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.”
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.
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.