory of assets we own and our culture is strong.

Most importantly, as the health of our balance sheet and cash flow are not distractions we continue to focus on our business and our clients. Our focus is clearly to control costs and improve margins and thereby deliver long-term results for our shareholders.

As always, we appreciate your support and now we would be happy to take any questions you may have.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from William Tanona – Goldman Sachs.

William Tanona – Goldman Sachs

You guys have been pretty aggressive out there in terms of new hires, particularly on the fixed income side. Obviously we saw the announcement today and then I think last quarter we saw the announcement of you guys hiring the Greenwich team on the mortgage side. It seems like mortgage is becoming an increasing focus for you guys. I’d just like to get a sense for how was the performance within the mortgage business this quarter. Can you give us some type of contribution of that as well as the other businesses within the FIC line?

Richard Handler

We haven’t broken out by division but across the board in our fixed income business including corporate and mortgage it was an exceptional quarter and the contributions from the folks at RBS Greenwich have hit the ground contributing immediately. It has been a good turnover of the inventory. The clients are very receptive to us providing liquidity in a very tough environment. It has been a very profitable business for them to start with us.

William Tanona – Goldman Sachs

In terms of the commission revenues, you certainly saw a significant bounce back there. We know there was a lot of dislocation in the market place. How much of that do you think is just increased level of existing customer activity versus you guys gaining market share as the result of the some of the dislocation that existed?

Richard Handler

It is hard to be sure but what I can tell you is it sure feels like we are gaining market share across our sales and trading businesses. We have obviously seen extreme volatility but our clients need us more than ever. We mentioned that in the script. The reality is liquidity is key. We are a very big liquidity provider in our sales and trading businesses so we have been very active across all asset classes.

William Tanona – Goldman Sachs

In terms of the outlook, could Brian provide us some pipeline information on the investment banking side and then Rich given what has happened here since the quarter has ended if you could provide us with some highlights from the high yield and asset management business just given the volatility and the declines that we have seen across the global markets.

Brian Friedman

On the investment banking side at a time such as this where there is relatively severe dislocation and extreme chop in the market the pipeline has become a little less relevant. I think in the very short-term, i.e. the last few weeks, the capital markets have been essentially shut. I can’t even think of deals getting done. On the M&A side things do elongate a bit and take longer to close. So on the one hand we have a lot of potential and a lot of pipeline but it is very, very hard to predict at this point what is going to close and what the next period of time looks like. So it is an unusual time where you have less visibility than normal and I can’t really comment beyond saying one the one hand we have pipeline but how it is going to come out of the pipe you just don’t know.

Richard Handler

In terms of the last couple of weeks it is no secret the first two weeks of October were probably the most scary times in the financial markets for all of us just watching the volatility and obviously we are not immune to that period and the last week or so felt a lot better hopefully returning to normalcy. It has been very volatile and we are focusing on risk and paying attention minute by minute.

Operator

The next question comes from Patrick Dabit – Merrill Lynch.

Patrick Dabit – Merrill Lynch

In regards to the Lehman loss do you foresee any additional losses from that bankruptcy or do you think that is it?

Richard Handler

We wrote our potential loss down 100% for all of our exposure and hopefully we will get some money back on a trade claim down the road but [inaudible].

Patrick Dabit – Merrill Lynch

I know you have addressed this in the past but I’m just curious now that we have better visibility in terms of what the compensation pressure might be from competitors. Do you think you might have a meaningful opportunity to bring comp down in the fourth quarter?

Richard Handler

Look, the world is a different place right now. Our employees have to be paid fairly and we also have to bring the firm to profitability and we are going to work that balance to the best of our ability.

Patrick Dabit – Merrill Lynch

Just a bit of housekeeping. Could you give us an update where assets under management are and asset management and how the flows are looking there and the performance?

Richard Handler

Can you give us a call after the call? We don’t have that breakdown handy right now.

Operator

The next question comes from Steve Stelmach – FBR Capital Market.

Steve Stelmach – FBR Capital Market

I was hoping you could maybe put a finer point on the opportunities in front of you guys given the market dislocation. Is it just a matter of market share? Is it also an issue of potentially higher commission rates going forward or higher investment banking fees going forward or is it just a market share issue?

Richard Handler

Our industry has really changed over the course of the last year and if you think about us as a firm focusing on mid-size and drilling companies our biggest competitors were truly UBS, Wachovia, Lehman and Bear. Those were really the ones on a day-to-day basis that we competed with on the sales and trading side as well as the investment banking side. The fact that those firms are all in different forms and many of those forms are harder to really serve our client base I think that is a big opportunity for us to both get market share and have a marketplace that is a little bit more rational in terms of how you do investment banking transactions with incremental capital.

Bid spreads are wide right now but I think that is probably a temporary situation given the fact you see extreme volatility.

Steve Stelmach – FBR Capital Market

On the prime brokerage business I was under the impression that maybe you dialed it back a little bit in the beginning part of the year. Maybe that is the wrong impression. Can you give us the state of where that stands now? It sounds like maybe you gained some new customers in the quarter. Are you guys being more aggressive in that business? Are you sort of status quo?

Richard Handler

I think we are benefiting somewhat from mid-sized clients who want to have a platform that has a very clean balance sheet and is a trading partner they can relate to. So we are definitely picking up clients. We have got a broader number, I think it is well over 200 clients we have today, and we are adding assets but we are also making sure we are adding the right type of partners and we are ramping up the business.

Steve Stelmach – FBR Capital Market

So you are adding capabilities in prime brokerage?

Richard Handler

Yes.

Steve Stelmach – FBR Capital Market

Lastly on the mortgage side, can you give us a feel for the past couple of weeks? Are counter parties taking a wait and see attitude following TARP or have you seen buying pick up? Have you seen activity levels increase significantly after the TARP announcement?

Richard Handler

I think over the course of the last couple of weeks it is not just mortgages but specifically the first few weeks of October everyone was afraid of who they were trading with so it was a really tough environment which is why we are watching the precipice in terms of illiquidity which is why the government acted in our opinion. I believe we are going to go back to a little bit more normalcy now that a lot of our competitors are banks and are effectively back stopped to some degree. People are comfortable trading and it is not just mortgages it is across the board.

Operator

The next question comes from James [Elman] – [Foots].

James [Elman] – [Foots]

Could you comment on your outlook for becoming a bank holding company? It seems the government has been saying independent firms should become bank holding companies. How would that change your business and what sort of cost would that incur in terms of supervision and support?

Richard Handler

We don’t believe the investment banking model is broken. What we do believe is you can’t finance long-term illiquid assets with short-term financing and that is something we never did. We don’t really see any benefit to us from becoming a bank and we believe our model just has a period of normalcy with our long-term capital base and the way we finance our business and the way we are a traditional investment bank and trading corporation. We think that is completely consistent without being a bank and being a broker dealer.

James [Elman] – [Foots]

Could you comment on the share count? It seems it went up relatively quickly during the quarter. Can you tell us the reasons for that and what should we expect in terms of share count going forward?

Richard Handler

You mean our number of outstanding shares? That didn’t change. What you may be referring to is this was the first full quarter of the shares that we issued to Lucadia being outstanding and in the second quarter they were only outstanding for a partial quarter so in this quarter they came fully into the count.

James [Elman] – [Foots]

That is why they went from 165 to 173?

Richard Handler

Yes. That is the reason for the driver of the EPS denominator. Yes.

James [Elman] – [Foots]

High yield indices appear to be trading as if we were going to have a severe recession and many defaults. If that does come to pass how would that affect your business?

Richard Handler

There is no question that high yield is under siege and we haven’t really hit a default cycle or a massive slowing of the economy which is a clearly possibility going forward if not a probability. We have been through periods of time before. Our trading business will be fine. We will have mark to market dislocations over time but I think if we are good at navigating it there are a lot of wealth creating opportunities having a flexible, distressed, high yield leveraged equity cap to capital base which we expect to participate in. In addition to which we have a very strong restructuring business which will help generate banking revenues.

Operator

The next question comes from [Casey Ambrick] – Millenium.

[Casey Ambrick] – Millenium

You talked about the six year lock up you have with some of your JV partners. What year are we in on that?

Richard Handler

About 1.5 to 1.75. Right around there.

[Casey Ambrick] – Millenium

So we are about 1.5 into it?

Richard Handler

Correct.

[Casey Ambrick] – Millenium

You went over the level three assets. Can you walk us through that a little bit slower? How much is in level three this quarter and what are the marks there?

Peregrine C. de M. Broadbent

I said that the amount of level three assets we have or hold after minority interest was about $298 million. Bear in mind this is an estimate at this point. We haven’t concluded our work but that is what we are estimating that figure to be which is a slightly decline since the end of the second quarter of last year.

[Casey Ambrick] – Millenium

The mortgage book right now is $1.1 billion?

Peregrine C. de M. Broadbent

It is around $1.1 billion and I mentioned within that $1.1 billion it was only $32 million worth of assets that are classed as level three.

[Casey Ambrick] – Millenium

On the comp ratio, it is kind of picking up here because of the challenging market, is it possible the comp rate should be over 100% next quarter?

Richard Handler

We are not going to predict what the comp ratio is going to be next quarter but we will tell you we are committed to restoring profitability as quickly as possible and we are committed to being fair with our employees and we are balancing the two.

[Casey Ambrick] – Millenium

Because the company has lost money four quarters in a row now. I’m just wondering when you start really kind of cutting back on expenses and try to get more falling to the bottom line?

Richard Handler

We are currently doing that.

Operator

The next question comes from Erin Cadell – Hovde Capital.

Erin Cadell – Hovde Capital

Can you talk about the dynamics of net interest income and why the net interest income would have only been so high this quarter?

Peregrine C. de M. Broadbent

Net interest income was about $30 million this quarter and was higher than in previous quarters because of the predominately because of the growth on our fixed income, the coupon we are collecting on in things like our mortgage backed industry that we turn over very rapidly is greater than the funding costs for that particular portfolio.

Erin Cadell – Hovde Capital

So you would plan to have a consistent level of mortgage activity and that would help?

Peregrine C. de M. Broadbent

To the extent we held inventory in the order of about $1 billion yes.

Operator

The next question comes from Horst Hueniken – Thomas Wiesel Partners.

Horst Hueniken – Thomas Wiesel Partners

I’d like to get the non-compensation expenses. I have noticed that line has continued to creep up. I’m wondering whether that relates mainly to the fact you are adding staff through this period and is there any opportunity to get that going the other way.

Peregrine C. de M. Broadbent

I think the first thing to say is it has crept up as a function of one-off items. So as we said the $106 million non-compensation expenses for this quarter includes the exceptional item and the write off that we received from Lehman Brothers of $12 million. So take that into account and other exceptional items we are running at around $94 million a quarter run rate. I wouldn’t necessarily say these costs are a function of headcount as much they are a function of technology costs incurred as the result of building up our equity trading platform and other related costs to do with other build outs.

Operator

The next question comes from John Lloyd – Aetna Investment Management.

John Lloyd – Aetna Investment Management

I was wondering if you could talk a little bit about your short-term day to day funding and how you view your repo and reverse repo book strategy balancing that within the funding strategy.

Peregrine C. de M. Broadbent

Predominately our secured funding opportunities are matched probably about 90% of our secured funding opportunities operate through Match Book and most of those activities are with AA plus or above counter parties, at least 70%. Additionally, virtually all of our repo and reverse repo activities on the match side are term financing for up to four months.

Richard Handler

We also mentioned we are sitting with almost $900 million of cash on our balance sheet and average maturity of our debt of 14 years with no maturities for another…

Peregrine C. de M. Broadbent

We rely only 10% of our secured funding activities not only for repo and security lending activities to fund firm positions is really the point about mentioning the split between matched and non-matched. The vast majority of our positions can actually be funded if necessary with capital and cash we have in hand which is why we haven’t encountered the same kind of problems as some of our competitors during the last quarter.

Operator

The next question comes from Tony Della Piana – John Hancock

Tony Della Piana – John Hancock

In terms of a follow-up on that last question just to make sure I heard this, in terms of your trading inventory on your assets basically how are all those funded? Obviously you have got repo; you have your long-term debt and capital. So when you talk about that 90% number could you give us some idea is that a true matched book? I think what people learned about Lehman and Bear Stearns was that the old idea of high quality match book may have gone down the drain. I guess how much of repo is at the end of the third quarter and how much of your inventory is being financed by repo?

Richard Handler

The answer on the match book is the match book is a matched book. You are pointing to Lehman.

Tony Della Piana – John Hancock

How much of that is your inventory?

Richard Handler

The match book is not inventory. The matched book is asset owned liability both being in activity having nothing to do with funding of inventory. What he said was that 90% of our seg lending and repo activity was in our mashed book, i.e. suggesting that 10% or so was in funding. If you take our balance sheet and match off the assets and liabilities by virtue of the matched book you would see securities positions which would represent our inventory. An example being the $1.1 billion of mortgage inventory that the bulk of our inventory is funded through our equity and long-term debt. Equity and long-term debt together exceed $4 billion. Now they also obviously fund our furniture and fixtures, so not all of it is available for inventory but a large majority of the $4 billion plus is available for underpin inventory, etc. The rest is funded clearing brokers and through funding activity to the side of our matched book. We are net of that still sitting with a larger amount of cash and an extremely small amount of short-term bank drawing which is in one case is outside the U.S. and it is a historic matter, we have significant undrawn bank lines.

Tony Della Piana – John Hancock

In terms of the comp expense, just to be clear here, obviously Wall Street is telling its folks there is going to be no bonus this year. In that comp number we see obviously you have hired new people but is there any sort of bonus allocation in the nine month numbers or guaranteed contract type things that could be important or is that really just at this point basic salary or maybe a further explanation would be what are the metrics that determine employee bonuses?

Richard Handler

I think the things to note, people may use the words no bonus. We are not aware of any of these firms truly saying no bonus to no one. Our expectation is that there will be bonuses paid in the industry to those deserve and obviously we are not going to determine what other people do but we know at Jefferies we will be attempting to pay people fairly for their role in light of firm results, in light of industry standards, in light of all of the relevant factors. Our compensation number that you see there includes a number of things. It includes salaries and payments made on a regular basis to employees. It also includes amortization of previously issued stock and for the quarter that was probably abut $40 million. It also includes an estimate of what we expect the year-end bonuses to be and there will be year-end bonuses and we take a portion of that on a quarterly basis. Number one, not all the comp expense is cash. Some of it is amortization of past stock issue. Two, a portion of it has not yet been paid out but it is being accrued with the year-end payment. Everyone I think in our industry has indicated that in the fourth quarter they will be taking a realistic further look and as you probably appreciate you are constantly making estimates each quarter it is our best estimate of what we think needs to be accrued but only at year-end will it finally be trued up. Every year in our fourth quarter we have always indicated there is a true up and it can go a little bit one way or the other from expectations.

I guess the last thing I would note and you could always take different mathematical looks at it but if you were to add back our high yield losses which is recognized losses, it is not realized losses but it is recognized losses, if you add it back to the revenue and divide the comp by that the ratio you get is I believe about 73% as opposed to the 90%. I think those are two numbers Peg mentioned. The comp can be looked at in a number of different ways. It is a very complex equation and it is a very complex year-end exercise yet to come.

Tony Della Piana – John Hancock

Do you think in terms of bonuses that once again I don’t know what level you are accruing at versus previous years, but in terms of metrics is it simply a profitability return on equity with some adjustments or is it very subjective in every sense of the word in terms of whatever you guys think an employees value is for the firm?

Richard Handler

I don’t think anyone is walking along the hallways at Jefferies expecting to get paid more this year than last year. In fact I think everyone is thankful to have a seat at this table given this snapshot in time. That being said we are paid for performance and we will go through individual by individual and pay them fairly but appropriately and go through the process as we always do. We understand the desire for profitability. We also have to balance that with the fact we want to keep our platform intact and it hasn’t been really worthwhile to take advantage of it when the dust remotely settles. We are keenly focused on it. We understand your point exactly.

Tony Della Piana – John Hancock

So if the fourth quarter is weak there may actually be a realization that we approved this for the year, things didn’t change and we have to make some adjustments so you could see a surprise lower number in the fourth quarter if results continue to be weak in the whole industry?

Richard Handler

Yes.

Operator

The next question comes from Ryan O’Connell – Citigroup.

Ryan O’Connell – Citigroup

On the components of minority interest, you mentioned that the high yield negative revenue of $61 million are offset by and I missed the dollar figure, but the dollar amount of minority interest but I wanted to try and remember how that works.

Peregrine C. de M. Broadbent

The figure I mentioned was $40 million. So we consolidate the whole of our Jefferies high yield trading results into our revenues which for this quarter was a $60 million loss but then we share that loss plus share some of the expenses that support that business with some of our partners in that business. So in aggregate we shared of that $60 million loss we actually had a credit or positive number of $40 million which is the give off from some of those losses and a give off of some of our expenses to our joint venture partners.

Ryan O’Connell – Citigroup

So the net impact on Jefferies itself is a 21?

Peregrine C. de M. Broadbent

Correct. 21 plus the expenses.

Ryan O’Connell – Citigroup

If we look at minority interest overall for the firm that was about negative 40. I’m just trying to figure out what the different components are.

Peregrine C. de M. Broadbent

Predominately just think of the minority interest as the share of net profitability associated with Jefferies high yield trading. There are some other components with other joint venture businesses but they are negligible. So think of that credit or that $40 million positive as predominately the impact of giving up loss costs associated with Jefferies high yield trading to our joint venture partners.

Ryan O’Connell – Citigroup

But on the income statement itself you have got revenues and then the minority interest of a negative $40. I was just trying to figure out how that interplays with the rest of it. I’m trying to relate the results of the firm, like the 40.

Peregrine C. de M. Broadbent

The size invention is a little confusing. That is actually the negative indicator or the bracketed number is actually a credit to our income statement.

Ryan O’Connell – Citigroup

Right but what I was trying to figure out was the relationship between that and the results quarter-over-quarter which was about 66% this quarter and 47% last quarter and 57% in the first quarter. I’m just trying to figure out the relationship here.

Peregrine C. de M. Broadbent

It is driven by expenses. It is also driven by the fact when the charge to our joint venture activities offset that were. There are different percentages of splits and revenues depending on what those revenues are.

Richard Handler

It is not linear to the revenue number. The minority interest is made up of several components, the largest of which is linear to the revenue but the other components are not linear to the revenue and don’t necessarily relate to the revenue. They relate to the costs or other items.

Operator

The next question comes from Michael Lipper – Lipper Advisory Services.

Michael Lipper – Lipper Advisory Services

You are experiencing both the various problems in the domestic market plus an aggressive built out of your European position. Can you give us some clue how much of the investment you may consider that losses is a factor of the European expansion and is there a level of investment that you think will top out on your European expansion?

Richard Handler

The significant investment we have made in Europe has been our addition of roughly 30 people from Bear Sterns in the equity sales and trading platform. While that was an investment we believe the pay back from that investment will be relatively quick as the day trading business with existing relationships and existing flow. The other build outs we had were years ago where we had acquired several M&A boutiques which were done at very modest multiples of EBITDA and integrated into the platform. I don’t think it is correct to say we are heavily investing in our European business with the exception of the recent hires from Bear Stearns.

Michael Lipper – Lipper Advisory Services

Does the hiring from Bear Stearns complete your needs?

Richard Handler

For now it is complete. It was a self contained group that was very successful in working together and we are very pleased to have them and beginning to integrate them into our overall trading platform.

Operator

There are no further questions at this time.

Richard Handler

Let me close by saying we are open for business and we are focused on our clients.

Operator

Ladies and gentlemen this concludes today’s conference. You may now disconnect.

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Source: Jefferies Group, Inc. Q3 2008 Earnings Call Transcript
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