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Executives

Richard Handler – Chairman, President and CEO

Peg Broadbent – CFO and EVP

Brian Friedman – Chairman

Analysts

Steve Stelmach – FBR Capital Markets

Daniel Harris – Goldman Sachs

Bradley Kelly – Magnum Financial

Chris Kotowski – Oppenheimer

Thomas Hiley [ph] – Pali Capital [ph]

Michael Hecht – JMP Securities

Lauren Smith – KBW

Karan Ahuja [ph] – Eminence Capital [ph]

Casey Ambrich – Millennium

David Trone – Fox-Pitt Kelton

Jefferies Group, Inc. (JEF) Q3 2009 Earnings Call Transcript October 20, 2009 9:00 AM ET

Operator

Welcome to the Jefferies’ 2009 third quarter financial results conference call. A question-and-answer period will follow management's prepared remarks. (Operator instructions). As a reminder, this conference call is being recorded. A press release containing Jefferies’ 2009 third quarter financial results was distributed via Business Wire before the market opened today and can be accessed at the Jefferies’ website, www.jefferies.com.

Some of the comments may contain 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 facts and represent only Jefferies’ belief as to future performance. They usually include the words continue, will, believe, should or other similar expressions.

Actual results could differ materially from those projected in these forward-looking statements. Please refer to Jefferies’ Annual Report on the Form 10-K filed by the Securities and Exchange Commission on February 27th, 2009 and in Jefferies’ Form 10-Qs and 8-Ks for discussion of important factors that could cause actual results to differ materially from those projected in these forward-looking statements.

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

Richard Handler

Good morning and thank you for joining Jefferies’ third quarter earnings discussion. I’m 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.

For the quarter ended September 30th, 2009, we were pleased to announce record net revenues of $700 million, record net income to common shareholders of $86 million, and earnings per share of $0.42, which matches our all-time record. Peg will take you through the details of our results in a moment.

We are pleased with our third quarter performance and the momentum we have developed in 2009. Our results benefited from the increased breadth and depth of our trading platform and – and the impact of some exceptional trading opportunities, as well as a rebound in market value, both of which are reflected in our fixed income and high-yield results.

For the more than two years since our results peaked in mid-2007 and the financial crisis developed and enveloped the entire system, all of us at Jefferies have worked hard, first, to preserve our platform and second, to take advantage of the dislocations and dramatically improve our market position.

Our results in 2009 validate our strategy and illustrate the long-term potential we envision. Our enlarged fixed income trading platform is clearly establishing a solid long-term position. As I will mention in a moment, we are now focused on globalizing this effort. Our equities effort has had key accounts is making progress to our objectives with particular progress in our electronic trading and prime brokerage offering.

Our investment banking business has clearly rebounded from the extreme bottom of Q1 2009 and has ever been stronger, more diversified, or more capable of serving our clients. Our capital markets business is beginning to regain traction and we are pleased to be able to achieve these quarterly results so early in the refinancing cycle and just have begun to see revival of mergers and acquisitions.

Again, please note that our third quarter fixed income and high-yield revenues benefited from several exceptional trading opportunities, as well as the recovery of market values. We historically have seen opportunities such as these in various of our product areas on a periodic basis, but we cannot predict whether or when they will recur. We do believe the continued diversification of our platform increases the possibility of these opportunities arising.

Consistent with our past practice, we offer no guidance regarding future results and as we’ve done in the past, we caution that our Q3 results should be viewed in light of this information.

During the quarter, we continued building our global sales and trading platform by mirroring some of the recent expansion activities at our domestically based businesses through additions to our team in Europe.

As we announced yesterday, we have established a European government bond sales and trading business by hiring 18 Eurobond professionals. Earlier in Q3, we added senior leadership to help drive the growth of our high-grade and high-yield sales and trading in Europe. Most recently, we have also established a London base complement to our global private wealth management business. We expect our new and expanded international businesses to be up and running shortly and to make a growing contribution to our results in 2010 and beyond.

Toward the end of the third quarter, we further enhanced our liquidity and long-term capital base by reopening the 10-year note we issued in June to raise a further $300 million. The proceeds from this issuance were included in our cash balance, which exceed $1.4 billion at quarter-end. We continue to have zero bank debt drawn and the weighted average life of our long-term debt is 12.7 years.

As had been our custom, we raise permanent capital when there is no urgent need for it and we do our best to use it cautiously and prudently for the long-term expansion of our firm.

Now, I’d like to turn it over to Peg.

Peg Broadbent

Thank you, Rich. As Rich mentioned, our net revenues for the quarter were $700 million, which is a 155% increase compared to the $275 million generated in the third quarter of 2008 and a 19% increase from the $590 million of net revenues we recorded in the second quarter of 2009.

Equities net revenues were $149 million for the quarter versus $135 million for the third quarter last year and $130 million for the second quarter of 2009. Our fixed income and commodities net revenues of $313 million are more than three times greater than the comparable quarter a year ago, and both a record as well as a 13% increase over the previous record set in the second quarter of 2009.

High yield net revenues were $95 million, an increase of 56% over the $61 million recorded in the second quarter this year and a considerable increase over the third quarter of last year, which was a loss of $60 million. Investment banking revenues were $123 million in the third quarter, virtually flat when compared to the comparable quarter last year and the second quarter of 2009.

Capital markets revenues were $79 million for the quarter and advisory revenues were $44 million. Asset management revenues for the quarter were $21 million compared to a loss of $3 million in the third quarter of 2008 and just above flat for the second quarter of this year.

Non-compensation expenses were $107 million for Q3, approximately the same as the $106 million and the $107 million reported in the third quarter of 2008 and the second quarter of 2009, respectively. Compensation expense for the quarter was $395 million or 56% of net revenues.

Earnings per common share were $0.42 as compared to a loss of $0.18 from the comparable quarter last year and a positive $0.30 last quarter. During the quarter, we repurchased 3.5 million shares at an average price of $23.10 per share. Book value per share was $12.66 at quarter-end based on 169 million shares outstanding. Our adjusted book value per common share was $10.91 based on 197 million shares outstanding including restricted stock units.

We estimate our gross and adjusted assets to total equity leverage ratios are still low on a relative and absolute basis at 11.3 times and 8.4 times respectively. Modest increases in these ratios since the end of the second quarter were driven by increases in highly liquid and price transparent fixed income inventories as our sales and trading businesses continue to expand by customer footprint. Both of these ratios are well below our historical peaks before the market panicked.

We estimate our Level 3 assets after accounting for non-economic interests were $464 million at the end of the third quarter of 2009 or approximately 5% of our total assets at fair value. We estimate our average VaR for the quarter was approximately $7.4 million compared to $6.2 million for the second quarter of 2009 and to our peak average operating VaR level of $9.5 million set during the fourth quarter of 2007.

We ended the quarter with 2,513 employees, a net increase of 206 people since the end of the second quarter of 2009 and versus about 2,550 at our peak on the 1st of January, 2008. This increase is driven by the build-out of our health care investment banking sector team, as well as our global fixed income rates business. It also includes additional support staff we have hired to support our growing sales and trading platform.

Rich will now address in more detail our sales and trading results.

Richard Handler

Thanks, Peg. Primarily for the facilitation and execution of strong client flow, our diversified fixed income business performed extremely well in Q3. We believe we continue to increase the market share in high-grade corporate bonds, mortgage and asset-backed securities, emerging market securities, municipals and rates.

As Peg mentioned, our high-yield revenues were $95 million, stronger than both last quarter and the third quarter of 2008. This is primarily a result of strong market conditions and our expansion and focus on gaining market share in high-yield and bank loan customer facilitation execution, as well as a rebound in market value.

Our equities revenues were $149 million for the third quarter, up 15% from the second quarter and up 11% from the third quarter of last year. Our commissions are still below prior year due to a combination of lower average price of securities trades and overall reduced market activity.

Now, I’d like to turn it over to Brian, who will discuss our investment banking results.

Brian Friedman

Thanks, Rich. As Peg indicated, investment banking revenues were $123 million for Q3, comparable to both the second quarter of 2009 and the third quarter of 2008. Capital markets revenues of $79 million in the third quarter were comparable to the $84 million reported in the second quarter and up 55% from the third quarter of 2008. Please note that capital markets revenues in 2009 also include primary fixed income related revenues, driven by our new mortgage-backed and public finance businesses. Advisory revenues were $44 million in the third quarter versus $37 million for last quarter, but lower than the $79 million we recorded in the same quarter last year.

The capital markets environment has improved compared to Q3 2008, which has resulted in a significantly stronger debt capital markets performance for Jefferies. The flow of public equity transactions for us was consistent to Q3 2008 in aggregate, although the market strengthened as Q3 progressed.

During the quarter, we completed 39 deals, of which 29 were lead managed by Jefferies. In contrast to the improving capital markets flow however, M&A and fund placement revenues were markedly down from Q3 2008. This is a reflection of the slowdown in strategic and financial sponsor activity in the first half of 2009. Deal activity is however picking up and we expect improved advisory revenues over time. Consistent with the environment, our restructuring advisory revenues continue to grow.

Our asset management revenues of $21 million are a significant improvement over recent periods. This was driven by excellent results in our global convertible bond asset management business, as well as by the results of our two hedge funds, which focus on financial services and technology respectively. Our investment in asset management funds is substantially unchanged from what was reported at the end of the second quarter.

Now, Rich has some final comments before we take your questions.

Richard Handler

Thanks, Brian. We are pleased with the trajectory, competitive position, increased diversification, and overall positive energy that is permeating Jefferies today. Our focused strategy has allowed Jefferies to emerge as a much stronger firm and has never been better positioned to serve our clients. The markets have stabilized, our balance sheet and liquidity have never been stronger, and we couldn’t be more pleased with the talent and commitment of our 2,513 employee partners.

Today, our plan is about execution and integration and to do our best to increase our market share and better serve an ever-increasing client base. We are committed every day to do our best for our clients, shareholders, employee partners, and bondholders.

We are now available for questions.

Question-and-Answer Session

Operator

(Operator instructions). One moment please for the first question. There are no questions at this time. Please continue with your presentation.

Richard Handler

Well, that was easy. Okay, as – operator, are you sure there are no questions?

Operator

Yes, sir. There are no questions on the phone lines at the moment.

Richard Handler

Are you sure the system is working?

Operator

Positive, sir.

Richard Handler

It can’t be right. I mean, I’m happy, but it can’t be right. Are you checking it, operator?

Operator

Yes, sir. There are no questions at the moment.

Richard Handler

How are questions to be registered?

Operator

By pressing one, four on the telephone keypad.

Richard Handler

We are going to check you right now to see if it’s working. Hold on one second. You’re on? We have someone internal here trying to ask a question by dialing one, four and they can’t get through your system, operator.

Operator

One moment please.

Brian Friedman

Operator, are you able to fix this, because it’s clear to us that we are getting notes from people who are looking to ask questions. We don’t want to foreclose that. Operator?

Operator

Yes, sir. I do see two questions registered at the moment.

Brian Friedman

Okay. Why don't you take the first one and then please work on your system because, again, we are getting notes about questions.

Operator

And the first question is coming from the line of Steve Stelmach with the affiliates in FBR Capital Markets. Please proceed with your question.

Steve Stelmach – FBR Capital Markets

Hi, guys.

Richard Handler

Hi.

Steve Stelmach – FBR Capital Markets

Aside from the Q&A, it’s a pretty good quarter. The – on the high yields or the fixed income, you mentioned you had some – it sounded like you need trading opportunities in the quarter. Can you just give us a little more color around that, maybe to the extent you can quantify the impact?

Richard Handler

Right. We are not going to be able to quantify specifically similar to what we’ve done in historical quarters when we feel like we’ve had exceptional opportunities, but what we will say is given the fact that third quarter is generally our seasonally slow quarter and second quarter was a rather solid quarter for us, if you exclude some of these items, we still had a very strong performance in the third quarter, probably exceeding the results in the second quarter. We just don't want people to start extrapolating and setting the bar unrealistically high. That being said, we think our platform is very well diversified and we have hopefully an increased number of opportunities going forward.

Steve Stelmach – FBR Capital Markets

Got it. Okay. And then, can you just quantify the impact of the debt offering in the summer? Was that helpful in terms of infiltrating business, putting more capital at work or was it just better market conditions that helped the quarter?

Peg Broadbent

The additional capital really did not have an effect because we have a large cash balance and the vast majority of our trading is customer facilitation. What we did was consistent with what we did – with our belief in the middle of this decade, you want to raise long-term capital to run your business, you want to do it when the markets are healthy and spreads are relatively tight and rates are low. You want to do it when you really don't need it, but you can use that as a foundation to build your company in periods – in the future. That’s what we did during the summer as well.

We saw a good opportunity, a good window, we raised long-term capital, and our goal is to use that to continue to grow our company in the future. Remember, the financial markets were closed as recently as end of March, early April this year. They do close and we want to make sure we have a growth capital.

Steve Stelmach – FBR Capital Markets

Okay. That makes sense. And then obviously you guys are doing a lot of other right things. You had a phenomenal first three quarters. How do you think about your business going forward? Is it based solely on organic growth, is there acquisition opportunities or is there ever an issue where you need to be bigger, you need to get more scale and you need to be part of somebody else? Any thoughts on that longer term?

Brian Friedman

There is a package of questions in that. I think we can take them one at a time. When we look at our current operating businesses, we see potential upside in our trading platforms as we continue to integrate people we’ve added in businesses that we started over the last number of periods. As Rich mentioned before, the opportunity in Europe for us in raising fixed income generally is meaningful. So we see a lot of inherent growth in the platform that we’ve already developed and are developing.

Secondly, similar to what we saw over the last 12 months, there continue to be individuals and – talented individuals, as well as groups of individuals that are displaced from other firms or otherwise available to us who can be additive either to businesses we have or adjacent businesses that we might want to enter.

Lastly, we do have obviously a reasonable cash holding and a strong capital base. We do, from time to time, consider outside opportunities. We don't comment on what we might or might not be doing, but we are always looking at ways to grow. So I’d say we believe we can grow internally from things that we’ve already done and have at process and we continue to look at additional ways to accelerate the growth.

Steve Stelmach – FBR Capital Markets

Okay. But then in terms of scale, you feel that your scale is sufficient to compete with anybody? You don't need to be –

Brian Friedman

As you said, we would suggest that the results of the third quarter, as well as the nine months support our strategy. We strongly believe that there is a position in the market for an independent, not-government finance broker-dealer, traditional Wall Street model and we think our results are proving that very clearly.

Steve Stelmach – FBR Capital Markets

Agreed. Thanks very much, guys.

Operator

And our next question is coming from the line of Daniel Harris with the affiliates in Goldman Sachs. Please proceed with your question.

Daniel Harris – Goldman Sachs

Hi guys, good morning. Thanks for getting the questions working for us.

Richard Handler

No problem.

Daniel Harris – Goldman Sachs

Can you talk a little bit about the returns you’ve seen from that health care team that you bought on both in terms of the advisory business, which I think is clear to some of us as we look at the public data, but also on the issuance side whether that’s equity or debt?

Brian Friedman

If you look back about two weeks ago, we ran a full page ad in Wall Street Journal and it had in it a series of tombstones, all attributed to the health care group. The health care group joined us from July through September. So we effectively had about in average of about half a quarter of actual work time from the new group. That being said, they impacted the revenue already in the third quarter, which is an exceptional performance. We are very confident of the overall potential of the group.

Very specifically, health care is one of the strong bastions of capital markets activity, tends to be less cyclical than a number of other sectors, and has a particularly strong presence in the equity capital markets. So we’ve had good performance already from the group in both debt capital markets and equity and we believe the health care effort will be part of leading our overall capital markets effort to the next level.

Daniel Harris – Goldman Sachs

Great. Thanks a lot. Trying to shift gears here to the headcount numbers that you guys put out today. So you are not quite there yet, but you are approaching your recent highs and while it certainly seems like your results are showing all the benefits of that, I’m just wondering how do you think about the opportunity for growth from here, but offset by – how long it takes to get people up to speed? And I guess just generally, the significant changes that have happened over the term of the last 18 months. So again, I guess just briefly, can you expand rapidly from here or does it take time to digest what you’ve gotten before may be getting more on the normal growth pattern at some point next year or two?

Richard Handler

I think the best time to expand and bring in talented people is when the world is in disarray and we had unfortunately a very long window when the world was in disarray and because our house was in order, we were able to capitalize on it and really ramp up some very proven and high quality revenue producers. That being said, the world is no longer in disarray and there is – there is a much more healthy competition for talent.

So I think the quick ramp-ups that we had to – and I would point out we are still below our historical levels, but the ramp-up we’ve had, that window is pretty much shut right now except for specific add-ons to our existing teams. So I think you’ll see us integrate and execute as opposed to having high hiring, but at the same time we are opportunistic and if things do develop, we will take advantage of it.

Daniel Harris – Goldman Sachs

Okay, that’s helpful. And then just sort of on the same topic, so the comp ratio, you guys had targeted 60% for the year and clearly coming in below that. I mean, is there any reason to think that over the next few years you wouldn't get back to the numbers that you had put up a few years, but down in the low-50s in that 53%, 54% range or can we still be thinking that 60% is your baseline and then from there, it depends on the year?

Peg Broadbent

I think we picked 60% because 2008 was such an impossible-to-predict year and we chose to basically compensate our people fairly and keep our platform in tact as opposed to having them leave the firm. So – because our comp ratio was so far out of whack, we picked 60% as a number and when we improve ourselves, we can operate the company back in, but the mentality of the organization to bring in operating leverage and create earnings per share, proper return on equity is the same today as it was in the middle part of the decade, and I think as we continue to integrate and grow and gain market share, you’ll see us starting to climb down again.

Daniel Harris – Goldman Sachs

Okay. Thanks a lot, guys. Great quarter.

Peg Broadbent

Thank you.

Operator

And our next question is coming from the line of Bradley Kelly with Magnum Financial. Please proceed.

Bradley Kelly – Magnum Financial

Hey, good morning, guys.

Brian Friedman

Good morning.

Bradley Kelly – Magnum Financial

So looking at your mix, the Americas, Europe, Asia and Middle East, can you guys give us a sense of – in terms of growth for the future what are some of those markets outside of the U.S. that are – you guys see really nice opportunities in?

Brian Friedman

Well, if you look at the current moment and Rich mentioned the announcement yesterday on euro rates, the addition we made over the summer to strengthen the leadership of our overall corporate and high yield business in Europe. It’s clear that from our London international headquarters with a heavy emphasis on Europe, but also with some flow out of Asia, we are looking we hope at some meaningful growth. Priorities are clearly Europe and then beyond that certain portions of Asia, we have a good presence and growing presence in India. Those would be our priorities for now.

Bradley Kelly – Magnum Financial

Okay, I appreciate it.

Richard Handler

Thank you.

Operator

And our next question is coming from the line of Chris Kotowski with Oppenheimer. Please proceed.

Chris Kotowski – Oppenheimer

Hi, a couple of questions. First of all, I’m just – you are kind of in a unique space between the boutiques that never run any balance sheet positions and have tens of millions of fixed income revenues and the bulge bracket that has billions of a quarter fixed income revenues and runs 20 or 20 plus kinds of leverage ratios. And I’m just wondering, to grow from this level of base, do you think you need to increase your leverage ratios up to that 15, 20 range as well?

Richard Handler

I think the way you are going to see us continue to grow is primarily through market share in facilitation versus in our balance sheet and the good news for us is that there are – the markets that we are participating in are still large and historically we weren’t able to hire the talents that had been in these businesses, but the marketplaces are still large that small amounts of market share really move the dial for a company our size, but I think you’ll see us continue to do what we’ve been doing, add on additional talent selectively, get additional market share, and in fact, our – there aren’t – competitively, there aren’t that many players capable of doing what we are doing and the clients do want choices when they are managing their funds. So our clients are encouraging us by giving us market share because they don't – there are a couple of – there are a handful of very high quality firms out there, but people want alternatives to those high quality firms.

Chris Kotowski – Oppenheimer

All right, okay. And so in other words, you don't see a need to take your balance sheet ratios up to what the bulge typically do over the next year?

Richard Handler

I mean, we don't. We don't – we think the historical, we are not in a position to – we don't believe our size company should have – we don't think any size company should have the kind of leverage that some of the financial institutions had over the last part of the cycle and we certainly don't believe it is warranted for our business.

Chris Kotowski – Oppenheimer

Okay. And I just heard of a hypothetical question. I mean, if – let’s just assume your comp levels are roughly at the current rate and just annualize what you have for the nine months. Given that assumption, could you give us an idea of how much your share count next year would go up versus this year?

Peg Broadbent

We don't forecast or speculate and changes in share count are influenced by a number of factors that are in the future. So we really can’t comment on that.

Chris Kotowski – Oppenheimer

Even with the qualifier of annualizing the nine months?

Richard Handler

All I’d say is we are cognizant to protect dilution of the company, but we’ll also operate the best manner for long-term growth.

Chris Kotowski – Oppenheimer

Okay, fair enough. Thank you.

Operator

And our next question is coming from the line of Thomas Hiley [ph] with Pali Capital [ph]. Please proceed with your question.

Thomas Hiley – Pali Capital

No, my question was answered. Thank you.

Operator

And the next question is coming from the line of Michael Hecht with JMP Securities. Please proceed.

Michael Hecht – JMP Securities

Hey guys, good morning.

Richard Handler

Good morning.

Michael Hecht – JMP Securities

So the globalization that you guys talked about in your remarks on the fixed income side, sounds like it could be kind of 2010. So can you help us out with I guess the total contribution – I guess across your business from non-U.S. in the quarter and maybe what if any kind of having fixed income today so we can have a starting point?

Peg Broadbent

In terms of revenue streams, domestic and international is about 90%, 10% respectively. Maybe 10% to 12% of the revenues were international, that sort of order of magnitude. That’s across our whole business. It’s fair to say that the growth in strength for the last year has been higher in the U.S. than outside of the U.S. Europe does tend to lag. What’s going to happen now is Europe will start to – we expect catch up a bit in terms of cyclical momentum and our emphasis on growth there is going to be meaningful.

We operate there – historically, we’ve been operating for the last several years a high yield platform that has had good performance and it’s part of our high yield results, but growing that out now to include high-grade corporates – we also have today an emerging markets business there. Adding the high-grade corporates business, as well as the rates business will be a significant expansion. We also are continuing to drive our investment banking and as you may recall, we added a meaningful team in international equities last year and we continue to see upside there.

So when we look across the group and I guess one other thing is we have the mortgages business that is continuing to grow in Europe. So Europe is likely to grow next year or international generally is likely to grow next year at a faster rate than the overall growth rate of the firm. So it will be a contributor to our upside.

Michael Hecht – JMP Securities

Okay, that makes sense. That’s helpful, thank you. And then I think the broad success you guys are having at fixed income certainly has more to do with the build-out and capabilities you’ve been adding. Can you help us with any impact you think primary dealers have in your business and do you see this driving further upside and I guess also more broadly, can you talk just a little bit about the competitive environment you are seeing in various fixed income areas, rates, MBS, ABS, do you have – whether you are seeing any evidence of trading spreads narrowing and what your outlook is there?

Brian Friedman

Well, gaining the primary dealer status clearly helps strengthen our participation in government and agency bond work and so that business is developing, it’s definitely not mature. Moreover, the addition of the euro rates business will give further leverage to the U.S. rates business. So the combined business has, in our view, meaningful growth potential into next year and beyond.

If you look at our overall fixed income business, our corporate business has come on obviously very strong over the last year to two years. Our mortgage business really took on a whole another level middle of last year and blossomed this year. Again, Europe is a relatively new area for the mortgage business for us. There will be growth there also next year, meaningful growth we expect.

On the emerging markets business, we particularly added sales people last year that further drove our growth this year. We think there is more potential to that business that’s operating both out of New York and London. And lastly, as you may recall, only six months ago we added the public finance business that we absorbed from a hypo, DEPFA and that particularly has growth potential not just in trading, but also as we use our greater platform to help support them in the origination business, potentially investment banking for public finance.

Michael Hecht – JMP Securities

Okay, fair enough. Thanks. And then on the high yield side, can you give us a little bit of sense I guess of how much revenues were kind of marks or mark-ups on like some of the high-yield inventory versus kind of secondary trading or flow business and maybe how much was realized versus unrealized?

Peg Broadbent

I think the flow business is really what drove the results, but at the same time we did have some of the mark-to-markets that we had at the downturn in 2008. We were – we got to the lockup nature of our fund, we were able to basically hold on to those securities. We’ve had some realizations up to the most part, we still like our position.

Michael Hecht – JMP Securities

Okay, that’s fair. And Rich, do you mind sharing a little bit your kind of outlook on the high yield side, just kind of state of the market where you think some of the challenges and opportunities are?

Richard Handler

It seems like things are awfully tight again very quickly and you are seeing the beginnings of people requesting dividend transactions and bank debt covenant like transactions and it just surprises me how quickly the cycle seem to go these days. So I think some of the easy money in the higher markets has been made over the course of the nine months this year and I think it’s not super frosty, but I think default rates are going to stay relatively low because the refinancing cycle is still readily available, but I think it – it’s fairly dangerous right now to be going back into the suit so quickly after where we were.

Michael Hecht – JMP Securities

Okay, that’s helpful. Thanks and just this last one from me and I’ll get back in queue. Total equity is up 15% quarter-over-quarter despite commissions being down about 8% this quarter, which I’m guessing is just mostly seasonal. Can you give us more color on the strength in equities outside of the cash business, where that’s coming from?

Peg Broadbent

I think – we put a bunch of investments into our equity department over the course of the last several years from our algo team to our research to our prime brokerage to just the traders that we have on the desk in terms of their ability to make market. I think given how challenging the equity markets have been and how volatile it is, I think we are pretty well positioned but absolute commissions are still compressed relative to where they were. The summer was on top of it, but we feel like we are making progress there.

Michael Hecht – JMP Securities

Okay, great. Thanks. Congratulations on a good quarter, guys.

Peg Broadbent

Thank you.

Operator

And our next question is coming from the line of Lauren Smith with KBW. Please proceed with your question.

Lauren Smith – KBW

Hi, good morning.

Richard Handler

Good morning.

Lauren Smith – KBW

I’m going to have to replace the one and four key on my phone, I think. Just a follow-up on Michael’s question on equities. Would you characterize – were there any exceptional trading opportunities in equities or any meaningful block trades in the quarter or is it, to your earlier comments, just a combination of prime brokerage gathering momentum, algo, et cetera?

Peg Broadbent

No. We kind of tried to highlight when there were exceptional opportunities. It was nothing that really stood out dramatically, it was one ordinary business.

Lauren Smith – KBW

Okay. Okay, great. And in terms of the progression of the quarter, July, August, September, I guess really for those equities and on the fixed income side, broadly speaking, was there any one month that’s particularly outsized or with flow pretty good over the course of the quarter?

Peg Broadbent

I’ll tell you, we’ll take the summer with those – the way the three months worked this year, we’ll take those three months any summer. They were all very solid.

Lauren Smith – KBW

Okay. And then given your dramatic return to profitability, any thoughts on the demand?

Peg Broadbent

I think it’s probably a topic our Board will think about after the end of this year. It’s probably the right way to think about it.

Lauren Smith – KBW

Okay. And I guess last one for me. With respect to share repurchase, I think you said 3.5 million in the quarter. So does that leave, if my math is right, something between 11 million and 12 million remaining on your current authorization?

Brian Friedman

I think it’s actually a little less than that since we repurchased some shares at the beginning of the year. So I think it’s less than 10 million is left on the authorization.

Lauren Smith – KBW

Okay, great. And I guess – actually, just one more for me. Back to the leverage question, looking back I guess if my numbers are right, in 2007 you actually creeped up, leverage got as high as I think on a growth basis like 18 or thereabout. Clearly, market has changed a lot since 2007, but your business mix has also broadened and changed. So I mean it wouldn't be unreasonable for you guys to get back to sort of those high-teen levels, right?

Peg Broadbent

We are fully committed to constantly try to improve our rating with the agencies. We just got off negative line from S&P, which we are very pleased with. We are very mindful of our overall leverage ratios and we don't believe you have to really lever up your balance sheet to generate solid shareholder returns. So that being said, we see some creep-up in our balance sheet as we are – our equity base expands and as we diversify our business, yes. Are we going to get anywhere near levels that we find imprudent? The answer is no.

Lauren Smith – KBW

Okay, thanks a lot and congrats on a good quarter.

Peg Broadbent

Thank you.

Operator

And our next question is coming from the line of Karan Ahuja [ph] with Eminence Capital [ph]. Please proceed.

Karan Ahuja – Eminence Capital

Hey guys, terrific quarter.

Brian Friedman

Thank you.

Karan Ahuja – Eminence Capital

Just had a couple of questions. One would be just on the point of revenue per employee. Is that a metric that you think is important to look at for you guys because clearly versus where you were in the past, you are doing a lot better? If I compare you to well, maybe a Bear or Lehman was doing in the past, you are better than them too. So is it something that matters or you kind of just say, “It’s not really that relevant for how we manage our business”?

Brian Friedman

Yes, we don’t get up in the morning thinking about that metric, but there is no question that it is a way to see productivity which means that you are getting leverage on your overhead and you are getting a good measure of frontline production. So it’s clearly a way to measure efficiency of our capital – human capital utilization and it shows the direction of the business, yes.

Karan Ahuja – Eminence Capital

Got you, okay. And then just one other quick question. I know you talked about your leverage and I know obviously you are going to measure equity and things in various ways. Could you give us the dollar amount of your assets right now, just a rough estimate of where they closed the quarter?

Peg Broadbent

Total assets were roughly around $28 billion at the end of the third quarter.

Karan Ahuja – Eminence Capital

Terrific. Thanks so much.

Peg Broadbent

Thank you.

Operator

And our next question is coming from the line of Casey Ambrich with Millennium. Please proceed.

Casey Ambrich – Millennium

Hi, thanks very much for hosting the call and taking the questions. I missed it, what is the size of the balance sheet at quarter-end?

Peg Broadbent

I could just say it’s around $28 billion.

Casey Ambrich – Millennium

$28 billion? Okay. And what was the size of the MBS book, it’s $2.7 billion at the end of 2Q ’09, what is it now?

Peg Broadbent

It’s a little hardened [ph], we are estimating around sort of $3 billion, $3.2 billion.

Casey Ambrich – Millennium

$3.2 billion –

Peg Broadbent

I got that before -- the increase is that inventories are all in – we still hold the same sort of percentage of liquid assets of mortgage assets and so forth and more than 90% of that 3.2 billion is liquid relatively easy to price and finance inventory.

Casey Ambrich – Millennium

Sure. And how big is the high-yield assets? How many assets, because I don't see the assets on your earnings release, how big is the high yield assets portfolio now?

Peg Broadbent

We never disclose that number. It is a subset of our corporate debt inventory.

Richard Handler

We didn't put in the release, because it will all be in our 10-Q.

Casey Ambrich – Millennium

Okay. And then just can you just go over again how you guys fund your balance sheet because it looks like the cash is relatively flat, your cash holdings, so just generally how do you think in terms of funding your balance sheet when you grow this quickly?

Peg Broadbent

We fund our balance sheet mostly through secured funding activities, so most of what I said on the mortgage side, most of the mortgage product, indeed all our inventory is easy to fund in the secured financing market, sec lending, sec borrowing or repo, to the extent it is not, then we deploy some of our capital to fund our positions.

Casey Ambrich – Millennium

All right. So this seven shows short funding through? Because these assets are generally liquid?

Peg Broadbent

These assets are very liquid. We on average I believe our secured funding activities on average extend up to 2 to 3 months.

Casey Ambrich – Millennium

Okay. And then maybe Rich, maybe you can just give us – yes.

Richard Handler

You have to understand is, our level III assets are roughly 5%. Our debt to equity is one-to-one. We have a 1.4 billion of cash on our balance sheet, we have none of our bank lines drawn, and the way we're running our fixed income business, and our high yield business, third-party capital, is extremely different from how some of the competitors you might be comparing it to funded theirs. And we're very cognizant of that, which is why we are not letting our ratios (inaudible), why we are not letting our level III assets (inaudible) and why we raised additional long-term capital during the summer to make sure we have plenty of ample long-term capital base to continue to grow the company with.

Casey Ambrich – Millennium

Okay. And then just one, just one other question on the – you know the fed says they are going to probably stop purchasing MBS securities in the end – by the end of the first quarter 2010, how do you think that is going to impact the MBS market?

Peg Broadbent

You know I think it is a little early for us to comment. One would expect that any action the fed would take would be predicated on their expectation that they would have little to no impact that the health of the market would allow their withdrawal and cessation of activities. So it is early and it is to be seen.

Casey Ambrich – Millennium

Okay, thanks very much.

Operator

And the next question is coming from the line of David Trone of Fox-Pitt Kelton. Please proceed with your question.

David Trone – Fox-Pitt Kelton

David Trone of Fox-Pitt Kelton. Congrats on a good quarter, just made me look on that, too early to downgrade. The employee question, I want to come back to that, you mentioned that it was easier to hire in past quarters and that more recently it is becoming more difficult and that is obviously pretty intuitive but also if I look at the actual numbers, you hired more people this quarter than by wide margin than you have in quite a few, so I'm wondering is it the case you boosted hiring of back-office and that is kind of juiced the numbers up to 206?

Peg Broadbent

Juiced the numbers is quite a statement but I think that you know as we indicated I mean we are relatively transparent. To the extent of what healthcare hiring, this is pretty obvious, to the extent of our rates hiring, this is pretty obvious. We mentioned the back-office because it was meaningful during this period as we support the growth of the business. It is not a disproportionate amount of that.

Richard Handler

There is also a lag period. A lot of the people we hired actually joined us in the summer of 2009 were people that we – that had 90 day of (inaudible) that we were able to bring out effectively from year-end of 2008.

Peg Broadbent

I think the question that was asked before is a relevant one, which is how the revenue that we have generated this year on the number of people that we employed relative to what we generated at the past peak is meaningful progress which would suggest both a strengthening of the average production and arguably that means the quality and the depth and the effort. It also means we are getting leverage on our operations and we have the right people in the right places.

I think the other thing that (inaudible) mentioned is that while it was an exceptional opportunity over the past year because of the disarray, we've emerged from the disarray in what we believe is a stronger and more differentiated position. Being the largest independent non-bank Wall Street firm, is attractive to many people, and that will continue to in our view it will be an advantage to us as we continue to recruit.

David Trone – Fox-Pitt Kelton

Okay, good. If you look at that 206 and I think it was 11 before that and 55 prior to that, if you have to take a wild guess, you probably don't know the number exactly, but how many people do think, producers do think you had at the end of the third quarter that weren't yet really fully up to speed working and – working for –

Richard Handler

You know it is not a number we spend a lot of time thinking about and the reality is at all times, at all times, we have people that are new to the firm, ramping up, getting potted, regaining relationships, whatever the case, so there is always going to be some number of people with lag, it doesn't pay to speculate on.

Peg Broadbent

With that being said, from a macro perspective, whether it be the bankers usually have a bigger lead time in sales and training, so we have healthcare team that did hit their stride early, and they is still a large amount of opportunity there. Our algorithmic team has hit their stride, but there is a lag in terms of signing everybody up. Prime brokerage is continuing to sign people up. Our European operation is relatively new. The point is we've added a fair amount of headcount and there is still a lot of opportunities that we have not realized yet, that being said, it is also good marketing execution.

David Trone – Fox-Pitt Kelton

Yes, okay. And switching gears a little bit, you obviously have tremendous opportunity internationally, if we focus back domestically and just kind of think about the product lines, do you feel like you're getting, you are kind of hitting, let me rephrase that, do you feel like you're pretty much everywhere you need to be or is there still great expansion opportunities in products in the US?

Richard Handler

We feel that we have got the footprints in equities and in fixed income although there are additional products in both cases to be added. We have growth and upside we think in all of the products we are offering. In invest banking, first of all you have got a meaningful cyclical recovery still underway, so just on that there is a lot of upside. Furthermore, there are sectors such as FIG [ph] where we have limited footprint at this time and there are other sectors where we think we can gain additional share. So we look across the firm, we see both a fair amount of opportunity and we have a fair amount of initiative underway to try to take advantage of that opportunity.

David Trone – Fox-Pitt Kelton

Okay great, thank you very much.

Operator

And we do have a follow-up question coming from the line of Bradley Kelly with Magnum Financials. Please proceed.

Bradley Kelly – Magnum Financial

Guys, just wanted to ask, go back again to the growth story, you had mentioned emerging markets, just real briefly in answering someone else's question, in emerging markets, would you be servicing individual clients or would you be providing investment banking services to companies?

Richard Handler

It is consistent with all of our other businesses. We are first and foremost an institutional provider and we're serving major institutions across the globe, it is institutionally focused.

Bradley Kelly – Magnum Financial

So do you see at some point in the future though offerings brokerage services to individuals or –

Richard Handler

No. I mean – let me be clear. Our emerging markets business is today a institutional trading business. In addition, we are beginning to engage in further investment banking in emerging markets. We have people in India, we are starting to focus on opportunities in Eastern Europe and in South America. Thirdly, separate from all this, we have a private wealth management business that is growing as we indicated. It's most recently added people in London over time that may grow to serve emerging markets but we are particularly focused on that right now.

Bradley Kelly – Magnum Financial

Excellent, okay. So are there in the next year, in 2010, do you see opportunities for IPOs in some of those emerging markets?

Richard Handler

We have a history of bringing capital markets transactions, cross-border transactions out of emerging markets, particularly out of India to a limited extent out of China, we expect that to increase in the future, yes.

Bradley Kelly – Magnum Financial

Okay, excellent, makes sense.

Operator

And we have another follow question coming from the line of Steve Stelmach with FBR Capital Markets. Please proceed.

Steve Stelmach - FBR Capital Markets

Hi, guys. Just a real quick follow-up on the comp ratio and to put a bit of a finer point on it, 70, 60% is probably going to be high going forward, obviously depending on revenue, but do you need to have a $700 million revenue run rate to maintain that 56% comp ratio going forward?

Peg Broadbent

I think the best way to answer that is not necessarily because a lot depends on the mix of the revenue, which groups are stronger performers than others. It is impossible for us right now to fix further on that given what we have gone through over the last you know two years or so, we're going to keep our answer to that open. We clearly as Rick said intend to manage it over time in a prudent way to be fair to employees and to retain our employees but at the same time to be fair to our shareholders in terms of returns and profitability and we will strike the balance as we go along.

Steve Stelmach - FBR Capital Markets

Okay. So not out of the realm of possibilities but subject to the determination.

Richard Handler

If you want us to say anything is possible, we will, but more importantly, you can see what our priorities are and what we're working on.

Steve Stelmach - FBR Capital Markets

I appreciate it. Thanks.

Operator

And we do have another follow-up question coming from the line of Michael Hecht with JMP Securities. Please proceed.

Michael Hecht – JMP Securities

All right guys. Thanks for taking the follow-up. But just a few housekeeping questions about the model, so 56% comp ratio in 3Q, very solid, I mean how do you think about the leverage you have going into Q4, and should we think like some of the recent hiring might not pay off until 2010 revenue wise might cause you to backtrack a little and is there any shift in the thinking around the mix of stock-based comp you expect to pay this year?

Richard Handler

Well first of all on that last point, if you go back to our announcement at the end of last year, stock-based compensation annual grants are expensed 100% in the year that they relate to. So there really aren't vagaries around that, that is very precise. On the question of sort of where we're going near term, again, we don't project, we don't look forward publicly. All we can say is that there is a history that as you get to year end, you obviously get absolute precision. The earlier quarters involved estimates. We don't expect anything unusual, but we also don't know with enough precision what our revenues will be so or for sure what the mix will be. So we have to leave that open.

Michael Hecht – JMP Securities

Okay, fair enough. And then on the non-comp side, pretty steady at 107 million despite the strong revenues this quarter, I mean any noise this quarter or last quarter that feels like a pretty steady run rate here, do you see a little bit of up tick in that given the growth?

Peg Broadbent

Well at this point – no, there is no notable items in those expense numbers either this quarter or last. It would be reasonable to considerable that to be a run rate but with the addition of the people we described, I wouldn't be surprised to seeing it ticking up a little bit in the quarters to come.

Michael Hecht – JMP Securities

Okay. And then can you help us with the tax rate expectations for the year and thoughts on 2010, I mean should – is it reasonable to think that a bigger mix of non US revenues might drive some downside to the tax rate in 2010?

Peg Broadbent

That would be a reasonable assumption but obviously that depends on the revenue growth internationally and it also depends on what the tax what the government internationally designs to do with the tax rates as well. But it would be a reasonable assumption to assume that as we grow internationally, our effective tax rate could come down.

Michael Hecht – JMP Securities

Okay, and then just last one for me, thanks for giving the pro forma book of I think you said 10.91 including RSUs, do you have the tangible book value and the pro forma tangible book?

Peg Broadbent

Yes I do. The tangible book value was $10.56 on a 169 million shares outstanding. If you adjust base shares for the RSUs, up to 197 million is $9.10.

Michael Hecht – JMP Securities

Okay great, thanks a lot.

Operator

And we do have a follow-up question coming from the line of Daniel Harris with Goldman Sachs.

Richard Handler

Operator, this will be the last question I will answer. This will be the last question.

Daniel Harris - Goldman Sachs

Okay, thanks guys. I'll try and keep it quick. I know it is not a core business for you but can you just sort of help me understand the asset management line, you know not so much the gains. I realize that it is going to be mixed, but on the fees, the number basically almost quadrupled this quarter, I was just wondering how should we think about that going forward and is the business just starting to turn around so there should be ongoing profitability here?

Brian Friedman

I would say we are hopeful for on going profitability. As you indicated, in and of itself, the business is not super material to our numbers. There is going to be some lumpiness in that business because there is performance and success based fees so they are going to tend to be, if we're going to achieve those, we are going to tend to achieve those in the third or fourth quarter. So there is going to be a lumpiness to that business and I guess I am effectively saying that there was some lump in that in the third quarter. So it’s not a number that particularly will naturally be, it was stronger than what the average will be in the near term for sure.

Richard Handler

That being said, I think the numbers aren't material for overall revenue because the amount of capital we actually have in this business is relatively small but the managers themselves are material for our company.

Daniel Harris - Goldman Sachs

Agreed. Thanks for the color, guys. Thank you.

Richard Handler

Okay. Operator, I think we are done. We’ve done our penance for the broke in the phone. Thank you everybody for listening to our call today. Simply put, our firm has never been stronger and the entire management team at Jefferies has never been more energized or more excited about the opportunities ahead. Thank you very much.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your lines.

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Source: Jefferies Group, Inc. Q3 2009 Earnings Call Transcript
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