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On Jefferies

Bruce Krasting's picture




 

This story got on the wild side yesterday. The stock broke for 20% in just 22 minutes. Then, just as fast, it came back and closed down a barely noticeable 2%. The rebound came after some "comforting" words by management. Some thoughts.

I will start on the plus side by saying that having Leucadia National (LUK) in the deal gives me comfort (LUK has a 28% stake in JEF). I've always known them to be a savvy bunch. They were willing to up the ante by another $12mm today. This makes me think that JEF is not the next crisis. That’s not to suggest that it's on my buy list.

While the market seemed very satisfied with the words from the company, I was left wondering what's going on.

The message that I got was:

 

“We’re fully hedged on $2.5b of investment grade EU sovereign bonds.” 



“Stop worrying!”


I don’t find that comforting at all. I get more worried when they say stuff like this.

This is simple. If Jefferies is hedged up AND both (all) legs of the sovereign bond positions have been MARKED to MARKET (as we have been told they have) then there is very little reason not to unwind this position. Yes, the actual unwind might result in an incremental loss, but if you believe that there are legit marks on this, then it should not be that big a deal.

If that were to happen JEF would get off the front pages and off of the “short” list. At one point today they lost 20% of their market cap. The bond positions on the books are simply not worth that kind of headache.

My first guess is that this is what we will get. In a week or so Jefferies will announce they have offloaded the positions the market does not like. If they don’t, we will see JEF back in the cross-hairs. I’m quite sure the guys at both Leucadia and Jefferies are well aware of this fact.

Say I’m right and this ends with an unwind. To me, there are very dark consequences to that outcome as well.

There is absolutely nothing wrong with capital that takes on risk in the pursuit of gain. Leveraging sovereign bonds is as old as the hills. It’s bread and butter for capital. If there are fewer risk takers, there will be less liquidity. Period. That translates to higher and higher borrowing costs for the sovereign issuers. The party will stop without the dancers.

I can’t see a soft landing to the JEF story. If they don’t clean up the books the market will grow suspicious (again) and junk the stock. If they do clean the books, dozens of global firms who make markets and take positions in Sov. bonds will have to back out. We may have a situation where the firms who do play in this space will have their stocks attacked. That road's a game ender.

 

Note:

We’re fairly close to the boiling point. I think things ratchet up another big notch if the Italian 10 year breaks through 6.75%. Last I saw, it was 6.20%. Dangerously close.

 

 

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Sat, 09/08/2012 - 03:09 | 2774073 bags
bags's picture

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Fri, 11/04/2011 - 14:15 | 1845558 Cthonic
Cthonic's picture

There is absolutely nothing wrong with capital that takes on risk in the pursuit of gain. Leveraging sovereign bonds is as old as the hills. It’s bread and butter for capital.

 

Except that it's not real capital that is taking these risks, it is cheap financing ultimately provided by Fed and guaranteed by taxpayers without their consent.

 

If there are fewer risk takers, there will be less liquidity. Period.

 

Gambling other people's borrowed funds (and getting paid regardless of the way the gamble turns out) is hardly risk taking.

 

That translates to higher and higher borrowing costs for the sovereign issuers. The party will stop without the dancers.

 

So be it.  Leverage is like an amplifier in a cyclic network with positive feedback.  For a given system's impedance, there is a threshold level of amplification which, when surpassed, the network will quickly be driven to saturation.  Saturation in the real world leads to component failure, which changes the topology of the network.  Failure can be localized, or cascade.  The powers-that-be can try either to save their (physical) necks, or to save the current finance model.  Which, as you say, is as old as the hills, and in need of some serious clean sheet re-architecting.

Fri, 11/04/2011 - 12:34 | 1845539 Augustus
Augustus's picture

The suggestion that Jefferies "get clean" by simply substantially unwinding the positions is a good one.  It reduces the leverage on the capital.  And it would allow them to be one of the first out the door.  Reducing positions has been suggested as the alternative for the BIG BANKS which are supposed to have larger capital bases or reduced leverage.  The govt. ministers believe they can command a capital raise and dilution.  The proper route might simply try to reduce requirements by reducing asset size.  That leads to bond sales and certainly not purchases.  Who could be the buyer for the off-loading and, following that, the new issuance?  ECB is already bankrupt with the writedowns they need to take on the belly full of Greek bonds they took in on that failed effort.  Now the focus shifts to supporting Italy.  Who will buy any more of this stuff when facing a big deleveraging on the way?

Fri, 11/04/2011 - 11:59 | 1845395 DOT
DOT's picture

Are we to expect another big reverse repo week at the Fed ?

Seems like the liquidity to prop the market is disappearing.

 

 

fd: I need guidance, I watched the Obama kiss the Cannes;my brain hurts.

Fri, 11/04/2011 - 10:38 | 1845110 Chappy
Chappy's picture

Now I'm short Jef and LUK.  Anyone else care to suggest some crappy firms they expect to go next?  I've tried making intelliegent guess and random guesses and lose money either way.  I figure any guess on here is at least a 50/50 for going under so I'm in.

Fri, 11/04/2011 - 10:54 | 1845186 prains
prains's picture

chappy you're operating in a 5/95 pond and your "alpha"is the small side. there is no 50/50, better to buy lotto, odds will be more in your favour.

Fri, 11/04/2011 - 10:07 | 1844945 boiltherich
boiltherich's picture

When the euro goes away JEF and anyone else playing in the euro bond market is going to be destroyed and anyone invested in them will also be destroyed.  Then we will see if the risk/return ratio justified the confidence.  Of course they will get made whole via massive bailouts by you and me the taxpayers.  But that is another topic.  When this happens CDS insurance will not be able to pay, the scope will just be to great. 

Fri, 11/04/2011 - 10:04 | 1844931 Hephasteus
Hephasteus's picture

Another great post bruce.

There's no such thing as fully hedged. Risk can not be created or destroyed. Only transfered.

Fri, 11/04/2011 - 09:57 | 1844868 Mercury
Mercury's picture

 Yes, the actual unwind might result in an incremental loss, but if you believe that there are legit marks on this, then it should not be that big a deal.

Or a big loss.  How low do you have to go hitting bids to get out of that amount of Euro (and which ones?) sovereign debt these days?

Fri, 11/04/2011 - 11:32 | 1845301 Bruce Krasting
Bruce Krasting's picture

Well you ask an excellent question. We are talking about a $2,5b "matched book". That is not a big deal. To buy or sell $1b of Bunds is a 3 second phone call (or just electric). So if you're right and the issue is liquidity and JEF can't trade out of this without a massive hit we are dead dead dead.

That would mean that the EU debt market is completely dis-functional.

Fri, 11/04/2011 - 09:32 | 1844797 handex
handex's picture

who did they hedge with? who is the counterparty on the hedge?

 

Fri, 11/04/2011 - 09:24 | 1844763 Prophetwithoutprofit
Prophetwithoutprofit's picture

I will start by saying I do not know anything about hedging sovereign bonds.  I did observe the EU play fast and loose with the issue of Greek default, engineering a 50% haircut and not triggering the CDS protections.  How can any dealer/investment firm say there are fully hedged when you do not know when the politicians will change the rules or jerry rig a solution depriving the hedger of protetction? Wouldn't this effectively destroy the sovereign market and firms dealing in their bonds

Fri, 11/04/2011 - 09:22 | 1844756 MobBarley
MobBarley's picture

You lost me at 'investment grade'

 

Fri, 11/04/2011 - 09:19 | 1844738 El Oregonian
El Oregonian's picture

It only gets bitter from here.

Fri, 11/04/2011 - 09:01 | 1844657 disabledvet
disabledvet's picture

JEF seems to me like the smallest of fish in smallest of fish tanks packed with the biggest of predators. we'll see but i agree...their existence is always threatened...and now they are vulnerable. Thanks John Corzine!

Fri, 11/04/2011 - 08:34 | 1844529 Mister Ponzi
Mister Ponzi's picture

Jefferies has been aggressively expanding into market making in European bonds. Consequently, as the company pointed out, their sovereign holdings are market maker inventories. Why, then, is the company supposed to drop these holding?

Fri, 11/04/2011 - 08:13 | 1844450 Clowns on Acid
Clowns on Acid's picture

Bruce if JEF is hedged on a 1:1 basis (more of a sov pairs trade), why wouldn't they maintain their position?

Are you suggesting that any Inv bank with a hedged or pairs trade in Sov begin to unwind?

I may agree from a concentration / liquidity point of view, but from a price risk point of view, I wouldn't think that you or I or any investor has enough info to make that call.

Fri, 11/04/2011 - 11:34 | 1844439 HD
HD's picture

Why is 6.75% significant?

Fri, 11/04/2011 - 11:35 | 1845319 Bruce Krasting
Bruce Krasting's picture

Because it's a line in the sand. It will be a point where margin requirements on collateral will be raised. That will create more selling.

Fri, 11/04/2011 - 11:47 | 1845358 HD
HD's picture

Thanks - appreciate all of your posts.

Fri, 11/04/2011 - 08:12 | 1844433 gangland
gangland's picture

6.24800 +0.05400 +0.87%

it's selling off scary took about 10 minutes to go from 6.239 to 6.248

Fri, 11/04/2011 - 08:29 | 1844516 gangland
gangland's picture

6.26500 0.07100 1.15%

Fri, 11/04/2011 - 08:35 | 1844535 gangland
gangland's picture

6.2600 0.07500 1.21%

Fri, 11/04/2011 - 08:39 | 1844551 gangland
gangland's picture

6.27100 0.07700 1.24%

Fri, 11/04/2011 - 08:44 | 1844579 gangland
gangland's picture

6.27200 0.07800 1.26%

Fri, 11/04/2011 - 09:06 | 1844678 gangland
gangland's picture

6.3200 0.12600 2.03%

Fri, 11/04/2011 - 09:08 | 1844687 gangland
gangland's picture

6.3400 0.14600 2.36%

Fri, 11/04/2011 - 09:09 | 1844694 gangland
gangland's picture

6.35100 0.15700 2.54%

Fri, 11/04/2011 - 12:04 | 1845415 LongBallsShortBrains
LongBallsShortBrains's picture

You'll never keep up with the ticker

Fri, 11/04/2011 - 12:24 | 1845456 Bananamerican
Bananamerican's picture

where else can you find a picture of the dude's balls under 7 amerikanazi flags?

This is...ZEROHEDGE

Fri, 11/04/2011 - 08:07 | 1844418 williambanzai7
williambanzai7's picture

It can't be good Toto.

Fri, 11/04/2011 - 08:54 | 1844620 disabledvet
disabledvet's picture

that's the name of the lawyer isn't it?

Fri, 11/04/2011 - 11:42 | 1845341 Don Birnam
Fri, 11/04/2011 - 08:01 | 1844401 apberusdisvet
apberusdisvet's picture

 

If the great derivative unwind begins, it will soon be obvious that there is no such thing as a "hedge" without risk.  All it will take is one of the counterparties going BK (AIG anyone?) and the dominoes will start tippling.

Fri, 11/04/2011 - 08:55 | 1844626 disabledvet
disabledvet's picture

yeah i didn't hear "we have 10 tons of gold as collateral" blow out of JEF's mouth. This is true.

Fri, 11/04/2011 - 08:00 | 1844398 Desert Irish
Desert Irish's picture

Thanks Bruce,

Question - At what yield do you think the ECB will throw in the towel or be unable to continue purchasing Italian 10 year bonds?

Fri, 11/04/2011 - 10:49 | 1845167 prains
prains's picture

Question - At what yield do you think the ECB will throw in the towel or be unable to continue purchasing Italian 10 year bonds?

 

when they can no longer pay the power bill to run the Heidelbergs...................infinity and beyond

Fri, 11/04/2011 - 07:51 | 1844369 max2205
max2205's picture

Being public is never worth the crap you got to put up with

Fri, 11/04/2011 - 09:02 | 1844659 ThisIsBob
ThisIsBob's picture

Try telling that to the kids at Groupon this morning.

Fri, 11/04/2011 - 09:28 | 1844777 Dr. No
Dr. No's picture

Its a sugar high.  Ask them in 1 year when the complimentry yogurt and trail mix is takenn away from the break room.  2 years from now, the unlimited vacation will be switched to PTO use-it-or-loose-it two weeks.

Not saying its bad.  But give me an example of bennies being increased after going public.

Fri, 11/04/2011 - 11:53 | 1845373 DOT
DOT's picture

Wait ! Unlimited trail mix is a vested RIGHT !  Er, for the Corp. Officers, that is.

Fri, 11/04/2011 - 10:47 | 1845160 ThisIsBob
ThisIsBob's picture

You are giving them 2 years?  Well, God bless you.

Fri, 11/04/2011 - 07:45 | 1844352 MrSteve
MrSteve's picture

Again, BK breaks it down like a seminar on Kindleberger's work. Revulsion and cries of "off with their heads" related to scandals are part of panic cycles. Seeing a panic in internet time requires keen thinking.

The imploding sovereign bond collapse points to a deepening depression, world-wide.

Bruce is one of the best weathermen forecasting on ZH! Thanks for the insights.

Fri, 11/04/2011 - 08:51 | 1844610 covert
covert's picture

govts always default. so there really isn't a bond.

http://expose2.wordpress.com

 

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