Jefferies - Too Small To Survive?

| About: Leucadia National (LUK)

The term big-too-fail has become well known even among the ordinary public. While the arrogance of the too big too fail (TBTF) firms has caused for a lot of uproar, some smaller firms seem to become victim of quite the opposite.

Chart forJefferies Group, Inc. (<a href='' title=''>JEF</a>)

Target of speculation

In the week of MF Global's (OTC:MFGLQ) demise, Jefferies (JEF) became the next target of speculators with the stock shedding 22% on a single day on a broker downgrade. While there was a brief moment of optimism, shares shed another 7% Thursday. Trading at $9.6, shares are down already some 65% for the year.

It is not just the stock taking a hit. Its 2019 8.5% coupon bonds are trading $0.91 on the dollar, implying a yield of over 10%. Comparative BBB-issues of such maturities trade around 5%.

Conservative management

While MF Global and Jefferies might be comparable in size, their management is not. While Jon Corzine made massive bets with the firm's capital (and some of its clients, as it appears) Jefferies was quick to wind down half of its gross $2.5B exposure and announced their positions on their website.

Furthermore the firm holds $3.2B in equity against $45B of total assets, giving it a 7% equity/capital ratio and even a much higher Tier-1 ratio on the basis of risk-weighted assets. Liquidity is also available with roughly $2B in cash positions and an equivalent amount in credit lines. At these depressed levels the bank is trading around 0.7x its book value.

But fundamentals don't count

In a market where emotions prevail over fundamentals, Jefferies is still at risk despite the fact that it is relatively conservatively financed compared to competitors and management is proactive and doing a good job. Speculators can push the market far and a run on Jefferies could occur any moment as soon as a few serious counterparties pull the lines. Some of its main competitors (TBTF) are eager to see another prime broker disappear and financial authorities are keen to set a precedent by allowing some non-systemic firms to go under.

Life is not always fair if you are small, and Jefferies management ought to know.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.