On Wall Street, where traders find an edge by having their orders placed a millisecond earlier than the next guy's and the speed at which trades are executed seems constrained only by physical barriers like the speed of light, nothing moves faster than a negative rumor.
On Monday, March 10, 2008, rumor started that investment banker Bear Stearns was having liquidity problems. In fact, the maverick investment bank had around $18 billion in cash reserves. But soon, the speculation created its own reality, and the race was on to keep Bear Stearns' crisis from ravaging the wider market. And we all know what happened after that.
As the reporting of unexpectedly gargantuan, supposedly once-in-a-lifetime losses by esteemed financial institutions has seemingly become the market's norm during the ongoing financial crisis, investors have understandably become ever more skeptical. Multiplying their fear through the interconnected web of gossip and news that flows through the financial institutions of New York and London, they've grown almost paranoid, maniacally trying to avoid any situation where they're the last one left when the party ends and the lights go off.
Could this be the case with Jefferies Group Inc., a mid-market pure play investment bank that has been battered for weeks first by a steady feed of negative rumors?
Here are the facts: Following the collapse of MF Global, which shook investor confidence in a wide array of financial firms, Jefferies' bonds were downgraded by rating agency Egan-Jones over short-term funding worries. Traders have since pounced, many surely believing they have spotted the next Bear Stearns, Lehman Brothers, or MF Global. The company's efforts to assure the market it's not in trouble have been largely ignored, and bearish sentiment in the future of the bank has been underscored with heavy short-selling of its public shares.
From October 28, shares of Jefferies Group Inc. (NYSE:JEF) have lost almost half of their market value. On Thursday, the company's stock was trading at a new 52-week low level of $9.50, before rebounding to a closing price of $10.11, down 21 cents or 2.03 percent. Shares dipped further in early-morning trading Friday, down 6 cents to $10.05 on the New York Stock Exchange. By comparison, the NASDAQ-100 Financials Index, is down 6.7 percent for the period.
"Few people believe Jefferies Group because we heard the same sort of denials from firms like Lehman Brothers, Bear Stearns and MF Global. Brokerage firms have very little credibility when it comes to making public statements to protect the firm," Andrew Stoltmann, a Chicago-based securities attorney at the Stoltmann Law Offices, told IBTimes.
Down Across the Board
If those dealing in the companies' shares are pessimistic in their sentiment, traders in Jefferies bonds and options seem to be downright apocalyptic in their assessment.
Thursday closed with over 11,000 of the November 9-strike puts on Jefferies stock being traded at 5 cents. That trade won't be profitable unless Jefferies' shares closes below $8.95 by November expiration - which is today. Similar put activity is also being seen for options expiring in December.
The stock's put-to-call ratio, a telling indicator that gauges how many options are bearish on the stock relative to how many are bullish, is decidedly favoring the doomsayers. Thursday, put volume was outpacing call volume by about 4 to 1
Trading in the firm's bonds also shows signs of high distrust. Thursday, $500 million of Jefferies' 3.875 percent bonds due November 2015 fell 3.5 cents to 75.5 cents on the dollar at 4:17 p.m. in New York. The debt pays a yield of 11.8 percent, 10.92 percentage points more than similar-maturity U.S. Treasuries
That yield exceeds the 10 percentage-point spread considered distressed. It is also more than the average of 8.8 percent for high-yield or speculative-grade issuers, according to Bank of America Merrill Lynch index data.
"We believe that, putting aside short-term downticks caused by rumors, half-truths, and short-selling, our stock price on any given day - including today - is influenced by the pressure facing the entire financial-services sector as well as the market generally," Richard Khaleel, a spokesperson for Jefferies, told the IBTimes, "Our operating and funding model, which has served us well for many years, continues to do so: our inventory, which is liquid and turns over frequently, remains readily financeable; and our cash on hand remains around third-quarter's $2 billion level."
Jefferies's stock began sliding on the news of the demise of MF Global, which took the respected broker-dealer from a situation where it had the confidence of the markets to one where it became the biggest U.S. casualty of Europe's debt crisis: the seventh-largest bankruptcy by assets in U.S. history.
Some speculators began connecting the dots.
Jefferies is (as MF Global was) an independent brokerage firm, which means it doesn't have access to the Fed's discount window. Unlike bank holding companies like Bank of America and J.P. Morgan, it cannot borrow short-term monies from the U.S. central bank to meet temporary shortages of liquidity.
Another direct, and damning link, was a bond deal Jefferies did for MF Global (among other firms) back in August.
Jefferies has tried to distance itself from the disgraced broker-dealer. It issued a statement on the day MF Global filed for bankruptcy, stating their exposure to MF Global debt securities, which resulted from client orders as part of normal-course market-making, is less than $9 million in marked-to-market positions.
In fairness to Jefferies, it is considerably more diversified and more of an investment bank than MF Global was, more akin to a smaller version of Wall Street behemoth Goldman Sachs.
They Said, They Said
On Nov. 3, trading in Jefferies's stock was halted twice as shares plunged as much as 20 percent, the most ever, sparked by Egan-Jones Ratings Co.'s downgrade of Jefferies's debt. In its note, Egan-Jones cited large "sovereign obligations" relative to equity.
Jefferies issued a statement, and then six more, to fend off fears and rumors following the controversial downgrade.
The company said it had "no meaningful" net exposure to European sovereign debt and disclosed its positions in the sovereign debts of Portugal, Italy, Ireland, Greece and Spain. According to the latest filings, as of Aug. 31, Jefferies had long positions of $2.684 billion, which was mostly offset by short positions of $2.545 billion, as well as offsetting positions in futures instrument.
Notably, Jefferies has been more transparent than its larger American peers.
"These are fragile times in the financial market and we decided the only way to conclusively dispel rumors, misinformation and misplaced concerns is with unprecedented transparency about internal information that is rarely, if ever, publicly disclosed," Richard Handler, Chairman and CEO of Jefferies, told IBTimes Friday.
On Nov. 7, Jefferies demonstrated the liquid nature of its market-making trading book by reducing its gross holding of European sovereign debt positions in half, $1.1 billion in both long and short, with no meaningful profit or loss. This move came after Egan-Jones president Sean Egan further questioned Jefferies's short-term funding ability.
According to information on the Jefferies website, eighty-five percent of the firm's highly liquid inventories are funded through central clearinghouses, while the rest of its positions are financed at terms of greater than 80 days, which is usually longer than the holding periods of the inventory.
The company reconfirmed that they currently have $2 billion in cash, just under $2 billion of lines of credit, and about $400 million in unpledged quality collateral. The company also said they have zero unsecured financing and about $8.2 billion in long-term capital, composed of $3.5 billion of equity, $4.3 billion of long-term debt, and $438 million of preferred equity.
The company's executives are also buying into the company's stock. On Thursday, the SEC released filings showing that top executives and directors of Jefferies collectively received more than 80,000 of the bank's shares on Tuesday, at a total price of $917,921. Amid suspicion of the company's effort to push up share price, Jefferies said the shares were acquired as part of the firm's deferred compensation plan.
Egan-Jones, however, haven't budged. One day after Jefferies release these statements, Egan appeared on CNBC in defense of his ratings.
"Our job is to issue timely, accurate ratings, and we did just that. We didn't cut to below investment grade. We didn't say the company is terribly managed. We said the leverage was too high and the environment has changed," he told CNBC.
"Life is more difficult for a medium-sized brokerage firm. I'm sorry but that's the reality," he added.
An unusual rebound in Jefferies' share price on Thursday past 1:30 p.m. came after Egan, the "most hated man at Jefferies," appeared on Fox News. When Charlie Gasparino asked Egan why he omitted Jefferies's hedging positions in his initial newsletter to his clients, Egan said: "Our problem is that we have space constrains." This remark sent Jefferies stocks up nearly 6 percent before the closing bell.
Fear and Loathing on Wall Street
"The market right now is one driven by fear and rumor more so than usual, and investors tend to sell first and ask questions later. There's not always a close relationship between the reality of the situation and investor response." said Kathleen Wailes, Senior Vice President of PR boutique firm Levick Strategic Communications.
"Jefferies should communicate as often and as transparent as possible to the market and to its investors, whenever there is a significant development that might affect its investor perception, rather than waiting for a big reaction and respond to it," Wailes added.
The end-game, it seems, has to do with the market environment. Brokers and other financial institutions, which by the nature of their business rely on less-than-transparent books, sovereign exposure, counter-party confidence and access to short-term funding are very vulnerable. Hedge funds and other optimistic short-sellers, whether justified or not, can use the fear in the market to profit off soft targets.
There is also the ever-present problem of confidence, the value that means "credit", in the high-minded words of Wall Street research firm Dun & Bradstreet is nothing more than "man's trust in man." In such an environment, investors seem to be saying, who is there to trust?