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Executives

Richard B. Handler - Executive Chairman, Chief Executive Officer, President and Director of Jefferies

Peregrine C. de M. Broadbent - Chief Financial Officer, Principal Accounting Officer and Executive Vice President

Brian Paul Friedman - Director, Chairman of Executive Committee and President of Jefferies Capital Partners

Analysts

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

Michael Lipper

Douglas Sipkin - Susquehanna Financial Group, LLLP, Research Division

Michael Rogers

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Meredith Ann Whitney - Meredith Whitney Advisory Group LLC

Jefferies Group (JEF) Q3 2012 Earnings Call September 20, 2012 9:00 AM ET

Operator

Welcome to the Jefferies 2012 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' 2012 fiscal third quarter financial results was distributed via Business Wire earlier this morning and can be accessed at 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 assumptions, expectations, strategic objectives, growth opportunities, business and prospects. These forward-looking statements are not statements of historical fact and represent only Jefferies' belief as to future performance. They usually include the words continue, will, believe, should, estimate or other similar expressions. Actual results could differ materially from those projected in these forward-looking statements. Please refer to Jefferies' Annual Report on Form 10-K filed with the Securities and Exchange Commission on January 27, 2012, and Jefferies' Form 8-Ks for discussions 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, Mr. Richard Handler, Chairman and CEO of Jefferies. Mr. Handler, you may begin your conference.

Richard B. 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.

For the third quarter ended August 31, 2012, we posted net revenues of $739 million, net income to common shareholders of $70 million and earnings per share of $0.31. Net income would have been $73 million and EPS would have been $0.32 on a non-GAAP basis without the negative impact in the current quarter of certain items arising from acquisitions and debt extinguishment accounting gains recognized in prior quarters.

Our results include a positive impact to net revenues of $103 million arising from our share ownership in Knight Capital. This contributed $0.08 to EPS. We acquired this position as we worked closely with Knight to first help stabilize and then recapitalize their company.

X Knight, our results are solid considering the usual seasonal slowdown in the trading market that persisted during this summer. Fixed Income proved resilient, and our Investment Banking results for a summer quarter were good. While Peg will go through the details shortly, our strong 9-month results reflect our increased market share and our significantly enhanced global brand, which has led to our strong competitive position.

We are particularly pleased that these results were accomplished while still being able to end the quarter with a balance sheet below $35 billion or roughly 9.3x shareholders' equity. Additionally, as Peg will point out, our liquidity has never been stronger, and every other metric is consistent with our historical conservative operating strategy. It is worth noting that not surprisingly, September has begun extremely well. While we are only in the third week of the quarter and results are always subject to the environment, our Investment Banking backlog and recent Fixed Income as well as equity trading results are very solid.

Now I will turn it over to Peg to discuss our results and financial condition in more detail.

Peregrine C. de M. Broadbent

Thank you, Rich. As Rich said, our net revenues for the third fiscal quarter were $739 million. Our net income to common shareholders was $70 million and earnings per share, $0.31 versus $0.10 for the third quarter last year, excluding the bargain purchase gain and certain expenses which arose upon the acquisition of Bache. Also as Rich mentioned, net income would have been $73 million and EPS would have been $0.32 on a non-GAAP basis without the impact of amortizing certain items arising from previously mentioned acquisitions and debt extinguishment accounting over the last year.

Now for the results. Our third quarter Investment Banking revenues were $260 million compared to $294 million reported in the third quarter of 2011. Of the $260 million, Capital Markets revenues were $127 million, and M&A and Advisory revenues were $133 million. Fixed Income revenues were $266 million for the third quarter, up significantly from last year's third quarter of $33 million, which was clearly the result of the extremely challenging Fixed Income environment.

Equities net revenues for our third quarter were $210 million, which includes the impact of the Knight position that Rich mentioned. Equity revenues without the Knight markup were lower than the $127 million reported in the comparable quarter last year. Asset Management revenues for the quarter were about $3 million. About $9 million of fee income this quarter was offset by $6 million of unrealized markdowns on our investments and unconsolidated private equity funds.

Non-compensation expenses were $168 million for the quarter, similar to the non-compensation expenses reported in last year's third quarter of $169 million. Our compensation expense ratio for the third quarter was 59.6% of net revenues, consistent with recent levels.

During the quarter, we repurchased 1.7 million shares at an average price of $12.67 per share. There are about 11.5 million shares authorized for future repurchases. Book value per share was $16.59 at quarter end based on 203 million shares outstanding. Our adjusted book value per common share was $15.63 based on 225 million shares outstanding, including restricted stock units.

As Rich mentioned, we estimate total assets at August 31 were about $34.4 billion or about 9.3x our estimated shareholders' equity. We estimate our total quarter end Level 3 trading inventory after accounting for noneconomic interests was approximately $436 million. Virtually all our trading inventory continues to be highly liquid, with 97% of our trading inventory continuing to be classified as either Level 1 or Level 2, which is consistent with levels of previous quarters.

We estimate that our quarter end liquidity buffer was about $4.2 billion. Of the $4.2 billion, we estimate $2.8 billion was cash and $1.4 billion was unencumbered liquid securities. We estimate our average VaR for the quarter was approximately $10.5 million. With the Knight position, VaR was about $8.4 million compared to last quarter's $8.8 million and the $10.6 million reported in the third quarter of 2011.

Our estimated tax rate for the quarter was 36% versus 35.8% for the second quarter. On August 31, we had a total of 3,814 employees, essentially flat when compared to the 3,809 at the end of the second quarter.

Brian will now address in more detail our Investment Banking results.

Brian Paul Friedman

As Peg indicated, Investment Banking revenues were a solid $260 million for the third quarter, fairly evenly balanced between M&A, Advisory and Capital Markets. Our M&A and Advisory revenues were $133 million in the third quarter. During the quarter, we closed 31 transactions.

Please bear with us as we review a rather extensive list of highlight transactions that demonstrates the breadth and depth of our firm's capabilities and relationships from a geographic, sectoral and product perspective.

Notable advisory deals included our acting as sole financial advisor to Novartis International on its $1.5 billion acquisition of Fougera Pharmaceuticals. We also acted as joint financial advisor to Chesapeake Energy on its sale of a $2 billion stake in Chesapeake Midstream Development to Global Infrastructure Partners. We acted as joint corporate broker to Cable & Wireless Worldwide PLC on their EUR 1.1 billion sale to Vodafone Group Plc. We also acted as sole advisor to Sunquest Information Systems on its $1.4 billion sale to Roper Industries.

We sole advised Paradigm Limited in its $1 billion sale to Apax Partners and JMI Equity, and we acted as sole financial advisor to Anchor Glass Container Corporation on its $880 million sale to Ardagh Packaging Group. We also sole advised Mercury Pharma Group on its $465 million sterling (sic) [GBP 465 million] sale to Cinven Limited, and we were book runner and mandated lead arranger on the GBP 235 million credit facility used to finance this acquisition. We acted as sole financial advisor to the $20 billion deepwater spill trust that was established to fund the damages from the Gulf of Mexico oil spill. And as everyone knows, we conceived and structured the $400 million Knight Capital convertible securities purchased by investors led by Jefferies.

Capital markets revenues were $127 million for the quarter, with debt capital markets generating $88 million and equity capital markets, $39 million. During the quarter, we completed 135 capital markets transactions. Notable debt capital markets transactions included our acting as sole provider of the EUR 630 million bridge commitment that enabled strategic value partners to fund the EUR 820 million acquisition of Klöckner Pentaplast. We then acted as sole lead arranger on the $500 million credit facility and sole book runner on the EUR 255 million senior notes that were the permanent financing for the Klöckner acquisition.

We also acted as joint lead arranger on the $1.8 billion credit facility that financed Vista Equity Partners' acquisition of Misys plc. We also acted as lead arranger to One Call Medical on its $450 million credit facility to finance the acquisition of MSC Group, in addition to serving as sole financial advisor to MSC in its sale to One Call. We also acted as joint lead arranger and joint book runner for EUR 572 million of debt financing for Stork Technical Services and its subsidiary Fokker Technologies consisting of a EUR 100 million revolving credit facility and EUR 272 million of senior notes for Stork Technical and a EUR 200 million term loan for Fokker Technologies.

We completed several other book run high-yield offerings, including acting as sole book runner for Icon Enterprises' $300 million senior notes offering, joint book runner for China Fishery's $300 million senior notes offering and joint book runner on Crescent Resources' $350 million senior notes offering. Finally, we were sole book runner on a $404 million CLO for Alcentra.

In equity capital markets, we acted as joint book runner on several IPOs, including $233 million IPO of Manchester United, the $188 million IPO of Five Below and the $87 million IPO of Chuy's Holdings. We also completed several follow-on offerings as joint book runners, including the $503 million offering for Williams Partners L.P., $300 million for Senior Housing Partners and $100 million for ImmunoGen, Inc.

Indeed, as this long and varied list of transactions indicates, our breadth and depth of activity in Investment Banking is outstanding. It is worth noting that our backlog in Investment Banking, while always subject to market conditions, is robust in terms of sectors, products and regional activity.

Now Rich will comment on our trading results before we take questions.

Richard B. Handler

Thanks, Brian. Our Fixed Income revenues were $266 million for the quarter, up significantly from last year's third quarter of $33 million. Despite the still challenging and volatile environment, our Mortgage, international and domestic credit and Municipal bond businesses performed well. Credit spreads narrowed during the period reflecting some investor demand for higher yielding assets, which translated into reasonably robust trading volumes. Our domestic rates business also performed strongly during this period, recording its best quarter ever, driven by reasonable customer flows and increased volatility.

Excluding Knight, equity revenues were $107 million for the quarter, down from the $120 million reported for the second quarter and the $127 million for the third quarter of 2011. Our core equity business continues to experience low volumes, but we are pleased with our relative performance. We've continued to gain traction with a variety of clients thanks to the quality of our research, trading and sales professionals. As we noted earlier, activity levels in September have improved.

On October 2, Jefferies will be 50 years old. Despite a turbulent and often treacherous environment, we have just finished the best 9-month period in our firm's history. Our equity base of $3.7 billion has never been more robust, and our balance sheet and liquidity have never been stronger. The Jefferies brand and our competitive position versus our competitors have also never been better. We would like to thank our clients, employee partners, shareholders and bondholders for putting Jefferies in our strongest position ever and allowing us collectively to continue our mission to build Jefferies in the next 50 years.

We are now available for questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Alex Blostein with Goldman Sachs.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Just to kick things off, maybe a couple more comments on Knight. Peg, can you give us a sense of, from a strategic position, do you guys anticipate this is going to be an ongoing partnership for you guys? Or this is more of a financial transaction, and you'll be looking to, I guess, exit at some point? And then from a comp perspective, it seems like you guys comped at around 60 along with the rest of the firm. Does it work the same way on the way down? Or how should we think about the comp rate on a full year basis?

Brian Paul Friedman

Well, to comment on the comp point. I mean, recognize that the amount of this gain, which is obviously a mark-to-market and will potentially fluctuate in future quarters, it represents a relatively tiny percentage of our annual revenue expectation, right? You can just take the 3 quarters and annualize revenue, want to get to an annual number, so it's a relatively small percentage. We didn't single it out for an adjusted accrual at the end of the year as we do every year. We will true up the compensation accrual based on the final year end results. So we just didn't take any extraordinary measure because on a percentage basis of the year, it just wasn't the right way to approach it. As far as our strategic view, we filed the 13D and all the rest of it, so we really can't comment more. As was noted in our filings, we did convert to common stock.

Alexander Blostein - Goldman Sachs Group Inc., Research Division

Understood. And then a couple of comments maybe on Fixed Income trading business. I know you highlighted that September started off on a stronger note. I was wondering, a, I guess if you could highlight any particular area that feels better from both an activity perspective and client engagement. And then second, I was wondering if, a little bit on the bigger picture side, we're getting closer and closer to just clearing up maturity and debt. Potentially, it might be a source of strength for you guys, since you guys didn't play in that market before. Rich, maybe you can comment how active are you planning on being in the OTC swaps market once they actually become cleared, how significant that could be for Jefferies on a go-forward basis.

Richard B. Handler

In terms of Fixed Income, September, literally across the board, from high-yield, credit, domestically and internationally, Mortgages, rates, Municipal bonds as well as equities, literally across the board, we've seen very solid customer flow activity. Obviously, this only helps with what the Fed has done and with the situation in Europe seeming to be a little bit more organized, but it's been a pretty robust client flow in every single asset class that we trade in. In terms of over the counter, look, from a regulatory perspective and from a shift of how things are going to be traded with transparency on exchanges, we consider that a very attractive way for us to enter businesses that we were never in before, and we plan on effectively making this a major part of our company going forward.

Operator

Your next question comes from the line of Patrick O'Shaughnessy with Raymond James.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

[Audio Gap]

QE3 might impact you going forward. It's probably a little bit early to tell, but you can have a sense for if it might impact your trading results at all or just kind of overall economic impact.

Richard B. Handler

Look, I think what affects us most is if you take the systemic risk card and minimize it or take it off the table and let people go back to investing in securities based upon their underlying value, that is very good for Jefferies and I think for our industry. So as QE3 and the European coordination, those 2 things have clearly brought investors, at least for the short term and who knows how long it lasts, they -- it's bought them back to fundamental analysis and fundamental investing, which is good.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Got you. My second question, so Moody's recently announced that I think they're reviewing your debt rating for a downgrade. How do you go about trying to convince them that the steps that you've taken in the last several quarters have made you guys actually a less risky company and get them comfortable with your business model at this point?

Richard B. Handler

Look, as we deal with all rating agencies, we show our -- the transparency of our inventory and liquidity of our inventory, our liquidity buffers, our core operating businesses, our historical track record of not over leveraging or overextending our company, our lack of concentration. We're in a world where all of our competitors have been significantly downgraded. We believe we're in the best position we've ever been as a company. And it's -- while the rest of the world has had hypothetical stress tests, we've had real-life stress tests. As an independent company that has not been bailed out by anybody or taken taxpayer dollars over the course of the last 5 years, I think we have a very strong story to tell, and we'll do our best.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Okay, appreciate that. And then last one from me. I guess looking forward, Peg, what do you think...

Richard B. Handler

I would also just add, in terms of amounts of money -- Peg, you might want to comment. It's not really a meaningful number in terms of amount of money we would have to post for any type of a downgrade.

Peregrine C. de M. Broadbent

It's negligible in terms of the impact on -- in terms of [indiscernible] calls. We have no -- virtually no derivatives -- over-the-counter derivatives portfolio to speak off, so nothing there. And with respect to clearing corporations and the like, virtually nothing there as well.

Patrick J. O'Shaughnessy - Raymond James & Associates, Inc., Research Division

Okay. That's helpful. And then the last question probably for you again, Peg. On the non-comp expenses, you talked about how they're relatively flat versus the year ago quarter. Kind of looking forward, do you see any kind of build-out expenses increase in the non-comp expense base? Or do you kind of view that you can keep it pretty flat from current levels?

Peregrine C. de M. Broadbent

We believe we can get it pretty flat from current levels, anticipating as to high 160s, low 170s. And we'll continue to work hard at chipping away at that number and hopefully, reduce it, actually.

Operator

Your next question comes from the line of Joel Jeffrey with KBW.

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

A sort of a robust backlog in your Investment Banking business. Have you seen any kind of meaningful shift in the confidence levels of CEOs at this point? Or is it just more of a pent-up backlog just pushing into the market?

Richard B. Handler

I think it's a combination of, on a macro basis, corporate America has paid down a lot of their debt, they've refinanced at low cost. They've cut their cost, and they're looking for growth. And so that lends itself to a very strong M&A environment. Additionally, with interest rates at these record low levels, it makes it very attractive to do just about any type of financing. With the equity markets coming back and having demand for IPOs and follow-ons, you see that as an alternative. I also think that we're seeing an increased amount of market share based upon our global positioning. So I think across the board, it bodes well for our ability to hopefully garner additional market share and take advantage of a relatively stable environment.

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And then just a question on the tax rate. It looks like it came in at about 36%, and that was inclusive of the higher tax rate on the Knight Capital stuff. Was there any reason why the remainder of the business was taxed at a meaningfully lower rate than what we've seen in the past few quarters?

Peregrine C. de M. Broadbent

Yes. We disclosed in Note 14 on Page 6 of our press release, the tax rate attributable to Knight was 40-odd percent, because the Knight position and -- mark-to-market was recorded in the U.S., where the U.S. rate is around 40%. The overall firm effective tax rate is in the mid-30s because of the impact of lower rates around the globe both in Asia and in Europe. And to the extent we've got activities and revenues in those jurisdictions, it adds up to a lower tax rate.

Joel Jeffrey - Keefe, Bruyette, & Woods, Inc., Research Division

Okay, great. And then just lastly, I mean it looks like you guys continued to purchase shares -- repurchase shares during the quarter, and your stock price had been down below tangible book before. Now that it's up a little bit, is there any thought on how you approach future buybacks? Or is it sort of still sort of standard operating procedure at this point?

Richard B. Handler

I think you'll see us consistently try to maintain a share count as we issue shares in terms of compensation, and we try to make sure we minimize the dilution.

Operator

Your next question comes from the line of Michael Lipper with Lipper Advisory Services.

Michael Lipper

Okay. Focusing for a moment on the comp ratio, is there a time where the comp ratio will drop to the range that other firms have, we can call that roughly 50%? Or as your revenues go up, so will your comp, and therefore, the ratio will not decline meaningfully?

Brian Paul Friedman

I think the answer is we expect our comp ratio to decline now over the next several years. I'm not sure we're going to grab on to the 50%, but we have, obviously, a long way to go from where we are to we need to get there. But if you look at our firm, we spent 3 strong years from 2008. And from the middle of 2008 to the middle of 2011, we aggressively grew our firm, because we saw an unprecedented opportunity to gain market position. There was a strategic opportunity that we felt could not be missed. We meaningfully increased our headcount. We significantly increased our support team. We did everything to build the Jefferies that we have today that we're very pleased to be operating. If you look at, particularly, the last year, and it's evidenced in the headcount numbers and in the operating expense number that Peg was just talking about, we have now been focused on both productivity and cost compression. So we see, basically, over this next couple of years, there'll be room for our comp ratio to come down and also, as a percentage of revenue, hopefully, for the OpEx to come down. And obviously, the offset of that is an increasing margin. So yes, we expect to bring the comp down, and as a part of that, the amortization of upfront and other costs that really are growth investment costs will peak in the current moments and come down over the next couple of years. So there's a number of forces, and obviously, revenue growth will support it. So yes, we have a lot of things going in our favor assuming that the environment is favorable, and we're able to execute as we think we can.

Michael Lipper

Will the mix of revenues have a dramatic impact on the comp ratio?

Brian Paul Friedman

The mix of the revenue impacts what the absolute ratio is, but there's no reason to think that there's going to be a dramatic change in mix such that it's going to have a meaningful impact on the ratio. The ratio should go down over the next couple of years from a combination of revenue growth, maturation of productivity so that productivity per person goes up and then the runoff of some of the upfront cost of the '08 to '11 expansion effort.

Operator

Your next question comes from the line of Douglas Sipkin with Susquehanna.

Douglas Sipkin - Susquehanna Financial Group, LLLP, Research Division

Two questions and then maybe just a clarification. So first, Fixed Income trading obviously continues to be impressive. I know the market share story has been there. I mean any noticeable sort of incremental increase in that in the face of sort of what's gone on in Europe, what's gone on with a lot of European competitors, which are strong in Fixed Income or were strong in Fixed Income? Now that the business maybe seems like it's getting a little bit better, I mean, are you guys noticing more market share grab and a little bit better tape [ph] with some of the competition falling on tougher times?

Richard B. Handler

Look, we can't really speak to our competition. Everyone has their challenges. We are clearly gaining market share. There's no lumpy one-off transaction. And our Fixed Income business has basically been traditional market making, market share gains across the board, across a variety of products. And basically, it's as advertised.

Douglas Sipkin - Susquehanna Financial Group, LLLP, Research Division

Okay, great. That's helpful. And then maybe just to clarify, I think it was the first question asked. I mean, I guess I can appreciate not adjusting the comp ratio until the year end, but do you guys intend to, when the full year's out, to sort of adjust for the comp on that just because it seems -- I don't understand why there would be, on a full year basis, a full comp on Knight. Maybe you can clarify that.

Brian Paul Friedman

I mean, again, it's something really that will just be decided at year end. I think you got to keep it in perspective. In other words, think about what our likely revenue for the year is, what percentage the Knight number represents of that and look at -- we've seen, obviously, different people publish different ideas of what the comp relevant to Knight is. If you get any number that someone's published and the difference to what our current comp rate would represent, it's an immaterial number against the comp rule. So the level of precision you're asking for is not something that, at this point, we can give. At the year end, it'll come out where it comes out. It is a comparatively small number, the difference.

Douglas Sipkin - Susquehanna Financial Group, LLLP, Research Division

Okay. And then just finally, to the conversation on the rating, I can completely appreciate you guys actually went through it and survived, and the validity of the model and liquidity of assets really came through. It feels like the rating agencies are sort of going after something different with respect to sort of sources of funding, and you guys have done a very good job diversifying the funding over the years. Any thought process to diversify further at some point and maybe try to tap into some deposits somewhere along the line? Or is that just not something you guys would ever consider?

Brian Paul Friedman

I mean when you talk about diversifying it, it's one of those -- again, it's difficult to put a dipstick in and say how diversified we are today versus 1 year, 2 years or 3 years ago. But there's no doubt that we continually open up new relationships and funding sources. The most important thing to remember about our funding is that it's done on a secured basis, okay? Deposits are unsecured. We don't need unsecured funding to run our business. It would be lovely to have, but it's not really part of our plan. And if you look at the regulatory and other limitations that come with deposit-type funding, we just don't see it. 90% of our funding is through clearinghouses which, in the end, speaks to the quality and liquidity of the collateral that we're funding. We're in a very different spot than others who have, particularly over the counter, more complex instruments and therefore, are looking for different versions of funding. So I think people use the world wholesale in respect to our funding, and we kind of keep repeating it's not wholesale, because it's not unsecured. It's secured funding. It's substantially done based upon the quality of the inventory with, in our view, relative indifference to the credit and to who owns the inventory. And we're very comfortable with the way that works for us and the way it has worked and the way we think it will continue to work.

Richard B. Handler

And we've created joint venture vehicles for other groups of our assets over a long period of time with strategic partners that have diversified our funding sources. We've announced a potential Eurobond program. We have many sources, and we have plenty of liquidity. I think the real issue that people are contemplating right now is relative -- credit ratings relative to people who have been downgraded rather significantly as opposed to singling out our specific funding sources.

Brian Paul Friedman

But again, we said earlier that we think Jefferies is in the best position it's ever been. We really have little doubt about that.

Douglas Sipkin - Susquehanna Financial Group, LLLP, Research Division

No, I appreciate those comments. And like I said, we saw in the second half of 2011, I mean you guys are under attack. You got through it, and the model proved out. I just worry that the perception of a certain type of funding. And as you guys indicated, it's secured, and it probably is a lot cleaner than what the other guys have done historically. It just feels like though that may be more what, I guess, the market is seeking, even though it may not be right I guess is sort of what I'm saying. The perception becomes the reality, so to speak.

Richard B. Handler

All we can do is operate our company in a clean, transparent, open manner as we've been doing, and that's what we'll continue to do.

Operator

Your next question comes from the line of Michael Rogers with Conning & Company.

Michael Rogers

A Moody's question, if I could, for one second. It seems clear, but let me ask the question anyhow, if I might. Has it impacted customer behavior in any way? Or do you think it could if a one-notch downgrade does happen?

Brian Paul Friedman

It absolutely has not -- the press release that was put out absolutely did not impact our customer activity, and as we said earlier, the last couple of weeks have been stronger than the prior several months. And there's really no reason to think that a -- if we were to be downgraded one notch, remaining an investment-grade company, we don't see it having any impact on the business.

Michael Rogers

Appreciate that. And just a follow-up on Europe, could you provide an update? Any comments on the exposures there? And what do you think are the prospects for Europe with the recent developments coming out of the ECB and the actions that have [indiscernible] going in a haphazard way but still going in the right direction?

Peregrine C. de M. Broadbent

Our pegged exposures at the 31st of August were similar to levels at the 31st of May, about $900 million long and $900 million short, 0 from a net perspective. So negligible, both gross and 0 net.

Brian Paul Friedman

I think on the bigger picture, what the ECB and a number of the governments' comments there have done is given the market some comfort that the issues will be managed in a somewhat more orderly way. The underlying issues have not been eliminated. They have to be confronted. And whether it's through austerity or other measures, there has to be a proper balance reached. So it's going to be a longer-term process to sort out the economic resolution in Europe, but I think the markets have at least been able to achieve some level of confidence about the potential glide path for that. So I think that's what you're seeing with the markets. On our side, what that's meant is solid trading activity and increased corporate interest on the Investment Banking side and potentially, transactions. So there's definitely been a pickup in both inquiry and management [ph].

Michael Rogers

Would Europe still be your chief worry, if it ever was a significant worry? And if not, what would you characterize -- what still is your chief challenge going forward 12 months?

Brian Paul Friedman

If you look at the last couple of years and then you think about the mix of our business from a regional perspective, we remain -- our largest market by far is the U.S., representing still over 75% of our activity. In fact, in recent periods, because of the weakness in Europe particularly, it's been over 80%. So if you want to look at geographies, we're most impacted in the near to intermediate term by what happens in the U.S. So if there were to be a major pause in the first part of next year due to U.S. macro factors, obviously, that can have an impact on us. I would say that we worry about it. We obviously watch it. We try to keep as much of our cost structure flexible. We showed, even in the third quarter and fourth quarters of last year, which were incredibly challenging periods, that we remained reasonably profitable. And while our results were down, they didn't fall off the map the way they may have in other cases.

Operator

Your next question comes from the line of Jeff Harte with Sandler O'Neill.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

A couple of questions. One, just touching on Knight again, I guess I'm thinking of it from a risk management standpoint. And appreciating that it's a small relative part of a $35 billion balance sheet, it did drive a 25 percentage spike in your VaR. What actions can or might you take to minimize some of the market risk from that position?

Richard B. Handler

I mean, look, our VaR, on a relative basis, is particularly low. Over the course of the last year, we've shrunk our balance sheet. Our inventories are very light. So I don't think the increase in VaR due to Knight is really material to our overall organization.

Brian Paul Friedman

Yes. I think, you also have to -- I mean, it drives VaR, because it brings a single idiosyncratic risk to the mix. I think you have to recognize that, whatever it is, about 40%-plus of the value we have at risk there is profit that we gained in the last 45 days. So we're in that tricky position where it's our profits that are creating a little risk for us. We're working with profit there.

Richard B. Handler

Not that we don't value each dollar, but that's just another way to look at it.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Okay. And just looking at the stuff in the press release, to -- how much of the economic exposure in the position is owned by Jefferies versus other? It looks like some of it's getting backed out through MCI.

Brian Paul Friedman

$100 million is owned by Jefferies Group. $25 million -- I'm going back to our original investment. So 80% is owned by Jefferies Group. 20% is owned by Jefferies High Yield Trading, in which we have a 40-something percent economic interest. So it's the equivalent of our owning 87%, 88%, 89% of the overall position.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Okay. And more of a macro thought, we're kind of sitting in a unique position where risk asset prices keep going up. And historically, that's been good for volumes, but it hasn't really shown up yet. I know there's a lot of uncertainty out there, but can you give any color as to kind of what you're hearing from clients, be it Investment Banking or Trading, if there's any improvement in the risk appetite out there, if you're sensing anything?

Richard B. Handler

I think it's a pretty interesting and confusing time, because a lot of the indexes have ripped up this year, especially recently, and a lot of the long-only natural investors and a lot of the hedge funds have been very cautious. Well, the hedge funds have been very cautious, and they haven't fully participated and the long-only have held a disproportionate large amount of cash. So whether they catch up on that side or people continue to be prudent is anyone's guess, but it's a very confusing time for investors. I do believe with the systemic risk card [indiscernible] on the table, you're going to see people start to focus on fundamental values again. I think that's what's driving our increased volumes that we've seen out since September 1.

Jeffrey Harte - Sandler O'Neill + Partners, L.P., Research Division

Okay. And finally, I think this was mentioned earlier, but I want to make sure I got it right. As far as the tax rate as we're looking forward, is 36% still a decent place to be?

Peregrine C. de M. Broadbent

Yes. One can assume 36%, mid-30s going forward and if one makes assumptions about the mix of revenues by region and by business plans as well.

Operator

Your next question comes from the line of Meredith Whitney with Meredith Whitney.

Meredith Ann Whitney - Meredith Whitney Advisory Group LLC

[indiscernible] question like that. Could you give me that number and then give me an update on the business? And then give a strategic outlook, if you would, for 2013. Know we're a quarter away from when you would normally do that, but given you've had such a big year, I'd be curious and I think most people would be curious in terms of how you match that or how you -- what your intentions are in terms of how you're looking at '13 versus '12.

Richard B. Handler

We missed the first part of your question. So after we answer the second part, perhaps you could repeat the first part. The second part of the question, in terms of 2013, look, I mean we think we're really well positioned. A number of our bankers who have joined us over the course of the last 18 months are seasoned. Our trading platform is very well diversified. We have a solid presence in Europe. We have the beginnings of a solid presence in Asia from our investment. Our franchise and brand are strong. We don't need the wind at our back but if there's not a direct headwind at our face, we think that we have the ability to grow every one of our businesses in 2013. And so we're pretty pleased with that as well as our competitive position with a lot of the challenges from a regulatory perspective and a balance sheet management perspective that our competitors are facing going forward. So I feel like we're in a very good spot. I missed your first part of your question. I apologize.

Meredith Ann Whitney - Meredith Whitney Advisory Group LLC

Okay. The first part of the question was just the number of assets under management, followed with an update on the Asset Management business, your aspirations in that business. And then just to follow up on your last answer, which is QE3 makes everybody feel like a really smart trader, and that may have delayed some of the M&A expectations in terms of this industry. Could you give your thoughts on that and when you see the fade from that?

Peregrine C. de M. Broadbent

The assets under management, Meredith, are similar to the end of last quarter, $2.3 billion.

Richard B. Handler

In terms of talking about QE3 making everybody feel very smart, I had the exact comment with all of our traders to make sure we continue to turn over our inventory and make sure it aged -- never creeps up because there's a bid for every single risk asset. So I agree with you, QE3 does make everyone feel a little bit better and a little bit smarter. By the same token, there's no question that the system is flushed with liquidity, and people are looking to invest, and trading volumes are going to increase in my opinion.

Operator

Your next question comes from the line of Don Jens [ph] with Sterne Agee.

Unknown Analyst

A couple of quick questions. It seems as though your net interest income has stabilized over the last few quarters, certainly more so than over the last few years. Does the firm actively manage its interest rate sensitivity? And what do you expect -- how volatile do you expect that to be over the coming quarters?

Peregrine C. de M. Broadbent

Our net interest runs at, as you indicated, at sort of mid-$30 million for the last few quarters. I've anticipated the current balance sheet levels which have stabilized over the last year or so, we'd anticipate that figure being similar going forward. There's no active management of that particular number, indeed I sort of encourage people not necessarily to sort of focus on that figure. That said, we clearly manage interest rate sensitivity from a market risk perspective. And as Rich indicated earlier, reflected in our VaR, our market risk levels are very low, which is also indicative of the fact that our interest rate or sensitivity to interest rates is also very low.

Unknown Analyst

Okay. Second question, it seems as though Investment Banking has definitely picked up a great deal of momentum over the last few years, good stability. Do you see or anticipate in the industry any lift-out opportunities available as have happened in the past? Or is the investment-making franchise at a place that you're happy with?

Brian Paul Friedman

Yes. I'm not sure we're ever going to say we're happy and not wanting to do more. So I'd say we're never complacent, and we both want to achieve more with the team we have. And we're very open at all times to individuals that can be additive to what we're doing, whether they add sectoral dimension, or they help us open up a new market that, geographically, that we haven't had presence in. So I'd say we continue to be open to growth. I think that the reality is that over the last several years, we did substantial build-out of our sectoral footprint. And so the urgency is not as great as it was, but -- particularly individuals, that, that can be additive. We're still very open to, and you will see additions.

Richard B. Handler

From a product service and geographical perspective, I mean we do not have many holes in our organization. So I agree with what Brian just said, but it will be most likely individuals as opposed to large lift-outs at this point.

Operator

That does conclude our question-and-answer session for today. I hand the program back over to Mr. Handler for further comments or closing remarks.

Richard B. Handler

Thank you, everybody. We look forward to performing our best for the fourth quarter, and have a nice day.

Operator

That does conclude today's conference call. You may now disconnect.

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