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Section 1: 10-Q (JEFFERIES FINANCIAL GROUP INC. 2ND QTR. 2018 FORM 10-Q)

Document


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C.  20549
__________
FORM 10-Q
 
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
 
[  ]
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                        to

Commission File Number 1-5721
JEFFERIES FINANCIAL GROUP INC.
(Exact name of registrant as specified in its Charter)
New York
(State or other jurisdiction of
13-2615557
(I.R.S. Employer
incorporation or organization)
Identification Number)
 
 
520 Madison Avenue, New York, New York
(Address of principal executive offices)
10022
(Zip Code)
(212) 460-1900
(Registrant’s telephone number, including area code)

Leucadia National Corporation
(Former name, former address and former fiscal year, if changed since last report)
______________________

Indicate by check mark whether the registrant:  (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No o

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).
Yes x No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company.  See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  x
Accelerated filer o
Non-accelerated filer    o
 
 
(Do not check if a smaller reporting company)
Smaller reporting company  o
Emerging growth company  o
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o No x

The number of shares outstanding of each of the issuer’s classes of common stock at July 25, 2018 was 333,332,094.




PART I. FINANCIAL INFORMATION

Item I. Financial Statements.
 
JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Financial Condition
June 30, 2018 and December 31, 2017
(Dollars in thousands, except par value)
(Unaudited)
 
June 30,
 
December 31,
 
2018
 
2017
ASSETS
 
 
 
Cash and cash equivalents
$
4,741,057

 
$
5,275,480

Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations
709,646

 
578,014

Financial instruments owned, including securities pledged of $11,079,600 and $10,842,051:
 

 
 

Trading assets, at fair value
18,318,992

 
16,082,676

Available for sale securities
1,242,475

 
716,561

Total financial instruments owned
19,561,467


16,799,237

Loans to and investments in associated companies
2,522,944

 
2,066,829

Securities borrowed
7,599,043

 
7,721,803

Securities purchased under agreements to resell
3,822,232

 
3,689,559

Receivables
5,876,389

 
5,419,015

Property, equipment and leasehold improvements, net
353,553

 
750,403

Intangible assets, net and goodwill
1,901,352

 
2,463,180

Deferred tax asset, net
537,063

 
743,811

Assets held for sale
249,825

 

Other assets
1,527,227

 
1,661,777

Total assets (1)
$
49,401,798


$
47,169,108

 
 
 
 
LIABILITIES
 

 
 

Short-term borrowings
$
506,218

 
$
436,215

Trading liabilities, at fair value
10,183,242

 
8,454,965

Securities loaned
2,555,701

 
2,843,911

Securities sold under agreements to repurchase
8,773,506

 
8,660,511

Other secured financings
1,464,571

 
1,029,485

Payables, expense accruals and other liabilities
7,496,897

 
7,167,666

Long-term debt
7,714,970

 
7,885,783

Total liabilities (1)
38,695,105


36,478,536

 
 
 
 
Commitments and contingencies


 


 
 
 
 
MEZZANINE EQUITY
 

 
 

Redeemable noncontrolling interests
14,252

 
426,593

Mandatorily redeemable convertible preferred shares
125,000

 
125,000

 
 
 
 
EQUITY
 

 
 

Common shares, par value $1 per share, authorized 600,000,000 shares; 333,310,944 and 356,227,038 shares issued and outstanding, after deducting 83,558,159 and 60,165,980 shares held in treasury
333,311

 
356,227

Additional paid-in capital
4,366,631

 
4,676,038

Accumulated other comprehensive income
314,973

 
372,724

Retained earnings
5,523,277

 
4,700,968

Total Jefferies Financial Group Inc. shareholders’ equity
10,538,192


10,105,957

Noncontrolling interests
29,249

 
33,022

Total equity
10,567,441


10,138,979

 
 
 
 
Total
$
49,401,798

 
$
47,169,108


(1)
Total assets include assets related to variable interest entities of $543.2 million and $382.9 million at June 30, 2018 and December 31, 2017, respectively, and Total liabilities include liabilities related to variable interest entities of $1,465.8 million and $1,031.0 million at June 30, 2018 and December 31, 2017, respectively. See Note 8 for additional information related to variable interest entities.

See notes to interim consolidated financial statements.

2



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Operations
For the periods ended June 30, 2018 and 2017
(In thousands, except per share amounts)
(Unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
 
2018
 
2017
 
2018
 
2017
Revenues:
 
 
 
 
 
 
 
Commissions and other fees
$
157,704

 
$
152,643

 
$
305,606

 
$
298,465

Principal transactions
53,755

 
225,234

 
199,418

 
641,637

Investment banking
500,297

 
351,863

 
940,288

 
759,884

Interest income
327,314

 
249,543

 
602,536

 
473,056

Manufacturing revenues
114,735

 
81,329

 
213,100

 
161,543

Other
90,021

 
53,584

 
143,989

 
298,524

Total revenues
1,243,826


1,114,196

 
2,404,937

 
2,633,109

Interest expense of Jefferies Group
332,667

 
257,335

 
598,343

 
469,722

Net revenues
911,159


856,861

 
1,806,594

 
2,163,387

 
 
 
 
 
 
 
 
Expenses:
 

 
 

 
 

 
 

Compensation and benefits
478,515

 
480,887

 
968,174

 
974,902

Cost of sales
90,690

 
69,982

 
172,625

 
139,238

Floor brokerage and clearing fees
45,046

 
44,435

 
87,222

 
90,293

Interest expense
24,279

 
25,580

 
45,777

 
51,150

Depreciation and amortization
31,905

 
26,258

 
60,065

 
53,369

Selling, general and other expenses
236,562

 
177,566

 
462,906

 
352,714

Total expenses
906,997


824,708

 
1,796,769

 
1,661,666

 
 
 
 
 
 
 
 
Income from continuing operations before income taxes and income (loss) related to associated companies
4,162

 
32,153

 
9,825

 
501,721

Income (loss) related to associated companies
33,353

 
14,104

 
65,453

 
(114,470
)
Income from continuing operations before income taxes
37,515


46,257

 
75,278

 
387,251

Income tax provision (benefit)
9,598

 
26,185

 
(38,831
)
 
117,428

Income from continuing operations
27,917


20,072

 
114,109

 
269,823

Income from discontinued operations, net of income tax provision of $31,111, $24,435, $47,045 and $37,366
77,106

 
53,990

 
130,063

 
98,162

Gain on disposal of discontinued operations, net of income tax provision of $229,553, $0, $229,553 and $0
643,921

 

 
643,921

 

Net income
748,944


74,062

 
888,093

 
367,985

Net (income) loss attributable to the noncontrolling interests
(136
)
 
1,446

 
1,208

 
1,969

Net income attributable to the redeemable noncontrolling interests
(22,108
)
 
(16,300
)
 
(36,904
)
 
(28,322
)
Preferred stock dividends
(1,171
)
 
(1,015
)
 
(2,343
)
 
(2,031
)
 
 

 
 

 
 

 
 

Net income attributable to Jefferies Financial Group Inc. common shareholders
$
725,529


$
58,193

 
$
850,054

 
$
339,601

 
 
 
 
 
 
 
 

(continued)











See notes to interim consolidated financial statements.

3



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Operations, continued
For the periods ended June 30, 2018 and 2017
(In thousands, except per share amounts)
(Unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Basic earnings per common share attributable to Jefferies Financial Group Inc. common shareholders:
 
 
 
 
 
 
 
Income from continuing operations
$
0.08

 
$
0.06

 
$
0.31

 
$
0.73

Income from discontinued operations
0.15

 
0.10

 
0.26

 
0.19

Gain on disposal of discontinued operations
1.82

 

 
1.79

 

Net income
$
2.05

 
$
0.16

 
$
2.36

 
$
0.92

 
 
 
 
 
 
 
 
Diluted earnings per common share attributable to Jefferies Financial Group Inc. common shareholders:
 
 
 
 
 
 
 
Income from continuing operations
$
0.08

 
$
0.06

 
$
0.31

 
$
0.72

Income from discontinued operations
0.15

 
0.10

 
0.25

 
0.19

Gain on disposal of discontinued operations
1.80

 

 
1.77

 

Net income
$
2.03

 
$
0.16

 
$
2.33

 
$
0.91

 
 
 
 
 
 
 
 
Dividends per common share
$
0.1000

 
$
0.0625

 
$
0.2000

 
$
0.1250

 
 
 
 
 
 
 
 
Amounts attributable to Jefferies Financial Group Inc. common shareholders:
 
 
 
 
 
 
 
Income from continuing operations, net of taxes
$
27,193

 
$
20,612

 
$
113,211

 
$
269,897

Income from discontinued operations, net of taxes
54,415

 
37,581

 
92,922

 
69,704

Gain on disposal of discontinued operations, net of taxes
643,921

 

 
643,921

 

Net income
$
725,529

 
$
58,193

 
$
850,054

 
$
339,601




























See notes to interim consolidated financial statements.

4



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Comprehensive Income (Loss)
For the periods ended June 30, 2018 and 2017
(In thousands)
(Unaudited)
 
For the Three Months Ended June 30,
 
For the Six Months Ended June 30,
 
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
Net income
$
748,944

 
$
74,062

 
$
888,093

 
$
367,985

Other comprehensive income (loss):
 

 
 

 
 

 
 

Net unrealized holding gains (losses) on investments arising during the period, net of income tax provision (benefit) of $227, $(203), $(143) and $5,704
818

 
(346
)
 
(408
)
 
9,797

Less: reclassification adjustment for net (gains) losses included in net income, net of income tax provision of $42, $282, $37 and $271
(118
)
 
(485
)
 
(103
)
 
(467
)
Net change in unrealized holding gains (losses) on investments, net of income tax provision (benefit) of $185, $(485), $(180) and $5,433
700


(831
)
 
(511
)
 
9,330

 
 
 
 
 
 
 
 
Net unrealized foreign exchange gains (losses) arising during the period, net of income tax provision (benefit) of $(2,719), $(10,066), $(793) and $(8,555)
(49,310
)
 
37,893

 
(31,407
)
 
37,875

Less: reclassification adjustment for foreign exchange (gains) losses included in net income, net of income tax provision (benefit) of $(16), $0, $(16) and $1,097
(20,459
)
 

 
(20,459
)
 
5,290

Net change in unrealized foreign exchange gains (losses), net of income tax provision (benefit) of $(2,703), $(10,066), $(777) and $(9,652)
(69,769
)

37,893

 
(51,866
)
 
43,165

 
 
 
 
 
 
 
 
Net unrealized gains (losses) on instrument specific credit risk arising during the period, net of income tax provision (benefit) of $8,875, $(1,074), $4,241 and $(7,419)
26,287

 
(2,683
)
 
14,718

 
(12,378
)
Less: reclassification adjustment for instrument specific credit risk (gains) losses included in net income, net of income tax provision of $78, $0, $78 and $0
(270
)
 

 
(270
)
 

Net change in unrealized instrument specific credit risk gains (losses), net of income tax provision (benefit) of $8,797, $(1,074), $4,163 and $(7,419)
26,017


(2,683
)
 
14,448

 
(12,378
)
 
 
 
 
 
 
 
 
Net change in unrealized cash flow hedges gains (losses), net of income tax provision (benefit) of $(721), $0, $513 and $0
251

 

 
1,499

 

 
 
 
 
 
 
 
 
Reclassification adjustment for pension (gains) losses included in net income, net of income tax provision (benefit) of $(188), $(199), $(339) and $(1,634)
457

 
426

 
6,263

 
(372
)
 
 
 
 
 
 
 
 
Other comprehensive income (loss), net of income taxes
(42,344
)

34,805

 
(30,167
)
 
39,745

 
 
 
 
 
 
 
 
Comprehensive income
706,600


108,867

 
857,926

 
407,730

Comprehensive (income) loss attributable to the noncontrolling interests
(136
)
 
1,446

 
1,208

 
1,969

Comprehensive income attributable to the redeemable noncontrolling interests
(22,108
)
 
(16,300
)
 
(36,904
)
 
(28,322
)
Preferred stock dividends
(1,171
)
 
(1,015
)
 
(2,343
)
 
(2,031
)
 
 
 
 
 
 
 
 
Comprehensive income attributable to Jefferies Financial Group Inc. common shareholders
$
683,185


$
92,998

 
$
819,887

 
$
379,346













See notes to interim consolidated financial statements.

5



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the six months ended June 30, 2018 and 2017
(In thousands)
(Unaudited)
 
2018
 
2017
Net cash flows from operating activities:
 
 
 
Net income
$
888,093

 
$
367,985

Adjustments to reconcile net income to net cash provided by (used for) operations:
 

 
 

Pre-tax income from discontinued operations, including gain on disposal
(1,050,582
)
 
(135,176
)
Deferred income tax provision
203,493

 
131,957

Depreciation and amortization of property, equipment and leasehold improvements
52,516

 
44,724

Other amortization
(15,748
)
 
(14,162
)
Share-based compensation
25,198

 
20,375

Provision for doubtful accounts
16,647

 
17,579

(Income) loss related to associated companies
(90,287
)
 
59,975

Distributions from associated companies
42,952

 
34,463

Net (income) losses related to property and equipment, and other assets
9,006

 
(125
)
Gain on sale of subsidiary

 
(178,236
)
Net change in:
 
 
 
Securities deposited with clearing and depository organizations
64,880

 
108

Trading assets
(2,245,744
)
 
(278,135
)
Securities borrowed
97,924

 
(143,554
)
Securities purchased under agreements to resell
(176,922
)
 
(452,154
)
Receivables from brokers, dealers and clearing organizations
(187,663
)
 
(969,962
)
Receivables from customers of securities operations
(419,506
)
 
(379,669
)
Other receivables
(86,984
)
 
(146,693
)
Other assets
(57,380
)
 
(161,807
)
Trading liabilities
1,799,908

 
683,987

Securities loaned
(266,028
)
 
616,701

Securities sold under agreements to repurchase
139,287

 
1,818,042

Payables to brokers, dealers and clearing organizations
518,671

 
(969,230
)
Payables to customers of securities operations
489,060

 
300,774

Trade payables, expense accruals and other liabilities
(351,950
)
 
107,562

Other
(87,605
)
 
20,585

Net cash provided by (used for) operating activities - continuing operations
(688,764
)

395,914

Net cash provided by operating activities - discontinued operations
164,650

 
77,578

Net cash provided by (used for) operating activities
(524,114
)
 
473,492

 
 
 
 
Net cash flows from investing activities:
 

 
 

Acquisitions of property, equipment and leasehold improvements, and other assets
(240,864
)
 
(63,574
)
Proceeds from disposals of property and equipment, and other assets
8,138

 
21,229

Proceeds from sale of subsidiary, net of expenses and cash of operations sold

 
289,767

Advances on notes, loans and other receivables

 
(41,456
)
Collections on notes, loans and other receivables
11,785

 
171,320

Loans to and investments in associated companies
(1,921,671
)
 
(2,756,274
)
Capital distributions and loan repayments from associated companies
1,925,104

 
2,595,676

Purchases of investments (other than short-term)
(1,961,344
)
 
(522,310
)
Proceeds from maturities of investments
370,360

 
112,455

Proceeds from sales of investments
955,785

 
409,881

Other
1

 
1,250

Net cash provided by (used for) investing activities - continuing operations
(852,706
)

217,964

Net cash provided by (used for) investing activities - discontinued operations
860,827

 
(22,165
)
Net cash provided by investing activities
8,121

 
195,799

(continued)


See notes to interim consolidated financial statements.

6



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows, continued
For the six months ended June 30, 2018 and 2017
(In thousands)
(Unaudited)
 
2018
 
2017
Net cash flows from financing activities:
 
 
 
Issuance of debt, net of issuance costs
$
1,863,299

 
$
1,013,886

Other changes in short-term borrowings, net

 
(85,158
)
Repayment of debt
(1,585,149
)
 
(346,838
)
Net change in other secured financings
434,188

 
(264,016
)
Net change in bank overdrafts
(2,722
)
 
(1,544
)
Distributions to noncontrolling interests

 
(9,347
)
Contributions from noncontrolling interests
113

 
24,669

Purchase of common shares for treasury
(562,429
)
 
(32,126
)
Dividends paid
(70,050
)
 
(45,409
)
Other
1,281

 
899

Net cash provided by financing activities - continuing operations
78,531

 
255,016

Net cash provided by (used for) financing activities - discontinued operations
120,322

 
(11,748
)
Net cash provided by financing activities
198,853

 
243,268

 
 
 
 
Effect of foreign exchange rate changes on cash, cash equivalents and restricted cash
(9,582
)
 
4,895

 
 
 
 
Change in cash classified as assets held for sale

 
(3,136
)
 
 
 
 
Net increase in cash, cash equivalents and restricted cash
(326,722
)
 
914,318

 
 

 
 

Cash, cash equivalents and restricted cash at January 1,
5,774,505

 
4,597,113

 
 

 
 

Cash, cash equivalents and restricted cash at June 30,
$
5,447,783

 
$
5,511,431


The following presents our cash, cash equivalents and restricted cash by category within the Consolidated Statements of Financial Condition to the total of the same amounts in the Consolidated Statements of Cash Flows above (in thousands):
 
June 30, 2018
 
June 30, 2017
Cash and cash equivalents
$
4,741,057

 
$
4,661,937

Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations
674,796

 
819,226

Other assets
31,930

 
30,268

Total cash, cash equivalents and restricted cash
$
5,447,783

 
$
5,511,431













See notes to interim consolidated financial statements.

7



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Equity
For the six months ended June 30, 2018 and 2017
(In thousands, except par value and per share amounts)
(Unaudited)

 
Jefferies Financial Group Inc. Common Shareholders
 
 
 
 
 
Common
Shares
$1 Par
Value
 
Additional
Paid-In
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Retained
Earnings
 
Subtotal
 
Noncontrolling
Interests
 
Total
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2017
$
359,425

 
$
4,812,587

 
$
310,697

 
$
4,645,391

 
$
10,128,100

 
$
175,549

 
$
10,303,649

Net income
 

 
 

 
 

 
339,601

 
339,601

 
(1,969
)
 
337,632

Other comprehensive income, net of taxes
 

 
 

 
39,745

 
 

 
39,745

 
 

 
39,745

Contributions from noncontrolling interests
 

 
 

 
 

 
 

 

 
24,669

 
24,669

Distributions to noncontrolling interests
 

 
 

 
 

 
 

 

 
(9,347
)
 
(9,347
)
Change in interest in consolidated subsidiary
 

 
44

 
 

 
 

 
44

 
(44
)
 

Share-based compensation expense
 

 
20,375

 
 

 
 

 
20,375

 
 

 
20,375

Change in fair value of redeemable noncontrolling interests
 

 
39,965

 
 

 
 

 
39,965

 
 

 
39,965

Purchase of common shares for treasury
(1,359
)
 
(32,713
)
 
 

 
 

 
(34,072
)
 
 

 
(34,072
)
Dividends ($.125 per common share)
 

 
 

 
 

 
(46,738
)
 
(46,738
)
 
 

 
(46,738
)
Other
579

 
3,708

 
 

 
 

 
4,287

 


 
4,287

Balance, June 30, 2017
$
358,645


$
4,843,966


$
350,442


$
4,938,254


$
10,491,307


$
188,858


$
10,680,165

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance, January 1, 2018
$
356,227

 
$
4,676,038

 
$
372,724

 
$
4,700,968

 
$
10,105,957

 
$
33,022

 
$
10,138,979

Cumulative effect of the adoption of accounting standards
 
 
 
 
(27,584
)
 
45,396

 
17,812

 
 

 
17,812

Balance, January 1, 2018, as adjusted
356,227

 
4,676,038

 
345,140

 
4,746,364

 
10,123,769

 
33,022

 
10,156,791

Net income
 

 
 

 
 

 
850,054

 
850,054

 
(1,208
)
 
848,846

Other comprehensive loss, net of taxes
 

 
 

 
(30,167
)
 
 

 
(30,167
)
 
 

 
(30,167
)
Contributions from noncontrolling interests
 

 
 

 
 

 
 

 

 
113

 
113

Reversal of cumulative National Beef redeemable noncontrolling interests fair value adjustments prior to deconsolidation
 

 
237,669

 
 

 
 

 
237,669

 

 
237,669

Change in interest in consolidated subsidiary
 

 
2,677

 
 

 
 

 
2,677

 
(2,677
)
 

Share-based compensation expense
 

 
25,198

 
 

 
 

 
25,198

 
 

 
25,198

Change in fair value of redeemable noncontrolling interests
 

 
(21,404
)
 
 

 
 

 
(21,404
)
 
 

 
(21,404
)
Purchase of common shares for treasury
(24,249
)
 
(562,102
)
 
 

 
 

 
(586,351
)
 
 

 
(586,351
)
Dividends ($.20 per common share)
 

 
 

 
 

 
(73,141
)
 
(73,141
)
 
 

 
(73,141
)
Other
1,333

 
8,555

 
 

 
 

 
9,888

 
(1
)
 
9,887

Balance, June 30, 2018
$
333,311


$
4,366,631


$
314,973


$
5,523,277


$
10,538,192


$
29,249


$
10,567,441












See notes to interim consolidated financial statements.

8



JEFFERIES FINANCIAL GROUP INC. AND SUBSIDIARIES
Notes to Consolidated Financial Statements


Note 1.  Nature of Operations

Jefferies Financial Group Inc. ("Jefferies" or the "Company"), formerly known as Leucadia National Corporation, is a diversified financial services company engaged in investment banking and capital markets, merchant banking and the early stages of building an alternative asset management platform. Our financial services businesses and subsidiaries include Jefferies Group (investment banking and capital markets), Leucadia Asset Management (alternative asset management), Berkadia (commercial mortgage banking, investment sales and servicing), HomeFed (real estate), FXCM (provider of online foreign exchange trading services) and Foursight Capital (vehicle finance).
Our merchant banking portfolio includes equity interests in NYSE-listed Spectrum Brands (consumer products), National Beef (beef processing), Vitesse Energy Finance and JETX Energy (oil and gas), Linkem (fixed wireless broadband services in Italy), Idaho Timber (manufacturing) and Golden Queen (gold and silver mining).
From time to time, we evaluate the retention and disposition of businesses and investments, and changes in the mix of these holdings should be expected.
We own 31% of National Beef Packing Company. National Beef processes and markets fresh and chilled boxed beef, ground beef, beef by-products, consumer-ready beef and pork, and wet blue leather for domestic and international markets. On June 5, 2018, we completed the sale of 48% of National Beef to Marfrig Global Foods S.A. ("Marfrig") for $907.7 million in cash, reducing our ownership in National Beef from 79% to 31%. The pre-tax gain recognized as a result of this transaction is $873.5 million for the three and six months ended June 30, 2018. During 2018, prior to the closing, we received an additional $229.4 million in distributions of recent profits plus a true-up to the debt amount set in the enterprise valuation associated with the sale. Marfrig has also acquired a further 3% of National Beef from other equity owners and owns 51% of National Beef. We will continue to designate two board members and have a series of other rights in respect of our continuing equity interest, with a lockup period of five years and thereafter fair market value liquidity protections. As of the closing of the sale on June 5, 2018, we have deconsolidated our investment in National Beef and account for our remaining 31% interest in National Beef under the equity method of accounting. We have classified the results of National Beef prior to June 5, 2018 as discontinued operations in the Consolidated Statements of Operations. See Note 24 for more information.

We currently own approximately 75% of Garcadia, an equity method joint venture that owns and operates 28 automobile dealerships in California, Texas, Iowa and Michigan. In April 2018, we entered into an agreement to sell 100% of our equity interests in Garcadia and our associated real estate to our current partners, the Garff family. At closing, we will receive $435 million in cash and $50 million in senior preferred equity of an entity that will own all of the automobile dealerships associated broadly with the Ken Garff Automotive Group, including all of the Garcadia dealerships. At or prior to closing, we will pay approximately $52 million to retire the mortgage debt on the real estate to be sold. This transaction is expected to close in the third quarter of 2018.

Vitesse Energy, LLC ("Vitesse Energy Finance") is our consolidated subsidiary that acquires and invests in non-operated working and royalty oil and gas interests in the Bakken Shale oil field in North Dakota and Montana, as well as the Denver-Julesburg Basin in Wyoming. These non-operated interests represent Vitesse Energy Finance’s share of mineral rights associated with specified acreage. As operators convert undeveloped portions of this acreage into flowing horizontal wells, our interests in the mineral rights are essentially converted into interests in the cash flows associated with the wells. In April 2018, Vitesse Energy Finance acquired a package of non-operated Bakken assets from a private equity fund for $190 million in cash, of which approximately $144 million was funded as equity by Jefferies and the balance was drawn under Vitesse Energy Finance’s credit line. The assets purchased include interests in mineral rights associated with future oil and gas development, as well as interests in existing cash flows from producing wells through revenue sharing arrangements.
 
Leucadia Asset Management ("LAM") supports and develops focused alternative asset management businesses led by distinct management teams. We are patiently developing this business over time, and changes in the platforms and structure should be expected. During the second quarter of 2018, we took steps to expand our asset management efforts including the formation of a strategic relationship with Weiss Multi-Strategy Advisers LLC. We invested $250.0 million in Weiss' strategy and will receive a profit share in the first year, and a revenue share thereafter. In addition, we finalized an agreement with Schonfeld Strategic Advisors LLC to merge the business of Folger Hill Asset Management with Schonfeld's fundamental equities business, under the Schonfeld brand. In connection with the pending merger, we have agreed to make a $250.0 million investment in the combined strategy and we will own a revenue share in the management company.


9



On July 13, 2018, HRG Group, Inc. ("HRG") merged into its 62% owned subsidiary, Spectrum Brands Holdings, Inc. ("Spectrum Brands"). Our approximately 23% interest in HRG thereby converted into approximately 14% of the outstanding shares of the re-named company, Spectrum Brands.

Note 2.  Basis of Presentation and Significant Accounting Policies

Our unaudited interim consolidated financial statements have been prepared in accordance with the instructions for Form 10-Q and, therefore, do not include all information and footnotes which are normally included in our Annual Report on Form 10-K.  These financial statements reflect all adjustments (consisting of normal recurring items or items discussed herein) that management believes are necessary to fairly state results for the interim periods presented. Results of operations for interim periods are not necessarily indicative of annual results of operations. For a detailed discussion about the Company’s significant accounting policies, see Note 2, Significant Accounting Policies, included in our Annual Report on Form 10-K for the year ended December 31, 2017 ("2017 10-K").

The preparation of these financial statements in accordance with accounting principles generally accepted in the United States of America ("GAAP") requires us to make estimates and assumptions that affect the reported amounts in the financial statements and disclosures of contingent assets and liabilities. On an on-going basis, we evaluate all of these estimates and assumptions. The most important of these estimates and assumptions relate to fair value measurements, compensation and benefits, asset impairment, the ability to realize deferred tax assets, the recognition and measurement of uncertain tax positions and contingencies. Although these and other estimates and assumptions are based on the best available information, actual results could be different from these estimates.

Jefferies Group has a November 30 year-end, which it retains for standalone reporting purposes. We reflect Jefferies Group in our consolidated financial statements utilizing a one month lag. We have reviewed Jefferies Group's business and internal operating results for the month of June 2018 for the purpose of evaluating whether financial statement disclosure or adjustments are required in this Quarterly Report on Form 10-Q, and we have concluded that no additional disclosures or adjustments are warranted.

During the six months ended June 30, 2018, other than the following, there were no significant updates made to the Company’s significant accounting policies. The accounting policy changes are attributable to the adoption of the Financial Accounting Standards Board ("FASB") guidance on Revenue from Contracts with Customers (the "new revenue standard"). These revenue recognition policy updates are applied prospectively in our financial statements from January 1, 2018 forward using the modified retrospective approach. Reported financial information for the historical comparable periods were not revised and continue to be reported under the accounting standards in effect during the historical periods.

Revenue Recognition Policies
Investment Banking Revenues:
Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed.
Expenses associated with investment banking advisory engagements are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized at a point in time. All other investment banking advisory related expenses, including expenses incurred related to restructuring advisory engagements, are expensed as incurred.
All investment banking expenses are recognized within their respective expense category in the Consolidated Statements of Operations and any expenses reimbursed by clients are recognized as Investment banking revenues.
Asset Management Fees:
Performance fee revenue is generally recognized only at the end of the performance period to the extent that the benchmark return has been met.
See Accounting Developments - Adopted Accounting Standards below and Note 17 for further information.

Changes to the Consolidated Statements of Operations

Manufacturing revenues, which were previously reported within Other revenues, are now broken out separately in the Consolidated Statements of Operations. Manufacturing revenues are primarily from Idaho Timber, which manufactures and distributes an extensive range of quality wood products to markets across North America. Idaho Timber's primary business consists of the sale of lumber that is manufactured or remanufactured at one of its locations. Agreements with customers for these sales specify the

10



type, quantity and price of products to be delivered as well as the delivery date and payment terms. The transaction price is fixed at the time of sale and revenue is generally recognized when the customer takes control of the product.

We have reorganized the presentation of our gains and losses generated from our capital invested in asset management funds. This was previously presented as Other revenues and is now presented within Principal transactions revenues. For the three months ended June 30, 2017, this resulted in a decrease to Principal transactions revenues of $0.8 million and an increase to Other revenues of $0.8 million. For the six months ended June 30, 2017, this resulted in a decrease to Principal transactions revenues of $0.9 million and an increase to Other revenues of $0.9 million.

Receivables

At June 30, 2018 and December 31, 2017, Receivables include receivables from brokers, dealers and clearing organizations of $2,831.0 million and $2,635.2 million, respectively, and receivables from customers of securities operations of $1,977.3 million and $1,563.8 million, respectively.

Payables, expense accruals and other liabilities

At June 30, 2018 and December 31, 2017, Payables, expense accruals and other liabilities include payables to brokers, dealers and clearing organizations of $2,753.1 million and $2,228.9 million, respectively, and payables to customers of securities operations of $3,153.0 million and $2,664.0 million, respectively.

Supplemental Cash Flow Information
 
For the Six Months Ended June 30,
 
 
2018
 
2017
Cash paid during the year for:
(In thousands)
Interest
$
654,370

 
$
535,959

Income tax payments (refunds), net
$
15,804

 
$
9,977

During the six months ended June 30, 2018 and 2017, we had $23.9 million and $1.9 million, respectively, in non-cash financing activities related to purchases of common shares for treasury which settled subsequent to quarter end.

Accounting Developments - Adopted Accounting Standards

Revenue Recognition.  In May 2014, the FASB issued new guidance that defines how companies report revenues from contracts with customers, and also requires enhanced disclosures. The core principle of guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. We adopted the guidance as of January 1, 2018 and recognized an increase of $17.8 million after-tax to beginning Retained earnings as the cumulative effect of adoption of accounting standards. The increase primarily relates to the recognition of $24.3 million of revenue previously deferred from the sale of real estate to HomeFed in 2014, offset by a decrease of $6.1 million related to Jefferies Group. For Jefferies Group, the impact of adoption primarily related to investment banking expenses that were deferred as of December 31, 2017 under the previously existing accounting guidance, which would have been expensed in prior periods under the new revenue standard and investment banking revenues that were previously recognized in prior periods, which would have been deferred as of December 31, 2017 under the new revenue standard. We elected to adopt the new guidance using a modified retrospective approach applied to contracts that were not completed as of January 1, 2018. Accordingly, the new revenue standard is applied prospectively in our financial statements from January 1, 2018 forward and reported financial information for historical comparable periods is not revised and continues to be reported under the accounting standards in effect during those historical periods.

11





The new revenue standard does not apply to revenue associated with financial instruments, including loans and securities that are accounted for under other GAAP, and as a result, did not have an impact on the elements of our Consolidated Statements of Operations most closely associated with financial instruments, including Principal transactions revenues, Interest income and Interest expense. The new revenue standard primarily impacts Jefferies Group's revenue recognition and presentation accounting policies as follows:

Investment Banking Revenues. Advisory fees from mergers and acquisitions engagements are recognized at a point in time when the related transaction is completed, as the performance obligation is to successfully broker a specific transaction.

Certain Capital Markets Revenues. Revenues associated with price stabilization activities as part of a securities underwriting were historically recognized as part of Investment banking revenues. Under the new revenue standard, revenues from these activities are recognized within Principal transactions revenues, as these revenues are not considered to be within the scope of the new standard.

• Investment Banking Advisory Expenses. Historically, expenses associated with investment banking advisory assignments were deferred until reimbursed by the client, the related fee revenue is recognized or the engagement is otherwise concluded. Under the new revenue standard, expenses are deferred only to the extent they are explicitly reimbursable by the client and the related revenue is recognized at a point in time. All other investment banking advisory related expenses, including expenses incurred related to restructuring assignments, are expensed as incurred.

Investment Banking Underwriting and Advisory Expenses. Expenses have historically been recorded net of client reimbursements and/or netted against revenues. Under the new revenue standard, all investment banking expenses will be recognized within their respective expense category in the Consolidated Statements of Operations and any expense reimbursements will be recognized as Investment banking revenues (i.e., expenses are no longer recorded net of client reimbursements and are not netted against revenues).

Asset Management Fees. In certain asset management fee arrangements, Jefferies Group and LAM receive performance-based fees, which vary with performance or, in certain cases, are earned when the return on assets under management exceed certain benchmark returns or other performance targets. Historically, performance fees have been accrued (or reversed) quarterly based on measuring performance to date versus any relevant benchmark return hurdles stated in the investment management agreement. Under the new revenue standard, performance fees are considered variable as they are subject to fluctuation (e.g., based on market performance) and/or are contingent on a future event during the measurement period (e.g., exceeding a specified benchmark index) and are recognized only to the extent it is probable that a significant reversal in the amount of cumulative revenue recognized will not occur when the uncertainty is resolved. Accordingly, performance fee revenue will generally be recognized only at the end of the performance period to the extent that the benchmark return has been met.

12




There was no significant impact as a result of applying the new revenue standard to our consolidated financial statements for the three and six months ended June 30, 2018, except as it relates to the presentation of Jefferies Group's investment banking expenses. The table below presents the impact of applying the new revenue recognition standard to the Consolidated Statements of Operations for the three and six months ended June 30, 2018 as a result of the change in presentation of investment banking expenses (in thousands):
 
For the Three Months Ended June 30, 2018
 
For the Six Months Ended June 30, 2018
 
As Reported
 
Impact of Adoption of Revenue Recognition Standard
 
Financial Results Prior to Adoption of Revenue Recognition Standard
 
As Reported
 
Impact of Adoption of Revenue Recognition Standard
 
Financial Results Prior to Adoption of Revenue Recognition Standard
Revenues:
 
 
 
 
 
 
 
 
 
 
 
Commissions and other fees
$
157,704

 
$

 
$
157,704

 
$
305,606

 
$

 
$
305,606

Principal transactions
53,755

 

 
53,755

 
199,418

 

 
199,418

Investment banking
500,297

 
32,342

 
467,955

 
940,288

 
64,827

 
875,461

Interest income
327,314

 

 
327,314

 
602,536

 

 
602,536

Manufacturing revenues
114,735

 

 
114,735

 
213,100

 

 
213,100

Other
90,021

 

 
90,021

 
143,989

 

 
143,989

Total revenues
1,243,826

 
32,342

 
1,211,484

 
2,404,937

 
64,827

 
2,340,110

Interest expense of Jefferies Group
332,667

 

 
332,667

 
598,343

 

 
598,343

Net revenues
911,159

 
32,342

 
878,817

 
1,806,594

 
64,827

 
1,741,767

 
 
 
 
 
 
 
 
 
 
 
 
Expenses:
 
 
 
 
 
 
 

 
 

 
 

Compensation and benefits
478,515

 

 
478,515

 
968,174

 

 
968,174

Cost of sales
90,690

 

 
90,690

 
172,625

 

 
172,625

Floor brokerage and clearing fees
45,046

 

 
45,046

 
87,222

 

 
87,222

Interest expense
24,279

 

 
24,279

 
45,777

 

 
45,777

Depreciation and amortization
31,905

 

 
31,905

 
60,065

 

 
60,065

Selling, general and other expenses
236,562

 
32,342

 
204,220

 
462,906

 
64,827

 
398,079

Total expenses
906,997

 
32,342

 
874,655

 
1,796,769

 
64,827

 
1,731,942

 
 
 
 
 
 
 
 
 
 
 
 
Income from continuing operations before income taxes and income (loss) related to associated companies
$
4,162

 
$

 
$
4,162

 
$
9,825

 
$

 
$
9,825


Financial Instruments. In January 2016, the FASB issued new guidance that affects the accounting for equity investments, financial liabilities under the fair value option and the presentation and disclosure requirements for financial instruments. The guidance is effective for annual and interim periods beginning after December 15, 2017. We have adopted the new guidance as of January 1, 2018 with a cumulative effect increase to opening retained earnings of $27.6 million and a corresponding decrease to Accumulated other comprehensive income. The opening retained earnings adjustment is to recognize the unrealized gains we had for available for sale equity securities. Beginning in 2018, these available for sale equity securities are now reported as part of Trading assets, at fair value within the Consolidated Statements of Financial Condition. Early adoption was permitted for the accounting guidance on financial liabilities under the fair value option and we adopted this guidance in the first quarter of 2016. The adoption of the guidance on financial liabilities under the fair value option did not have a material impact on our consolidated financial statements.

Retirement Benefits. In March 2017, the FASB issued new guidance for improving the presentation of net periodic pension costs in the statement of operations. The update also allows the service cost to be eligible for capitalization, when applicable. We adopted

13



this guidance in the first quarter of 2018 and the adoption did not have a material impact on our consolidated financial statements. The adoption of this guidance resulted in the following adjustments to the Consolidated Statements of Operations for the three and six months ended June 30, 2017: a decrease of $0.9 million and $1.7 million, respectively, to Compensation and benefits expenses and an increase to Selling, general and other expenses of $0.9 million and $1.7 million, respectively.

Cash Flow Classifications. In August 2016, the FASB issued new guidance to reduce the diversity in practice in how certain transactions are classified in the statement of cash flows. The guidance adds or clarifies guidance on the classification of certain cash receipts and payments in the statement of cash flows. The guidance is effective for annual and interim periods beginning after December 15, 2017. In November 2016, the FASB issued new guidance on restricted cash. The guidance requires that a statement of cash flows explain the change during the period in the total of cash, cash equivalents and amounts generally described as restricted cash or restricted cash equivalents. We adopted this guidance in the first quarter of 2018. Prior periods were retrospectively adjusted to conform to the current period presentation. The adoption of the guidance did not have a material impact on our Consolidated Statements of Cash Flows. Upon adoption, we recorded an increase of $64.4 million in Net cash provided by operating activities and a decrease of $(5.1) million in Net cash provided by investing activities for the six months ended June 30, 2017 related to reclassifying the changes in our restricted cash balance from operating and investing activities to the cash and cash equivalent balances within the Consolidated Statements of Cash Flows.

Compensation. In May 2017, the FASB issued new guidance providing clarity and reducing diversity in practice and cost and complexity when accounting for a change to the terms or conditions of a share-based payment award. We adopted this guidance in the first quarter of 2018 and the adoption did not have a material impact on our consolidated financial statements.

Accounting Developments - Accounting Standards to be Adopted in Future Periods

Leases. In February 2016, the FASB issued new guidance that affects the accounting and disclosure requirements for leases. The FASB requires the recognition of all leases that are longer than one year onto the balance sheet, which will result in the recognition of a right of use asset and a corresponding lease liability. The right of use asset and lease liability will be measured initially using the present value of the remaining rental payments. This guidance change for leases where we are the lessee will require modifications to our current lease accounting systems and the determination of the present value of the remaining rental payments. The guidance is effective for annual and interim periods beginning after December 15, 2018. We are currently evaluating the impact this new guidance will have on our consolidated financial statements.

Financial Instruments - Credit Losses. In June 2016, the FASB issued new guidance for estimating credit losses on certain types of financial instruments by introducing an approach based on expected losses. The guidance is effective for annual and interim periods beginning after December 15, 2019. We are currently evaluating the impact this new guidance will have on our consolidated financial statements.

Goodwill. In January 2017, the FASB issued new guidance for simplifying goodwill impairment testing. The guidance is effective for annual and interim periods beginning after December 15, 2019. We do not believe the new guidance will have a material impact on our consolidated financial statements.

Derivatives and hedging. In August 2017, the FASB issued new guidance to improve the financial reporting of hedging relationships to better portray the economic results of an entity's risk management activities in its financial statements. The guidance is effective for annual and interim periods beginning after December 15, 2018 and early adoption is permitted. We do not believe the new guidance will have a material impact on our consolidated financial statements.

14



Note 3.  Fair Value Disclosures

The following is a summary of our financial instruments, trading liabilities, short-term borrowings and long-term debt that are accounted for at fair value on a recurring basis, excluding Investments at fair value based on net asset value ("NAV") (within trading assets) of $405.0 million and $590.1 million at June 30, 2018 and December 31, 2017, respectively, by level within the fair value hierarchy (in thousands):
 
June 30, 2018
 
Level 1
 
Level 2
 
Level 3
 
Counterparty
and
Cash
Collateral
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Trading assets, at fair value:
 
 
 
 
 
 
 
 
 
Corporate equity securities
$
3,472,077

 
$
70,011

 
$
44,871

 
$

 
$
3,586,959

Corporate debt securities
821

 
2,858,014

 
28,066

 

 
2,886,901

Collateralized debt obligations and
collateralized loan obligations

 
82,399

 
42,517

 

 
124,916

U.S. government and federal agency securities
2,095,792

 
40,450

 

 

 
2,136,242

Municipal securities

 
827,478

 

 

 
827,478

Sovereign obligations
1,332,770

 
1,141,113

 

 

 
2,473,883

Residential mortgage-backed securities

 
2,037,431

 
3,655

 

 
2,041,086

Commercial mortgage-backed securities

 
941,432

 
27,239

 

 
968,671

Other asset-backed securities

 
281,821

 
55,535

 

 
337,356

Loans and other receivables

 
1,771,853

 
64,036

 

 
1,835,889

Derivatives (2)
27,435

 
3,369,641

 
5,743

 
(3,102,888
)
 
299,931

Investments at fair value

 

 
318,543

 

 
318,543

FXCM term loan

 

 
76,100

 

 
76,100

Total trading assets, excluding investments at fair value based on NAV
$
6,928,895


$
13,421,643


$
666,305


$
(3,102,888
)

$
17,913,955

 
 
 
 
 
 
 
 
 
 
Available for sale securities:
 

 
 

 
 

 
 

 
 

U.S. government securities
$
1,217,550

 
$

 
$

 
$

 
$
1,217,550

Residential mortgage-backed securities

 
661

 

 

 
661

Commercial mortgage-backed securities

 
10,756

 

 

 
10,756

Other asset-backed securities

 
13,508

 

 

 
13,508

Total available for sale securities
$
1,217,550


$
24,925


$


$


$
1,242,475

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

 
 

Trading liabilities:
 

 
 

 
 

 
 

 
 

Corporate equity securities
$
2,344,870

 
$
4,313

 
$
87

 
$

 
$
2,349,270

Corporate debt securities

 
1,721,602

 
522

 

 
1,722,124

U.S. government and federal agency securities
1,914,531

 

 

 

 
1,914,531

Sovereign obligations
1,518,030

 
1,083,853

 

 

 
2,601,883

Loans

 
1,106,907

 
12,881

 

 
1,119,788

Derivatives
19,357

 
3,684,018

 
11,617

 
(3,239,346
)
 
475,646

Total trading liabilities
$
5,796,788


$
7,600,693


$
25,107


$
(3,239,346
)

$
10,183,242

Short-term borrowings
$

 
$
68,818

 
$

 
$

 
$
68,818

Long-term debt - structured notes
$

 
$
547,630

 
$
160,626

 
$

 
$
708,256


15



 
December 31, 2017
 
Level 1
 
Level 2
 
Level 3
 
Counterparty
and
Cash
Collateral
Netting (1)
 
Total
Assets:
 
 
 
 
 
 
 
 
 
Trading assets, at fair value:
 
 
 
 
 
 
 
 
 
Corporate equity securities
$
2,975,463

 
$
60,300

 
$
22,270

 
$

 
$
3,058,033

Corporate debt securities

 
3,261,300

 
26,036

 

 
3,287,336

Collateralized debt obligations and
collateralized loan obligations

 
139,166

 
42,184

 

 
181,350

U.S. government and federal agency securities
1,269,230

 
39,443

 

 

 
1,308,673

Municipal securities

 
710,513

 

 

 
710,513

Sovereign obligations
1,381,552

 
1,035,907

 

 

 
2,417,459

Residential mortgage-backed securities

 
1,453,294

 
26,077

 

 
1,479,371

Commercial mortgage-backed securities

 
508,115

 
12,419

 

 
520,534

Other asset-backed securities

 
217,111

 
61,129

 

 
278,240

Loans and other receivables

 
1,620,581

 
47,304

 

 
1,667,885

Derivatives
165,396

 
3,323,278

 
9,295

 
(3,318,481
)
 
179,488

Investments at fair value

 
946

 
329,944

 

 
330,890

FXCM term loan

 

 
72,800

 

 
72,800

Total trading assets, excluding investments at fair value based on NAV
$
5,791,641


$
12,369,954


$
649,458


$
(3,318,481
)

$
15,492,572

 
 
 
 
 
 
 
 
 
 
Available for sale securities:
 

 
 

 
 

 
 

 
 

Corporate equity securities (3)
$
88,486

 
$

 
$

 
$

 
$
88,486

U.S. government securities
552,805

 

 

 

 
552,805

Residential mortgage-backed securities

 
34,561

 

 

 
34,561

Commercial mortgage-backed securities

 
5,870

 

 

 
5,870

Other asset-backed securities

 
34,839

 

 

 
34,839

Total available for sale securities
$
641,291


$
75,270


$


$


$
716,561

 
 
 
 
 
 
 
 
 
 
Liabilities:
 

 
 

 
 

 
 

 
 

Trading liabilities:
 

 
 

 
 

 
 

 
 

Corporate equity securities
$
1,721,267

 
$
32,122

 
$
48

 
$

 
$
1,753,437

Corporate debt securities

 
1,688,825

 
522

 

 
1,689,347

U.S. government and federal agency securities
1,430,737

 

 

 

 
1,430,737

Sovereign obligations
1,216,643

 
956,992

 

 

 
2,173,635

Commercial mortgage-backed securities

 

 
105

 

 
105

Loans

 
1,148,824

 
3,486

 

 
1,152,310

Derivatives
249,361

 
3,480,506

 
16,041

 
(3,490,514
)
 
255,394

Total trading liabilities
$
4,618,008


$
7,307,269


$
20,202


$
(3,490,514
)

$
8,454,965

Short-term borrowings
$

 
$
23,324

 
$

 
$

 
$
23,324

Long-term debt - structured notes
$

 
$
606,956

 
$

 
$

 
$
606,956


(1)
Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.
(2)
During the six months ended June 30, 2018, Jefferies Group transferred from Level 1 to Level 2 $20.8 million of listed options included in Trading assets - Derivatives, which are measured based on broker quotes or mid-market valuations. There were no other material transfers of Trading assets and Trading liabilities between Level 1 and Level 2 for the three and six months ended June 30, 2018 and 2017.
(3)
As of January 1, 2018, the Company adopted the FASB's new guidance that affects the accounting for equity investments and the presentation and disclosure requirements for financial instruments. At June 30, 2018, equity investments are primarily classified as Trading assets, at fair value and the change in fair value of equity securities is now recognized through the Consolidated Statements of Operations. See Note 2 for additional information.


16



The following is a description of the valuation basis, including valuation techniques and inputs, used in measuring our financial assets and liabilities that are accounted for at fair value on a recurring basis:

Corporate Equity Securities

Exchange Traded Equity Securities:  Exchange traded equity securities are measured based on quoted closing exchange prices, which are generally obtained from external pricing services, and are categorized within Level 1 of the fair value hierarchy, otherwise they are categorized within Level 2 of the fair value hierarchy. To the extent these securities are actively traded, valuation adjustments are not applied.
Non-Exchange Traded Equity Securities:  Non-exchange traded equity securities are measured primarily using broker quotations, pricing data from external pricing services and prices observed from recently executed market transactions and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange traded equity securities are categorized within Level 3 of the fair value hierarchy and measured using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/Earnings before interest, taxes, depreciation and amortization ("EBITDA"), price/book value), discounted cash flow analyses and transaction prices observed from subsequent financing or capital issuance by Jefferies Group. When using pricing data of comparable companies, judgment must be applied to adjust the pricing data to account for differences between the measured security and the comparable security (e.g., issuer market capitalization, yield, dividend rate, geographical concentration).
Equity Warrants:  Non-exchange traded equity warrants are measured primarily using pricing data from external pricing services, prices observed from recently executed market transactions and broker quotations and are categorized within Level 2 of the fair value hierarchy. Where such information is not available, non-exchange traded equity warrants are generally categorized within Level 3 of the fair value hierarchy and are measured using the Black-Scholes model with key inputs impacting the valuation including the underlying security price, implied volatility, dividend yield, interest rate curve, strike price and maturity date.

Corporate Debt Securities

Corporate Bonds:  Corporate bonds are measured primarily using pricing data from external pricing services and broker quotations, where available, prices observed from recently executed market transactions and bond spreads or credit default swap spreads of the issuer adjusted for basis differences between the swap curve and the bond curve. Corporate bonds measured using these valuation methods are categorized within Level 2 of the fair value hierarchy. If broker quotes, pricing data or spread data is not available, alternative valuation techniques are used including cash flow models incorporating interest rate curves, single name or index credit default swap curves for comparable issuers and recovery rate assumptions. Corporate bonds measured using alternative valuation techniques are categorized within Level 3 of the fair value hierarchy and are a limited portion of our corporate bonds.
High Yield Corporate and Convertible Bonds:  A significant portion of our high yield corporate and convertible bonds are categorized within Level 2 of the fair value hierarchy and are measured primarily using broker quotations and pricing data from external pricing services, where available, and prices observed from recently executed market transactions of institutional size. Where pricing data is less observable, valuations are categorized within Level 3 and are based on pending transactions involving the issuer or comparable issuers, prices implied from an issuer’s subsequent financing or recapitalization, models incorporating financial ratios and projected cash flows of the issuer and market prices for comparable issuers.

Collateralized Debt Obligations and Collateralized Loan Obligations

Collateralized Debt Obligations ("CDOs") and Collateralized Loan Obligations ("CLOs") are measured based on prices observed from recently executed market transactions of the same or similar security or based on valuations received from third party brokers or data providers and are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability and significance of the pricing inputs. Valuation that is based on recently executed market transactions of similar securities incorporates additional review and analysis of pricing inputs and comparability criteria, including, but not limited to, collateral type, tranche type, rating, origination year, prepayment rates, default rates and loss severity.

U.S. Government and Federal Agency Securities

U.S. Treasury Securities:  U.S. Treasury securities are measured based on quoted market prices and categorized within Level 1 of the fair value hierarchy.
U.S. Agency Debt Securities:  Callable and non-callable U.S. agency debt securities are measured primarily based on quoted market prices obtained from external pricing services and are generally categorized within Level 1 or Level 2 of the fair value hierarchy.


17



Municipal Securities

Municipal securities are measured based on quoted prices obtained from external pricing services and are generally categorized within Level 2 of the fair value hierarchy.

Sovereign Obligations

Sovereign government obligations are measured based on quoted market prices obtained from external pricing services, where available, or recently executed independent transactions of comparable size. To the extent external price quotations are not available or recent transactions have not been observed, valuation techniques incorporating interest rate yield curves and country spreads for bonds of similar issuers, seniority and maturity are used to determine fair value of sovereign bonds or obligations. Sovereign government obligations are classified in Level 1 or Level 2 of the fair value hierarchy, primarily based on the country of issuance.

Residential Mortgage-Backed Securities

Agency Residential Mortgage-Backed Securities:  Agency residential mortgage-backed securities include mortgage pass-through securities (fixed and adjustable rate), collateralized mortgage obligations and principal-only securities and are generally measured using market price quotations from external pricing services and categorized within Level 2 of the fair value hierarchy.
Agency Residential Interest-Only and Inverse Interest-Only Securities:  The fair value is estimated using expected future cash flow techniques that incorporate prepayment models and other prepayment assumptions to amortize the underlying mortgage loan collateral. We use prices observed from recently executed transactions to develop market-clearing spread and yield curve assumptions. Valuation inputs with regard to the underlying collateral incorporate weighted average coupon, loan-to-value, credit scores, geographic location, maximum and average loan size, originator, servicer and weighted average loan age. Agency residential interest-only and inverse interest-only securities are categorized within Level 2 of the fair value hierarchy. We also use vendor data in developing our assumptions, as appropriate.
Non-Agency Residential Mortgage-Backed Securities:  The fair value of non-agency residential mortgage-backed securities is determined primarily using discounted cash flow methodologies and securities are categorized within Level 2 or Level 3 of the fair value hierarchy based on the observability and significance of the pricing inputs used. Performance attributes of the underlying mortgage loans are evaluated to estimate pricing inputs, such as prepayment rates, default rates and the severity of credit losses. Attributes of the underlying mortgage loans that affect the pricing inputs include, but are not limited to, weighted average coupon; average and maximum loan size; loan-to-value; credit scores; documentation type; geographic location; weighted average loan age; originator; servicer; historical prepayment, default and loss severity experience of the mortgage loan pool; and delinquency rate. Yield curves used in the discounted cash flow models are based on observed market prices for comparable securities and published interest rate data to estimate market yields. In addition, broker quotes, where available, are also referenced to compare prices primarily on interest-only securities.

Commercial Mortgage-Backed Securities

Agency Commercial Mortgage-Backed Securities:  Government National Mortgage Association ("GNMA") project loan bonds are measured based on inputs corroborated from and benchmarked to observed prices of recent securitization transactions of similar securities with adjustments incorporating an evaluation of various factors, including prepayment speeds, default rates and cash flow structures, as well as the likelihood of pricing levels in the current market environment. Federal National Mortgage Association ("FNMA") Delegated Underwriting and Servicing ("DUS") mortgage-backed securities are generally measured by using prices observed from recently executed market transactions to estimate market-clearing spread levels for purposes of estimating fair value. GNMA project loan bonds and FNMA DUS mortgage-backed securities are categorized within Level 2 of the fair value hierarchy.
Non-Agency Commercial Mortgage-Backed Securities:  Non-agency commercial mortgage-backed securities are measured using pricing data obtained from external pricing services and prices observed from recently executed market transactions and are categorized within Level 2 and Level 3 of the fair value hierarchy.

Other Asset-Backed Securities

Other asset-backed securities include, but are not limited to, securities backed by auto loans, credit card receivables, student loans and other consumer loans and are categorized within Level 2 and Level 3 of the fair value hierarchy. Valuations are primarily determined using pricing data obtained from external pricing services and broker quotes and prices observed from recently executed market transactions.


18



Loans and Other Receivables

Corporate Loans:  Corporate loans categorized within Level 2 of the fair value hierarchy are measured based on market price quotations where market price quotations from external pricing services are supported by transaction data. Corporate loans categorized within Level 3 of the fair value hierarchy are measured based on price quotations that are considered to be less transparent, market prices for debt securities of the same creditor and estimates of future cash flow incorporating assumptions regarding creditor default and recovery rates and consideration of the issuer’s capital structure.
Participation Certificates in Agency Residential Loans: Valuations of participation certificates in agency residential loans are based on observed market prices of recently executed purchases and sales of similar loans and data provider pricing. The loan participation certificates are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions and availability of data provider pricing.
Project Loans and Participation Certificates in GNMA Project and Construction Loans:  Valuations of participation certificates in GNMA project and construction loans are based on inputs corroborated from and benchmarked to observed prices of recent securitizations with similar underlying loan collateral to derive an implied spread. Securitization prices are adjusted to estimate the fair value of the loans to account for the arbitrage that is realized at the time of securitization. The measurements are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions.
Consumer Loans and Funding Facilities:  Consumer and small business whole loans and related funding facilities are valued based on observed market transactions and incorporating valuation inputs including, but not limited to, delinquency and default rates, prepayment rates, borrower characteristics, loan risk grades and loan age. These assets are categorized within Level 2 or Level 3 of the fair value hierarchy.
Escrow and Trade Claim Receivables:  Escrow and trade claim receivables are categorized within Level 3 of the fair value hierarchy where fair value is estimated based on reference to market prices and implied yields of debt securities of the same or similar issuers. Escrow and trade claim receivables are categorized within Level 2 of the fair value hierarchy where fair value is based on recent trade activity in the same receivable.

Derivatives

Listed Derivative Contracts:  Listed derivative contracts that are actively traded are measured based on quoted exchange prices, broker quotes or vanilla option valuation models, such as Black-Scholes, using observable valuation inputs from the principal market. Exchange quotes and/or valuation inputs are generally obtained from external vendors and pricing services. Broker quotes are validated directly through observable and tradeable quotes. Listed derivative contracts that use unadjusted exchange close prices are generally categorized within Level 1 of the fair value hierarchy. All other listed derivative contracts are generally categorized within Level 2 of the fair value hierarchy.
Over-the-Counter ("OTC") Derivative Contracts:  OTC derivative contracts are generally valued using models, whose inputs reflect assumptions that we believe market participants would use in valuing the derivative in a current transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC derivative contracts, the valuation models do not involve material subjectivity as the methodologies do not entail significant judgment and the inputs to valuation models do not involve a high degree of subjectivity as the valuation model inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized within Level 2 of the fair value hierarchy given the observability and significance of the inputs to the valuation models. Where significant inputs to the valuation are unobservable, derivative instruments are categorized within Level 3 of the fair value hierarchy.

OTC options include OTC equity, foreign exchange, interest rate and commodity options measured using various valuation models, such as the Black-Scholes, with key inputs including the underlying security price, foreign exchange spot rate, commodity price, implied volatility, dividend yield, interest rate curve, strike price and maturity date. Discounted cash flow models are utilized to measure certain OTC derivative contracts including the valuations of our interest rate swaps, which incorporate observable inputs related to interest rate curves, valuations of our foreign exchange forwards and swaps, which incorporate observable inputs related to foreign currency spot rates and forward curves and valuations of our commodity swaps and forwards, which incorporate observable inputs related to commodity spot prices and forward curves. Discounted cash flow models are also utilized to measure certain variable funding note swaps, which are backed by CLOs and incorporate constant prepayment rate, constant default rate and loss severity assumptions. Credit default swaps include both index and single-name credit default swaps. External prices are available as inputs in measuring index credit default swaps and single-name credit default swaps. For commodity and equity total return swaps, market prices are generally observable for the underlying asset and used as the basis for measuring the fair value of the derivative contracts. Total return swaps executed on other underlyings are measured based on valuations received from external pricing services.




19



Oil Futures Derivatives: Vitesse Energy Finance uses swaps and call and put options in order to reduce exposure to future oil price fluctuations. Vitesse Energy Finance accounts for the derivative instruments at fair value, which are classified as either Level 1 or Level 2 within the fair value hierarchy. Fair values classified as Level 1 are measured based on quoted closing exchange prices obtained from external pricing services and Level 2 are determined under the income valuation technique using an option-pricing model that is based on directly or indirectly observable inputs.

Investments at Fair Value

Investments at fair value based on NAV include investments in hedge funds, fund of funds and private equity funds, which are measured at the NAV of the funds, provided by the fund managers and are excluded from the fair value hierarchy. Investments at fair value also include direct equity investments in private companies, which are measured at fair value using valuation techniques involving quoted prices of or market data for comparable companies, similar company ratios and multiples (e.g., price/EBITDA, price/book value), discounted cash flow analyses and transaction prices observed for subsequent financing or capital issuance by the company. Direct equity investments in private companies are categorized within Level 2 or Level 3 of the fair value hierarchy. Additionally, investments at fair value include investments in insurance contracts relating to Jefferies Group's defined benefit plan in Germany. Fair value for the insurance contracts is determined using a third party and is categorized within Level 3 of the fair value hierarchy. 

The following tables present information about our investments in entities that have the characteristics of an investment company (in thousands).
 
Fair Value (1)
 
Unfunded
Commitments
 
Redemption
Frequency
(if currently eligible)
June 30, 2018
 
 
 
 
 
Equity Long/Short Hedge Funds (2)
$
107,384

 
$

 
(2)
Fixed Income and High Yield Hedge Funds (3)
342

 

 
Fund of Funds (4)
176

 

 
Equity Funds (5)
35,991

 
20,696