Full-year earnings from Jefferies put Wall Street’s dilemma in a nutshell.
The wannabe bulge-bracket investment bank posted record revenue of almost $3 billion for its fiscal year to Nov. 30. But the top line didn’t translate into bumper profits: the firm’s $282 million of net income equates to a paltry 8.2 percent return on equity. Its chief executive, Richard Handler, like bosses of larger rivals, wants to improve on that. He has a couple of tricks up his sleeve – but others don’t.
For starters, Mr. Handler has been enlarging Jefferies for almost four years. First, he took advantage of post-crisis pain at giant financial firms to lure away bankers and traders. Then last year he bought commodities and futures brokerage firm Prudential Bache. Mr. Handler now expects the extra costs from these forays to drop, which should boost margins – though he has not provided any specific numbers.
And then just last month Jefferies agreed to be bought by Leucadia, an investment firm that already owns 28 percent of the investment bank. It’s essentially a reverse takeover, as Handler will lead the combined group. And it will come with an immediate benefit to the Wall Street firm’s earnings: Leucadia has $1.4 billion of deferred tax assets which can be used to reduce the slice of future earnings that will be owed to Uncle Sam. For example, if Jefferies’ 2012 tax rate fell to 20 percent from 34.3 percent, that would add $70 million to the firm’s net income. On its 2012 numbers, a boost of that size would have nudged the return on equity above 10 percent, a rough proxy for the typical investment bank’s overall cost of capital.
Mr. Handler’s rivals don’t have that advantage, and most big bank C.E.O.s are under pressure to shrink, if anything, rather than grow. To boost their companies’ returns to more respectable levels in the short term, they need either an upturn in business – something that few on Wall Street expect any time soon – or big cuts in compensation or other costs.
For bank bosses reporting their 2012 numbers in January, it won’t be a comfortable start to the new year.
Antony Currie is an associate editor at Reuters Breakingviews. For more independent commentary and analysis, visit breakingviews.com.