On several prior occasions (here and here) we have explained why Jefferies, as the last "pure-play" investment bank left standing, and thus with a one-month offset fiscal year-end calendar, is a great harbinger of Wall Street's reporting season: "it provides an invaluable glimpse into the fortunes of its Wall Street peers with a 4 week advance notice."
Earlier today, Jefferies which is now a part of Leucadia, provided this much anticipated glimpse into how the rest of Wall Street is doing. The answer, if Jefferies is any indication, is "quote horribly" because just like two of the past four quarters, Q3 was also a disaster and indicative of nothing short of a trading bloodbath on Wall Street in the past three months of trading and especially August.
In fact, it was so bad for Jefferies, it reported a massive 31% plunge in total revenues down to $579 million resulting in net income of a tiny $2.5 million as a result of what may be only its first negative fixed income revenue print since the financial crisis.
Wait, how can revenue be negative? Simple: when a bank passes its prop trading losses through the top line and after quarters of delaying, finally marks its energy junk bond book to market. To wit from today's 8-K:
“Fixed Income net revenues were negative $14 million for the quarter, reflecting the slow environment and the volatility that resulted in mark-to-market write-downs in our inventory. Trading results of our high yield distressed sales and trading business for the quarter particularly impacted our results negatively. As is the nature of the distressed market making business, Jefferies assumes positions in sectors where the firm's clients and the market are most active, with mark to market gains and losses recognized on a daily basis. During the last nine months, losses totaling $90 million were recorded across more than 25 distressed energy positions. For the nine month period we recognized negative revenues in respect of the ten largest individual loss-making positions of about $4 million to $19 million each, or an average of about $8 million. These markdowns, combined with lower activity levels and more modest inventory write downs in several other areas of our global fixed income business, accounted for much of the balance of negative pressure on our fixed income results. As one of the leading investment banking platforms serving the energy sector, with meaningful recent involvement in restructurings and financings, we continue to be committed to our energy clients.”
“We believe most of the issues we faced this past quarter in Fixed Income were due to distinct factors that began about a year ago and the largest portion of which relates to the turmoil in the oil and gas industry. For the first nine months of 2015, we have provided liquidity and traded approximately $5 billion in distressed energy securities for our clients. Our exposures in our distressed energy trading business decreased approximately 50% during the quarter and are currently down to $70 million in total net market value. We believe that, with our exposures in distressed securities reduced to current levels, there should be no similar impact on our future results.”
Oh, so that's why Volcker warned against prop trading. Well, Jefferies not having its ATMs, was exempt from the prop trading prohibition resulting in the above charts. Although the question remains: why did Jefferies wait so many quarters before finally writing down its massively money-losing positions?
The question then emerges: how many of the FDIC-insured banks reporting in 1 month will admit they too were quietly harboring their own secret prop trading desks in violation of the Volcker Rule, and just how bad will revenues end up being. We already know Citi and Bank of America: both admitted Q3 trading revenue will drop at least 5%. The question, since the long-end has barely budged, is how will banks offset this drop in trading revenue with the traditional bank revenue stream, rising Net Interest Margin, failing to kick in for the 7th year in a row.
The answer will be revealed in just a few more weeks when what is set to be the worst earnings season for the S&P 500 in years begins in earnest.