On one hand, the Q2 earnings reported by the last “pure play” investment bank – one with a 1 month leading quarter end as per the pre-new normal tradition and thus a key indicator of what is to come for the rest of Wall Street – were not bad: Jefferies reported a 29.4% increase in overall quarterly profit (even with a recent 6% increase in the company’s tax rate) thanks to a 39% bounce in investment banking revenue, i.e. M&A and underwriting fees, to $351.9 million in the quarter, primarily reflecting an “improved environment” for debt and equity new issuance according to CEO Dick Handler.
That was the good news.
The neutral news is that revenue from equities (when stripping away one-time benefits from the sale of KCG) was roughly flat, at $175.5MM in the quarter, up fractionally from $167.5MM one year ago. Total equity revenues were $271.5 million but including $96 million in mark-to-market gain on Jefferies’ 24% equity ownership of KCG Holdings vs $223.5 million a year ago (with $56m KCG markup). According to Handler, the core equity sales/trading business “enjoyed a solid quarter and, despite quiet market activity and low volatility, our global cash businesses continued to gain market share.”
But the bad news, and a confirmation of recent warnings from JPM and BofA, was that the recent boost in fixed income revenue, Wall Street’s most profitable segment, tumbled by 33% in the second quarter, dropping from $238.5 million to $158.6 million Y/Y, and down from $221.9 million last quarter.
Discussing the sharp drop in fixed income revenue, the Leucadia subsidiary said that “Fixed Income revenues were $159 million for the quarter as lower volumes and lower volatility prevailed throughout much of the quarter.”
The problem for the rest of Wall Street is that “lower volumes and lower volatility” were endemic for everyone, impacting the rest of the banks equally, which coupled with the ongoing flattening of the yield curve – recall banks surged when the curve steepened, but then forgot to drop when it contracted…
… means that bank earnings reports next months will likely be even worse than what many analysts expect.
Finally, Jefferies had an interesting disclosure on why it ended up paying a far higher tax rate this quarter compared to others:
Our tax expense for the quarter was $46 million, or about 40% of pre-tax profits. Following recently enacted legislation from New York State and New York City, our tax expense includes a net charge of $7 million that reflects the revaluation of a portion of our net deferred tax asset, which was partially offset by current year reduced state and local tax rates. The impact of this legislation will reduce the income apportioned to these jurisdictions going forward and thereby reduce our effective tax rate.
While we are not sure precisely what legislation Jefferies refers to, one wonders how many other companies will follow in the bank’s footsteps and “apportion” far less jurisdiction to New York State and City going forward, potentially resulting in a fiscal crisis for the largest US fiscal economy.
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