10-Q
Table of Contents

 

 

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 February 28, 2014

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 1-14947

 

 

JEFFERIES GROUP LLC

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   95-4719745

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

520 Madison Avenue, New York, New York   10022
(Address of principal executive offices)   (Zip Code)

Registrant’s telephone number, including area code: (212) 284-2550

 

 

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  ¨

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  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x      Smaller reporting company   ¨

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

The Registrant is a wholly-owned subsidiary of Leucadia National Corporation and meets the conditions set forth in General Instructions H(1)(a) and (b) of Form 10-Q and is therefore filing this Form 10-Q with a reduced disclosure format as permitted by Instruction H (2).

 

 

 


Table of Contents

JEFFERIES GROUP LLC

INDEX TO QUARTERLY REPORT ON FORM 10-Q

FEBRUARY 28, 2014

 

PART I. FINANCIAL INFORMATION   
Item 1.  

Financial Statements

  
 

Consolidated Statements of Financial Condition (Unaudited)- February 28, 2014 and November 30, 2013

     2   
  Consolidated Statements of Earnings (Unaudited)- Three Months Ended February 28, 2014 (Successor) and February 28, 2013 (Predecessor)      5   
  Consolidated Statements of Comprehensive Income (Unaudited)- Three Months Ended February 28, 2014 (Successor) and February 28, 2013 (Predecessor)      6   
  Consolidated Statements of Changes in Equity (Unaudited)- Three Months Ended February 28, 2014 (Successor), Nine Months Ended November 30, 2013 (Successor) and Three Months Ended February  28, 2013 (Predecessor)      7   
  Consolidated Statements of Cash Flows (Unaudited)- Three Months Ended February 28, 2014 (Successor) and February 28, 2013 (Predecessor)      8   
 

Notes to Consolidated Financial Statements (Unaudited)

     10   
Item 2.  

Management’s Discussion and Analysis of Financial Condition and Results of Operations

     74   
Item 3.  

Quantitative and Qualitative Disclosures About Market Risk

     109   
Item 4.  

Controls and Procedures

     109   
PART II. OTHER INFORMATION   
Item 1.  

Legal Proceedings

     109   
Item 1A.  

Risk Factors

     110   
Item 2.  

Unregistered Sales of Equity Securities and Use of Proceeds

     110   
Item 6.  

Exhibits

     110   

 

1


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(In thousands)

 

     February 28,
2014
     November 30,
2013
 

ASSETS

     

Cash and cash equivalents

   $ 2,864,910       $ 3,561,119   

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

     3,801,517         3,616,602   

Financial instruments owned, at fair value, including securities pledged of $15,065,084 and $13,253,537 at February 28, 2014 and November 30, 2013, respectively:

     

Corporate equity securities

     2,609,789         2,098,597   

Corporate debt securities

     3,260,638         2,982,768   

Government, federal agency and other sovereign obligations

     5,429,302         5,346,152   

Mortgage- and asset-backed securities

     5,083,832         4,473,135   

Loans and other receivables

     1,294,096         1,349,128   

Derivatives

     223,699         261,093   

Investments, at fair value

     118,278         101,282   

Physical commodities

     105,982         37,888   
  

 

 

    

 

 

 

Total financial instruments owned, at fair value

     18,125,616         16,650,043   

Investments in managed funds

     71,142         57,285   

Loans to and investments in related parties

     725,293         701,873   

Securities borrowed

     6,119,935         5,359,846   

Securities purchased under agreements to resell

     4,448,531         3,746,920   

Securities received as collateral

     1,051         11,063   

Receivables:

     

Brokers, dealers and clearing organizations

     2,596,998         2,119,279   

Customers

     1,275,955         1,046,945   

Fees, interest and other

     286,688         251,072   

Premises and equipment

     230,251         202,467   

Goodwill

     1,724,883         1,722,346   

Other assets

     1,167,061         1,130,136   
  

 

 

    

 

 

 

Total assets

   $ 43,439,831       $ 40,176,996   
  

 

 

    

 

 

 

 

Continued on next page.

2


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION – CONTINUED (UNAUDITED)

 

(In thousands, except share amounts)

 

     February 28,
2014
     November 30,
2013
 

LIABILITIES AND EQUITY

     

Short-term borrowings

   $ 12,000       $ 12,000   

Financial instruments sold, not yet purchased, at fair value:

     

Corporate equity securities

     1,601,171         1,823,299   

Corporate debt securities

     1,773,525         1,346,078   

Government, federal agency and other sovereign obligations

     5,060,521         3,155,683   

Mortgage- and asset-backed securities

     7,230         34,691   

Loans

     706,107         695,300   

Derivatives

     188,505         180,079   

Physical commodities

     41,545         36,483   
  

 

 

    

 

 

 

Total financial instruments sold, not yet purchased, at fair value

     9,378,604         7,271,613   

Collateralized financings:

     

Securities loaned

     3,082,032         2,506,122   

Securities sold under agreements to repurchase

     10,777,065         10,779,845   

Other secured financings

     270,394         234,711   

Obligation to return securities received as collateral

     1,051         11,063   

Payables:

     

Brokers, dealers and clearing organizations

     1,569,582         1,281,253   

Customers

     5,703,520         5,208,768   

Accrued expenses and other liabilities

     923,832         1,217,141   

Long-term debt

     6,259,664         6,232,806   
  

 

 

    

 

 

 

Total liabilities

     37,977,744         34,755,322   
  

 

 

    

 

 

 

EQUITY

     

Member’s paid-in capital

     5,393,795         5,280,420   

Accumulated other comprehensive income:

     

Currency translation adjustments

     35,125         21,341   

Additional minimum pension liability

     2,759         2,759   
  

 

 

    

 

 

 

Total accumulated other comprehensive income

     37,884         24,100   
  

 

 

    

 

 

 

Total member’s equity

     5,431,679         5,304,520   

Noncontrolling interests

     30,408         117,154   
  

 

 

    

 

 

 

Total equity

     5,462,087         5,421,674   
  

 

 

    

 

 

 

Total liabilities and equity

   $ 43,439,831       $ 40,176,996   
  

 

 

    

 

 

 

 

Continued on next page.

3


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION – CONTINUED (UNAUDITED)

 

(In thousands)

The table below presents the carrying amount and classification of assets of consolidated variable interest entities (“VIEs”) that can be used only to settle obligations of the consolidated VIEs and the liabilities of consolidated VIEs for which creditors (or beneficial interest holders) do not have recourse to our general credit. The assets and liabilities of these consolidated VIEs are included in the Consolidated Statements of Financial Condition and are presented net of intercompany eliminations.

 

     February 28,
2014
     November 30,
2013
 

Assets

     

Cash and cash equivalents

   $ 176       $ 176   

Financial instruments owned, at fair value

     

Loans and other receivables

     97,500         97,500   

Investments, at fair value

     378         412   
  

 

 

    

 

 

 

Total financial instruments owned, at fair value

     97,878         97,912   

Other assets

     3,243         2,275   
  

 

 

    

 

 

 

Total assets

   $ 101,297       $ 100,363   
  

 

 

    

 

 

 

Liabilities

     

Other secured financings

   $ 240,000       $ 226,000   

Accrued expenses and other liabilities

     668         706   
  

 

 

    

 

 

 

Total liabilities

   $ 240,668       $ 226,706   
  

 

 

    

 

 

 

See accompanying notes to consolidated financial statements.

 

4


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

(In thousands, except per share amounts)

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
          Three Months Ended
February 28, 2013
 
 

Revenues:

         

Commissions

   $ 162,063           $ 146,240   

Principal transactions

     238,363             300,278   

Investment banking

     414,320             288,278   

Asset management fees and investment income from managed funds

     9,957             10,883   

Interest

     249,268             249,277   

Other

     23,069             27,004   
  

 

 

        

 

 

 

Total revenues

     1,097,040             1,021,960   

Interest expense

     198,012             203,416   
  

 

 

        

 

 

 

Net revenues

     899,028             818,544   

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     —               10,961   
  

 

 

        

 

 

 

Net revenues, less interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     899,028             807,583   
  

 

 

        

 

 

 

Non-interest expenses:

         

Compensation and benefits

     507,899             474,217   
 

Non-compensation expenses:

         

Floor brokerage and clearing fees

     49,513             46,155   

Technology and communications

     64,306             59,878   

Occupancy and equipment rental

     27,017             24,309   

Business development

     26,476             24,927   

Professional services

     24,304             24,135   

Other

     17,244             14,475   
  

 

 

        

 

 

 

Total non-compensation expenses

     208,860             193,879   
  

 

 

        

 

 

 
 

Total non-interest expenses

     716,759             668,096   
  

 

 

        

 

 

 
 

Earnings before income taxes

     182,269             139,487   

Income tax expense

     66,877             48,645   
  

 

 

        

 

 

 

Net earnings

     115,392             90,842   

Net earnings attributable to noncontrolling interests

     2,960             10,704   
  

 

 

        

 

 

 

Net earnings attributable to Jefferies Group LLC

   $ 112,432           $ 80,138   
  

 

 

        

 

 

 
 

Earnings per common share:

         

Basic

     N/A           $ 0.35   

Diluted

     N/A           $ 0.35   
 

Dividends declared per common share

     N/A           $ 0.075   
 

Weighted average common shares:

         

Basic

     N/A             213,732   

Diluted

     N/A             217,844   

See accompanying notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
          Three Months Ended
February 28, 2013
 
 

Net earnings

   $ 115,392           $ 90,842   
  

 

 

        

 

 

 

Other comprehensive income (loss), net of tax:

         

Currency translation adjustments

     13,784             (10,018
  

 

 

        

 

 

 

Total other comprehensive income (loss), net of tax (1)

     13,784             (10,018
  

 

 

        

 

 

 
 

Comprehensive income:

     129,176             80,824   

Net earnings attributable to noncontrolling interests

     2,960             10,704   
  

 

 

        

 

 

 

Comprehensive income attributable to Jefferies Group LLC

   $ 126,216           $ 70,120   
  

 

 

        

 

 

 

 

(1) No other comprehensive income (loss) is attributable to noncontrolling interests.

See accompanying notes to consolidated financial statements.

 

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JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY (UNAUDITED)

(In thousands, except per share amounts)

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
    Nine Months Ended
November 30, 2013
          Three Months Ended
February 28, 2013
 
 

Common stock, par value $0.0001 per share

           

Balance, beginning of period

   $ —        $ —             $ 20   

Issued

     —          —               1   
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ —        $ —             $ 21   
  

 

 

   

 

 

        

 

 

 
 

Member’s paid-in capital

           

Balance, beginning of period

   $ 5,280,420      $ 4,754,101           $ —     

Contributions

     —          362,255             —     

Net earnings to Jefferies Group LLC

     112,432        161,191             —     

Tax benefit for issuance of share-based awards

     943        2,873             —     
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ 5,393,795      $ 5,280,420           $ —     
  

 

 

   

 

 

        

 

 

 
 

Additional paid-in capital

           

Balance, beginning of period

   $ —        $ —             $ 2,219,959   

Benefit plan share activity (3)

     —          —               3,138   

Share-based expense, net of forfeitures and clawbacks

     —          —               22,288   

Proceeds from exercise of stock options

     —          —               57   

Acquisitions and contingent consideration

     —          —               2,535   

Tax deficiency for issuance of share-based awards

     —          —               (17,965

Dividend equivalents on share-based plans

     —          —               1,418   
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ —        $ —             $ 2,231,430   
  

 

 

   

 

 

        

 

 

 
 

Retained earnings

           

Balance, beginning of period

   $ —        $ —             $ 1,281,855   

Net earnings to common shareholders

     —          —               80,138   

Dividends

     —          —               (17,217
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ —        $ —             $ 1,344,776   
  

 

 

   

 

 

        

 

 

 
 

Accumulated other comprehensive income (loss) (1) (2)

           

Balance, beginning of period

   $ 24,100      $ —             $ (53,137

Currency adjustment

     13,784        21,341             (10,018

Pension adjustment, net of tax

     —          2,759             —     
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ 37,884      $ 24,100           $ (63,155
  

 

 

   

 

 

        

 

 

 
 

Treasury stock, at cost

           

Balance, beginning of period

   $ —        $ —             $ (12,682

Purchases

     —          —               (166,541

Returns / forfeitures

     —          —               (1,922
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ —        $ —             $ (181,145
  

 

 

   

 

 

        

 

 

 
 

Total member’s / common stockholders’ equity

   $ 5,431,679      $ 5,304,520           $ 3,331,927   
  

 

 

   

 

 

        

 

 

 
 

Noncontrolling interests

           

Balance, beginning of period

   $ 117,154      $ 356,180           $ 346,738   

Net earnings attributable to noncontrolling interests

     2,960        8,418             10,704   

Contributions

     31,075        100,210             —     

Distributions

     —          (25          (1,262

Redemptions

     —          (347,629          —     

Consolidation (deconsolidation) of asset management entity

     (120,781     —               —     
  

 

 

   

 

 

        

 

 

 

Balance, end of period

   $ 30,408      $ 117,154           $ 356,180   
  

 

 

   

 

 

        

 

 

 
 

Total equity

   $ 5,462,087      $ 5,421,674           $ 3,688,107   
  

 

 

   

 

 

        

 

 

 

 

 

(1) The components of other comprehensive income (loss) are attributable to Jefferies Group LLC (formerly Jefferies Group, Inc.). None of the components of other comprehensive income (loss) are attributable to noncontrolling interests.
(2) There were no reclassifications out of Accumulated other comprehensive loss during the nine months ended November 30, 2013.
(3) Includes grants related to the Incentive Plan, Deferred Compensation Plan and Directors’ Plan.

See accompanying notes to consolidated financial statements.

 

7


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
          Three Months Ended
February 28, 2013
 

Cash flows from operating activities:

         

Net earnings

   $ 115,392           $ 90,842   
  

 

 

        

 

 

 

Adjustments to reconcile net earnings to net cash used in operating activities:

         

Depreciation and amortization

     (3,951          17,393   

Gain on conversion option

     (1,967          —     

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     —               10,961   

Accruals related to various benefit plans and stock issuances, net of forfeitures

     —               23,505   

Income on loans to and investments in related parties

     (20,629          —     

Distributions received on investments in related parties

     2,388             —     

Other adjustments

     (1,338          (1,154

Net change in assets and liabilities:

         

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

     (183,710          352,891   

Receivables:

         

Brokers, dealers and clearing organizations

     (478,066          (1,027,671

Customers

     (227,813          (130,543

Fees, interest and other

     (35,076          (29,149

Securities borrowed

     (756,481          (224,557

Financial instruments owned

     (1,650,607          229,394   

Loans to and investments in related parties

     —               (197,166

Investments in managed funds

     16,696             (2,213

Securities purchased under agreements to resell

     (694,175          (224,418

Other assets

     (39,193          25,489   

Payables:

         

Brokers, dealers and clearing organizations

     287,356             (1,031,335

Customers

     488,178             (111,139

Securities loaned

     572,285             (28,138

Financial instruments sold, not yet purchased

     2,282,870             2,327,667   

Securities sold under agreements to repurchase

     (10,772          (197,493

Accrued expenses and other liabilities

     (297,462          (267,336
  

 

 

        

 

 

 

Net cash used in operating activities

     (636,075          (394,170
  

 

 

        

 

 

 
 

Cash flows from investing activities:

         

Contributions to loans to and investments in related parties

     (784,818          —     

Distributions from loans to and investments in related parties

     779,638             —     
 

Net payments on premises and equipment

     (40,271          (10,706

Deconsolidation of asset management entity

     (137,856          —     

Cash received from contingent consideration

     1,442             1,203   
  

 

 

        

 

 

 

Net cash used in investing activities

     (181,865          (9,503
  

 

 

        

 

 

 

 

Continued on next page.

8


Table of Contents

JEFFERIES GROUP LLC AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS – CONTINUED (UNAUDITED)

(In thousands)

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
          Three Months Ended
February 28, 2013
 

Cash flows from financing activities:

         

Excess tax benefits from the issuance of share-based awards

   $ 953           $ 5,682   

Proceeds from short-term borrowings

     —               6,744,000   

Payments on short-term borrowings

     —               (6,794,000

Proceeds from secured credit facility

     250,000             900,000   

Payments on secured credit facility

     (200,000          (990,007

Net proceeds from other secured financings

     35,683             60,000   

Payments on mandatorily redeemable preferred interest of consolidated subsidiaries

     —               (61

Payments on repurchase of common stock

     —               (166,541

Payments on dividends

     —               (15,799

Proceeds from exercise of stock options, not including tax benefits

     —               57   

Net proceeds from issuance of senior notes, net of issuance costs

     —               991,469   

Proceeds from contributions of noncontrolling interests

     31,075             —     

Payments on distributions to noncontrolling interests

     —               (1,262
  

 

 

        

 

 

 

Net cash provided by financing activities

     117,711             733,538   
  

 

 

        

 

 

 

Effect of exchange rate changes on cash and cash equivalents

     4,020             (4,502
  

 

 

        

 

 

 

Net (decrease) increase in cash and cash equivalents

     (696,209          325,363   
 

Cash and cash equivalents at beginning of period

     3,561,119             2,692,595   
  

 

 

        

 

 

 

Cash and cash equivalents at end of period

   $ 2,864,910           $ 3,017,958   
  

 

 

        

 

 

 
 

Supplemental disclosures of cash flow information:

         
 

Cash paid (received) during the period for:

         

Interest

   $ 244,269           $ 178,836   

Income tax refunds, net of cash paid

     (4,836          (34,054

See accompanying notes to consolidated financial statements.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Index

 

Note

   Page  

Note 1. Organization and Basis of Presentation

     11   

Note 2. Summary of Significant Accounting Policies

     13   

Note 3. Accounting Developments

     20   

Note 4. Leucadia and Related Transactions

     21   

Note 5. Cash, Cash Equivalents and Short-Term Investments

     24   

Note 6. Fair Value Disclosures

     25   

Note 7. Derivative Financial Instruments

     40   

Note 8. Collateralized Transactions

     46   

Note 9. Securitization Activities

     48   

Note 10. Variable Interest Entities

     50   

Note 11. Investments

     54   

Note 12. Goodwill and Other Intangible Assets

     57   

Note 13. Short-Term Borrowings

     59   

Note 14. Long-Term Debt

     59   

Note 15. Mandatorily Redeemable Convertible Preferred Stock

     61   

Note 16. Noncontrolling Interests and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries

     62   

Note 17. Benefit Plans

     62   

Note 18. Compensation Plans

     63   

Note 19. Earnings per Share

     66   

Note 20. Income Taxes

     66   

Note 21. Commitments, Contingencies and Guarantees

     67   

Note 22. Net Capital Requirements

     71   

Note 23. Segment Reporting

     71   

Note 24. Related Party Transactions

     73   

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Note 1. Organization and Basis of Presentation

Organization

Jefferies Group LLC, and its subsidiaries operate as a global full service, integrated securities and investment banking firm. Jefferies Group LLC was previously known as Jefferies Group, Inc., which on March 1, 2013 was converted into a limited liability company and renamed Jefferies Group LLC. In addition, certain subsidiaries of Jefferies Group, Inc. also converted into limited liability companies. The accompanying Consolidated Financial Statements therefore refer to Jefferies Group LLC and represent the accounts of Jefferies Group, Inc., as it was formerly known, and all our subsidiaries (together “we” or “us”). The subsidiaries of Jefferies Group LLC include Jefferies LLC (“Jefferies”), Jefferies Execution Services, Inc. (“Jefferies Execution”), Jefferies Bache, LLC, Jefferies International Limited, Jefferies Bache Limited, Jefferies Hong Kong Limited, Jefferies Bache Financial Services, Inc., Jefferies Mortgage Funding, LLC and Jefferies Leveraged Credit Products, LLC and all other entities in which we have a controlling financial interest or are the primary beneficiary.

On March 1, 2013, Jefferies Group LLC through a series of transactions, became an indirect wholly owned subsidiary of Leucadia National Corporation (“Leucadia”) (referred to herein as the “Leucadia Transaction”). Each outstanding share of Jefferies Group LLC was converted into 0.81 of a share of Leucadia common stock (the “Exchange Ratio”). Leucadia did not assume nor guarantee any of our outstanding debt securities. Our 3.875% Convertible Senior Debentures due 2029 are now convertible into Leucadia common shares at a price that reflects the Exchange Ratio and the 3.25% Series A Convertible Cumulative Preferred Stock of Jefferies Group, Inc. was exchanged for a comparable series of convertible preferred shares of Leucadia. Jefferies Group LLC continues to operate as a full-service investment banking firm and as the holding company of its various regulated and unregulated operating subsidiaries. Richard Handler, our Chief Executive Officer and Chairman, was also appointed the Chief Executive Officer of Leucadia, as well as a Director of Leucadia. Brian Friedman, our Chairman of the Executive Committee, was also appointed Leucadia’s President and a Director of Leucadia. Following the Leucadia Transaction, we continue to operate as a full-service global investment banking firm, retain a credit rating separate from Leucadia and remain an SEC reporting company, filing annual, quarterly and periodic financial reports.

We operate in two business segments, Capital Markets and Asset Management. Capital Markets, which represents principally our entire business, includes our securities, commodities, futures and foreign exchange trading and investment banking activities, which provides the research, sales, trading, origination and advisory effort for various equity, fixed income and advisory products and services. Asset Management provides investment management services to various private investment funds, separate accounts and mutual funds.

In addition, on April 1, 2013, we merged Jefferies High Yield Trading, LLC (our high yield trading broker-dealer) with Jefferies (a U.S. broker-dealer) and our high yield activities are now conducted by Jefferies. In addition, during the three months ended May 31, 2013, we redeemed the third party interests in our high yield joint venture.

Basis of Presentation

The accompanying Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for financial information and with the instructions to Form 10-K.

As more fully described in Note 4, Leucadia and Related Transactions, the Leucadia Transaction is accounted for using the acquisition method of accounting, which requires that the assets, including identifiable intangible assets, and liabilities of Jefferies Group LLC be recorded at their fair values. The application of the acquisition method of accounting has been pushed down and reflected in the financial statements of Jefferies Group LLC as a wholly-owned subsidiary of Leucadia. The application of push down accounting represents the termination of the prior reporting entity and the creation of a new reporting entity, which do not have the same bases of accounting. As a

 

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(Unaudited)

 

result, our consolidated financial statements are presented for periods subsequent to March 1, 2013 for the new reporting entity (the “Successor”), and before March 1, 2013 for the prior reporting entity (the “Predecessor.”) The Predecessor and Successor periods are separated by a vertical line to highlight the fact that the financial information for such periods have been prepared under two different cost bases of accounting.

We have made a number of estimates and assumptions relating to the reporting of assets and liabilities and the disclosure of contingent assets and liabilities to prepare these financial statements in conformity with U.S. GAAP. The most important of these estimates and assumptions relate to fair value measurements, compensation and benefits, goodwill and intangible assets, the ability to realize deferred tax assets and the recognition and measurement of uncertain tax positions. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

Cash Flow Statement Presentation

For the three months ended February 28, 2014, certain amounts relating to loans and investments in related parties are classified as components of investing activities on the Consolidated Statements of Cash Flows to conform to the presentation of our Parent company in connection with the establishment of a new accounting entity through the application of push down accounting. These amounts were classified by the Predecessor entity as operating activities for reporting periods prior to the Leucadia Transaction.

Consolidation

Our policy is to consolidate all entities in which we control by ownership a majority of the outstanding voting stock. In addition, we consolidate entities which meet the definition of a variable interest entity for which we are the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity. For consolidated entities that are less than wholly owned, the third-party’s holding of equity interest is presented as Noncontrolling interests in the Consolidated Statements of Financial Condition and Consolidated Statements of Changes in Equity. The portion of net earnings attributable to the noncontrolling interests are presented as Net earnings to noncontrolling interests in the Consolidated Statements of Earnings.

In situations where we have significant influence, but not control, of an entity that does not qualify as a variable interest entity, we apply either the equity method of accounting or fair value accounting pursuant to the fair value option election under U.S. GAAP, with our portion of net earnings or gains and losses recorded within Other revenues or Principal transaction revenues, respectively. We also have formed nonconsolidated investment vehicles with third-party investors that are typically organized as partnerships or limited liability companies and are carried at fair value. We act as general partner or managing member for these investment vehicles and have generally provided the third-party investors with termination or “kick-out” rights.

Intercompany accounts and transactions are eliminated in consolidation.

Immaterial 2013 Adjustments

As indicated in our Quarterly Report on Form 10-Q for the three months ended May 31, 2013 and our Annual Report on Form 10-K for the year ended November 30, 2013, we have made correcting adjustments (referred to as “adjustments”) to our historical financial statements for the first quarter of 2013. We do not believe these adjustments are material to our financial statements for the quarterly period ended February 28, 2013. For additional information on these adjustments, see Note 1, Organization and Basis of Presentation, and Note 26, Selected Quarterly Financial Data (Unaudited), of the Consolidated Financial Statements of our Annual Report on Form 10-K for the year ended November 30, 2013.

 

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Note 2. Summary of Significant Accounting Policies

Revenue Recognition Policies

Commissions. All customer securities transactions are reported on the Consolidated Statements of Financial Condition on a settlement date basis with related income reported on a trade-date basis. We permit institutional customers to allocate a portion of their gross commissions to pay for research products and other services provided by third parties. The amounts allocated for those purposes are commonly referred to as soft dollar arrangements. These arrangements are accounted for on an accrual basis and, as we are not the primary obligor for these arrangements, netted against commission revenues in the Consolidated Statements of Earnings. The commissions and related expenses on client transactions executed by Jefferies Bache, LLC, a futures commission merchant, are recorded on a half-turn basis.

Principal Transactions. Financial instruments owned and Financial instruments sold, but not yet purchased (all of which are recorded on a trade-date basis) are carried at fair value with gains and losses reflected in Principal transactions in the Consolidated Statements of Earnings on a trade date basis. Fees received on loans carried at fair value are also recorded within Principal transactions.

Investment Banking. Underwriting revenues and fees from mergers and acquisitions, restructuring and other investment banking advisory assignments or engagements are recorded when the services related to the underlying transactions are completed under the terms of the assignment or engagement. Expenses associated with such assignments are deferred until reimbursed by the client, the related revenue is recognized or the engagement is otherwise concluded. Expenses are recorded net of client reimbursements and netted against revenues. Unreimbursed expenses with no related revenues are included in Business development and Professional services expenses in the Consolidated Statements of Earnings.

Asset Management Fees and Investment Income From Managed Funds. Asset management fees and investment income from managed funds include revenues we earn from management, administrative and performance fees from funds and accounts managed by us, revenues from management and performance fees we earn from related-party managed funds and investment income from our investments in these funds. We earn fees in connection with management and investment advisory services performed for various funds and managed accounts. These fees are based on assets under management or an agreed upon notional amount and may include performance fees based upon the performance of the funds. Management and administrative fees are generally recognized over the period that the related service is provided. Generally, performance fees are earned when the return on assets under management exceeds certain benchmark returns, “high-water marks” or other performance targets. Performance fees are accrued (or reversed) on a monthly basis based on measuring performance to date versus any relevant benchmark return hurdles stated in the investment management agreement. Performance fees are not subject to adjustment once the measurement period ends (generally annual periods) and the performance fees have been realized.

Interest Revenue and Expense. We recognize contractual interest on Financial instruments owned and Financial instruments sold, but not yet purchased, on an accrual basis as a component of interest revenue and expense. Interest flows on derivative trading transactions and dividends are included as part of the fair valuation of these contracts and recognized in Principal transactions in the Consolidated Statements of Earnings rather than as a component of interest revenue or expense. We account for our short- and long-term borrowings on an accrual basis with related interest recorded as Interest expense. Discounts/premiums arising on our long-term debt are accreted / amortized to Interest expense using the effective yield method over the remaining lives of the underlying debt obligations. In addition, we recognize interest revenue related to our securities borrowed and securities purchased under agreements to resell activities and interest expense related to our securities loaned and securities sold under agreements to repurchase activities on an accrual basis.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Cash Equivalents

Cash equivalents include highly liquid investments, including certificates of deposit and money market funds, not held for resale with original maturities of three months or less.

Cash and Securities Segregated and on Deposit for Regulatory Purposes or Deposited With Clearing and Depository Organizations

In accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, Jefferies as a broker-dealer carrying client accounts, is subject to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients. In addition, certain financial instruments used for initial and variation margin purposes with clearing and depository organizations are recorded in this caption. Jefferies Bache, LLC, as a futures commission merchant, is obligated by rules mandated by the Commodities Futures Trading Commission under the Commodities Exchange Act, to segregate or set aside cash or qualified securities to satisfy such regulations, which regulations have been promulgated to protect customer assets. Certain other entities are also obligated by rules mandated by their primary regulators to segregate or set aside cash or equivalent securities to satisfy regulations, promulgated to protect customer assets.

Financial Instruments

Financial instruments owned and Financial instruments sold, not yet purchased are recorded at fair value, either as required by accounting pronouncements or through the fair value option election. These instruments primarily represent our trading activities and include both cash and derivative products. Gains and losses are recognized in Principal transactions in our Consolidated Statements of Earnings. The fair value of a financial instrument is the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (the exit price).

Fair Value Hierarchy

In determining fair value, we maximize the use of observable inputs and minimize the use of unobservable inputs by requiring that observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability based on market data obtained from independent sources. Unobservable inputs reflect our assumptions that market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. We apply a hierarchy to categorize our fair value measurements broken down into three levels based on the transparency of inputs as follows:

 

Level 1:   Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level 2:   Pricing inputs are other than quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these financial instruments include cash instruments for which quoted prices are available but traded less frequently, derivative instruments whose fair value have been derived using a model where inputs to the model are directly observable in the market, or can be derived principally from or corroborated by observable market data, and instruments that are fair valued using other financial instruments, the parameters of which can be directly observed.
Level 3:   Instruments that have little to no pricing observability as of the reported date. These financial instruments are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.

Financial instruments are valued at quoted market prices, if available. Certain financial instruments have bid and ask prices that can be observed in the marketplace. For financial instruments whose inputs are based on bid-ask prices, the financial instrument is valued at the point within the bid-ask range that meets our best estimate of fair value. We use

 

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(Unaudited)

 

prices and inputs that are current as of the measurement date. For financial instruments that do not have readily determinable fair values using quoted market prices, the determination of fair value is based upon consideration of available information, including types of financial instruments, current financial information, restrictions on dispositions, fair values of underlying financial instruments and quotations for similar instruments.

The valuation of financial instruments may include the use of valuation models and other techniques. Adjustments to valuations derived from valuation models may be made when, in management’s judgment, features of the financial instrument such as its complexity, the market in which the financial instrument is traded and risk uncertainties about market conditions require that an adjustment be made to the value derived from the models. Adjustments from the price derived from a valuation model reflect management’s judgment that other participants in the market for the financial instrument being measured at fair value would also consider in valuing that same financial instrument. To the extent that valuation is based on models or inputs that are less observable or unobservable in the market, the determination of fair value requires more judgment.

The availability of observable inputs can vary and is affected by a wide variety of factors, including, for example, the type of financial instrument and market conditions. As the observability of prices and inputs may change for a financial instrument from period to period, this condition may cause a transfer of an instrument among the fair value hierarchy levels. Transfers among the levels are recognized at the beginning of each period. The degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.

Valuation Process for Financial Instruments

Our Independent Price Verification (“IPV”) Group, which is part of our Finance department, in partnership with Risk Management, is responsible for establishing our valuation policies and procedures. The IPV Group and Risk Management, which are independent of our business functions, play an important role and serve as a control function in determining that our financial instruments are appropriately valued and that fair value measurements are reliable. This is particularly important where prices or valuations that require inputs are less observable. In the event that observable inputs are not available, the control processes are designed to assure that the valuation approach utilized is appropriate and consistently applied and that the assumptions are reasonable. The IPV Group reports to the Global Controller and is subject to the oversight of the IPV Committee, which is comprised of our Chief Financial Officer, Global Controller, Global Head of Product Control, Chief Risk Officer and Principal Accounting Officer, among other personnel. Our independent price verification policies and procedures are reviewed, at a minimum, annually and changes to the policies require the approval of the IPV Committee.

Price Testing Process. The business units are responsible for determining the fair value of our financial instruments using approved valuation models and methodologies. In order to ensure that the business unit valuations represent a fair value exit price, the IPV Group tests and validates the fair value of our financial instruments inventory. In the testing process, the IPV Group obtains prices and valuation inputs from sources independent of Jefferies, consistently adheres to established procedures set forth in our valuation policies for sourcing prices and valuation inputs and utilizing valuation methodologies. Sources used to validate fair value prices and inputs include, but are not limited to, exchange data, recently executed transactions, pricing data obtained from third party vendors, pricing and valuation services, broker quotes and observed comparable transactions.

To the extent discrepancies between the business unit valuations and the pricing or valuations resulting from the price testing process are identified, such discrepancies are investigated by the IPV Group and fair values are adjusted, as appropriate. The IPV Group maintains documentation of its testing, results, rationale and recommendations and prepares a monthly summary of its valuation results. This process also forms the basis for our classification of fair values within the fair value hierarchy (i.e., Level 1, Level 2 or Level 3). The IPV Group utilizes the additional expertise of Risk Management personnel in valuing more complex financial instruments and financial instruments with less or limited pricing observability. The results of the valuation testing are reported to the IPV Committee on a monthly basis, which discusses the results and is charged with the final conclusions as to the financial instrument fair values in the consolidated financial statements. This process specifically assists the Chief Financial Officer in

 

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asserting as to the fair presentation of our financial condition and results of operations as included within our Quarterly Reports on Form 10-Q and Annual Report on Form 10-K. At each quarter end, the overall valuation results, as concluded upon by the IPV Committee, are presented to the Audit Committee.

Judgment exercised in determining Level 3 fair value measurements is supplemented by daily analysis of profit and loss performed by the Product Control functions. Gains and losses, which result from changes in fair value, are evaluated and corroborated daily based on an understanding of each of the trading desks’ overall risk positions and developments in a particular market on the given day. Valuation techniques generally rely on recent transactions of suitably comparable financial instruments and use the observable inputs from those comparable transactions as a validation basis for Level 3 inputs. Level 3 fair value measurements are further validated through subsequent sales testing and market comparable sales, if such information is available. Level 3 fair value measurements require documentation of the valuation rationale applied, which is reviewed for consistency in application from period to period; and the documentation includes benchmarking the assumptions underlying the valuation rationale against relevant analytic data.

Third Party Pricing Information. Pricing information obtained from external data providers (including independent pricing services and brokers) may incorporate a range of market quotes from dealers, recent market transactions and benchmarking model derived prices to quoted market prices and trade data for comparable securities. External pricing data is subject to evaluation for reasonableness by the IPV Group using a variety of means including comparisons of prices to those of similar product types, quality and maturities, consideration of the narrowness or wideness of the range of prices obtained, knowledge of recent market transactions and an assessment of the similarity in prices to comparable dealer offerings in a recent time period. We have a process whereby we challenge the appropriateness of pricing information obtained from external data providers (including independent pricing services and brokers) in order to validate the data for consistency with the definition of a fair value exit price. Our process includes understanding and evaluating the external data providers’ valuation methodologies. For corporate, U.S. government and agency, and municipal debt securities, and loans, to the extent independent pricing services or broker quotes are utilized in our valuation process, the vendor service providers are collecting and aggregating observable market information as to recent trade activity and active bid-ask submissions. The composite pricing information received from the independent pricing service is not based on unobservable inputs or proprietary models. For mortgage- and other asset-backed securities and collateralized debt obligations, our independent pricing service uses a matrix evaluation approach incorporating both observable yield curves and market yields on comparable securities as well as implied inputs from observed trades for comparable securities in order to determine prepayment speeds, cumulative default rates and loss severity. Further, we consider pricing data from multiple service providers as available as well as compare pricing data to prices we have observed for recent transactions, if any, in order to corroborate our valuation inputs.

Model Review Process. Where a pricing model is to be used to determine fair value, the pricing model is reviewed for theoretical soundness and appropriateness by Risk Management, independent from the trading desks, and then approved by Risk Management to be used in the valuation process. Review and approval of a model for use may include benchmarking the model against relevant third party valuations, testing sample trades in the model, backtesting the results of the model against actual trades and stress-testing the sensitivity of the pricing model using varying inputs and assumptions. In addition, recently executed comparable transactions and other observable market data are considered for purposes of validating assumptions underlying the model. Models are independently reviewed and validated by Risk Management annually or more frequently if market conditions or use of the valuation model changes.

Investments in Managed Funds

Investments in managed funds include our investments in funds managed by us and our investments in related-party managed funds in which we are entitled to a portion of the management and/or performance fees. Investments in nonconsolidated managed funds are accounted for at fair value with gains or losses included in Asset management fees and investment income from managed funds in the Consolidated Statements of Earnings.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Loans to and Investments in Related Parties

Loans to and investments in related parties include investments in private equity and other operating entities made in connection with our capital markets activities in which we exercise significant influence over operating and capital decisions and loans issued in connection with such activities. Loans to and investments in related parties are accounted for using the equity method or at cost, as appropriate. Revenues on Loans to and investments in related parties are included in Other revenues in the Consolidated Statements of Earnings. See Note 11, Investments, and Note 24, Related Party Transactions, for additional information regarding certain of these investments.

Receivable from and Payable to Customers

Receivable from and payable to customers includes amounts receivable and payable on cash and margin transactions. Securities owned by customers and held as collateral for these receivables are not reflected in the accompanying consolidated financial statements. Receivable from officers and directors included within this financial statement line item represents balances arising from their individual security transactions. These transactions are subject to the same regulations as customer transactions and are provided on substantially the same terms.

Securities Borrowed and Securities Loaned

Securities borrowed and securities loaned are carried at the amounts of cash collateral advanced and received in connection with the transactions and accounted for as collateralized financing transactions. In connection with both trading and brokerage activities, we borrow securities to cover short sales and to complete transactions in which customers have failed to deliver securities by the required settlement date, and lend securities to other brokers and dealers for similar purposes. We have an active securities borrowed and lending matched book business in which we borrow securities from one party and lend them to another party. When we borrow securities, we generally provide cash to the lender as collateral, which is reflected in our Consolidated Statements of Financial Condition as Securities borrowed. We earn interest revenues on this cash collateral. Similarly, when we lend securities to another party, that party provides cash to us as collateral, which is reflected in our Consolidated Statements of Financial Condition as Securities loaned. We pay interest expense on the cash collateral received from the party borrowing the securities. The initial collateral advanced or received approximates or is greater than the fair value of the securities borrowed or loaned. We monitor the fair value of the securities borrowed and loaned on a daily basis and request additional collateral or return excess collateral, as appropriate.

Securities Purchased Under Agreements to Resell and Securities Sold Under Agreements to Repurchase

Securities purchased under agreements to resell and Securities sold under agreements to repurchase (collectively “repos”) are accounted for as collateralized financing transactions and are recorded at their contracted resale or repurchase amount plus accrued interest. We earn and incur interest over the term of the repo, which is reflected in Interest income and Interest expense on our Consolidated Statements of Earnings on an accrual basis. Repos are presented in the Consolidated Statements of Financial Condition on a net-basis-by counterparty, where permitted by generally accepted accounting principles. We monitor the fair value of the underlying securities daily versus the related receivable or payable balances. Should the fair value of the underlying securities decline or increase, additional collateral is requested or excess collateral is returned, as appropriate.

Premises and Equipment

Premises and equipment are depreciated using the straight-line method over the estimated useful lives of the related assets (generally three to ten years). Leasehold improvements are amortized using the straight-line method over the term of the related leases or the estimated useful lives of the assets, whichever is shorter. Premises and equipment includes internally developed software, which was increased to its fair market value in the allocation of the purchase price on March 1, 2013. The revised carrying values of internally developed software ready for its intended use are depreciated over the remaining useful life. See Note 4, Leucadia and Related Transactions for more information regarding the allocation of the purchase price.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Goodwill and Intangible Assets

Goodwill. Goodwill represents the excess acquisition cost over the fair value of net tangible and intangible assets acquired. Goodwill is not amortized and is subject to annual impairment testing on August 1 or between annual tests if an event or change in circumstance occurs that would more likely than not reduce the fair value of a reporting unit below its carrying value. In testing for goodwill impairment, we have the option to first assess qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events and circumstances, we conclude that it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing the two-step impairment test is not required. If we conclude otherwise, we are required to perform the two-step impairment test. The goodwill impairment test is performed at the reporting unit level by comparing the estimated fair value of a reporting unit with its respective carrying value. If the estimated fair value exceeds the carrying value, goodwill at the reporting unit level is not impaired. If the estimated fair value is less than carrying value, further analysis is necessary to determine the amount of impairment, if any.

The fair value of reporting units are based on widely accepted valuation techniques that we believe market participants would use, although the valuation process requires significant judgment and often involves the use of significant estimates and assumptions. The methodologies we utilize in estimating the fair value of reporting units include market capitalization, price-to-book multiples of comparable exchange traded companies and multiples of merger and acquisitions of similar businesses. The estimates and assumptions used in determining fair value could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Adverse market or economic events could result in impairment charges in future periods.

Intangible Assets. Intangible assets deemed to have finite lives are amortized on a straight line basis over their estimated useful lives, where the useful life is the period over which the asset is expected to contribute directly, or indirectly, to our future cash flows. Intangible assets are reviewed for impairment on an interim basis when certain events or circumstances exist. For amortizable intangible assets, impairment exists when the carrying amount of the intangible asset exceeds its fair value. At least annually, the remaining useful life is evaluated.

An intangible asset with an indefinite useful life is not amortized but assessed for impairment annually, or more frequently, when events or changes in circumstances occur indicating that it is more likely than not that the indefinite-lived asset is impaired. Impairment exists when the carrying amount exceeds its fair value. In testing for impairment, we have the option to first perform a qualitative assessment to determine whether it is more likely than not that an impairment exists. If it is determined that it is not more likely than not that an impairment exists, a quantitative impairment test is not necessary. If we conclude otherwise, we are required to perform a quantitative impairment test. Our annual indefinite-lived intangible asset impairment testing date is August 1.

To the extent an impairment loss is recognized, the loss establishes the new cost basis of the asset that is amortized over the remaining useful life of that asset, if any. Subsequent reversal of impairment losses is not permitted.

Income Taxes

Prior to the Leucadia Transaction we filed a consolidated U.S. federal income tax return, which included all of our qualifying subsidiaries. Subsequently, our results of operations are included in the consolidated federal and applicable state income tax returns filed by Leucadia. In states that neither accept nor require combined or unitary tax returns, certain subsidiaries file separate state income tax returns. We also are subject to income tax in various foreign jurisdictions in which we operate. For the Successor period, we account for our provision for income taxes using a “separate return” method. Amounts provided for income taxes are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and for tax loss carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect of a change in tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. Under acquisition accounting, the recognition of certain assets and liabilities at fair value created a change in the financial reporting basis for our assets and liabilities, while the tax basis of our assets and liabilities remained the same. As a result, deferred tax assets and liabilities were recognized for the change in the basis differences. In the Successor period, Jefferies provides deferred taxes on its temporary differences and on any carryforwards that it could claim on its hypothetical tax return. The realization of deferred tax assets is assessed and a valuation allowance is recorded to the extent that it is more likely than not that any portion of the deferred tax asset will not be realized on the basis of its projected separate return results. The tax benefit related to Leucadia dividends and dividend equivalents paid on nonvested share-based payment awards are recognized as an increase to Additional paid-in capital. These amounts are included in tax benefits for issuance of share-based awards on the Consolidated Statements of Changes in Equity.

We record uncertain tax positions using a two-step process: (i) we determine whether it is more likely than not that each tax positions will be sustained on the basis of the technical merits of the position; and (ii) for those tax positions that meet the more-likely-than-not recognition threshold, we recognize the largest amount of tax benefit that is more than 50 percent likely to be realized upon ultimate settlement with the related tax authority.

Legal Reserves

In the normal course of business, we have been named, from time to time, as a defendant in legal and regulatory proceedings. We are also involved, from time to time, in other exams, investigations and similar reviews (both formal and informal) by governmental and self-regulatory agencies regarding our businesses, certain of which may result in judgments, settlements, fines, penalties or other injunctions.

We recognize a liability for a contingency in Accrued expenses and other liabilities when it is probable that a liability has been incurred and the amount of loss can be reasonably estimated. If the reasonable estimate of a probable loss is a range, we accrue the most likely amount of such loss, and if such amount is not determinable, then we accrue the minimum in the range as the loss accrual. The determination of the outcome and loss estimates requires significant judgment on the part of management. As of February 28, 2014, we have reserved approximately $21.0 million for remaining payments under a non-prosecution agreement with the United States Attorney for the District of Connecticut and a settlement agreement with the Securities and Exchange Commission, both with respect to an investigation of certain purchases and sales of mortgage-backed securities. We believe that any other matters for which we have determined a loss to be probable and reasonably estimable are not material to the consolidated financial statements.

In many instances, it is not possible to determine whether any loss is probable or even possible or to estimate the amount of any loss or the size of any range of loss. We believe that, in the aggregate, the pending legal actions or regulatory proceedings and any other exams, investigations or similar reviews (both formal and informal) should not have a material adverse effect on our consolidated results of operations, cash flows or financial condition. In addition, we believe that any amount that could be reasonably estimated of potential loss or range of potential loss in excess of what has been provided in the consolidated financial statements is not material.

Share-based Compensation

Share-based awards are measured based on the grant-date fair value of the award and recognized over the period from the service inception date through the date the employee is no longer required to provide service to earn the award. Expected forfeitures are included in determining share-based compensation expense.

 

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Foreign Currency Translation

Assets and liabilities of foreign subsidiaries having non-U.S. dollar functional currencies are translated at exchange rates at the end of a period. Revenues and expenses are translated at average exchange rates during the period. The gains or losses resulting from translating foreign currency financial statements into U.S. dollars, net of hedging gains or losses and taxes, if any, are included in Other comprehensive income. Gains or losses resulting from foreign currency transactions are included in Principal transactions in the Consolidated Statements of Earnings.

Earnings per Common Share

As a single member limited liability company, earnings per share is not calculated for Jefferies Group LLC (the Successor company).

Prior to the Leucadia Transaction, Jefferies Group, Inc. (the Predecessor company) had common shares and other common share equivalents outstanding. For the Predecessor periods, basic earnings per share (“EPS”) is computed by dividing net earnings available to common shareholders by the weighted average number of common shares outstanding and certain other shares committed to be, but not yet issued. Net earnings available to common shareholders represent net earnings to common shareholders reduced by the allocation of earnings to participating securities. Losses are not allocated to participating securities. For Predecessor periods, diluted EPS is computed by dividing net earnings available to common shareholders plus dividends on dilutive mandatorily redeemable convertible preferred stock by the weighted average number of common shares outstanding and certain other shares committed to be, but not yet issued, plus all dilutive common stock equivalents outstanding during the period. Unvested share-based payment awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and, therefore, are included in the earnings allocation in computing earnings per share under the two-class method of earning per share.

Securitization Activities

We engage in securitization activities related to corporate loans, commercial mortgage loans and mortgage-backed and other asset-backed securities. Such transfers of financial assets are accounted for as sales when we have relinquished control over the transferred assets. The gain or loss on sale of such financial assets depends, in part, on the previous carrying amount of the assets involved in the transfer allocated between the assets sold and the retained interests, if any, based upon their respective fair values at the date of sale. We may retain interests in the securitized financial assets as one or more tranches of the securitization. These retained interests are included within Financial instruments owned in the Consolidated Statements of Financial Condition at fair value. Any changes in the fair value of such retained interests are recognized within Principal transactions revenues in the Consolidated Statements of Earnings.

When a transfer of assets does not meet the criteria of a sale, we account for the transfer as a secured borrowing and continue to recognize the assets of a secured borrowing in Financial instruments owned and recognize the associated financing in Other secured financings in the Consolidated Statements of Financial Condition.

 

Note 3. Accounting Developments

Adopted Accounting Standards

Balance Sheet Offsetting Disclosures. In December 2011, the FASB issued ASU No. 2011-11, Disclosures about Offsetting Assets and Liabilities and in January 2013 the FASB issued ASU 2013-01, Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities. The updates require new disclosures regarding balance sheet offsetting and related arrangements. For derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions, the updates require disclosure of gross asset and liability amounts, amounts offset on the balance sheet, and amounts subject to the offsetting requirements but not offset on the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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balance sheet. We adopted the guidance effective December 1, 2013 and have reflected the new disclosures in our consolidated financial statements. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

Accumulated Other Comprehensive Income. In February 2013, the FASB issued ASU No. 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. The guidance requires an entity to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in net income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety from accumulated other comprehensive income to net income in the same reporting period, an entity is required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail about those amounts. We adopted the guidance effective March 1, 2013, presenting the additional disclosures within our Consolidated Statements of Changes in Equity. Adoption did not affect our results of operations, financial condition or cash flows.

Accounting Standards to be Adopted in Future Periods

Income Taxes. In July 2013, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2013-11, Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists to eliminate diversity in practice. The guidance requires an entity to net their unrecognized tax benefit, or a portion of an unrecognized tax benefit, in the financial statements against a deferred tax asset for a net operating loss carryforward, a similar tax loss or tax credit carryforward, unless such tax loss or credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes resulting from the disallowance of a tax position. In the event that the tax position is disallowed or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit shall be presented in the financial statements as a liability and shall not be combined with deferred tax assets. The guidance is effective for fiscal years and interim periods within those years, beginning after December 15, 2013, and is to be applied prospectively to all unrecognized tax benefits that exist at the effective date. We do not expect that the adoption of this update will have a material effect on our consolidated financial statements.

 

Note 4. Leucadia and Related Transactions

Leucadia Transaction

On March 1, 2013, Jefferies Group LLC completed a business combination with Leucadia and became a wholly-owned subsidiary of Leucadia as described in Note 1, Organization and Basis of Presentation. Each share of Jefferies Group Inc.’s common stock outstanding was converted into common shares of Leucadia at an Exchange Ratio of 0.81 of a Leucadia common share for each share of Jefferies Group, Inc. (the “Exchange Ratio”). Leucadia exchanged Jefferies Group, Inc.’s $125.0 million 3.25% Series A-1 Convertible Cumulative Preferred Stock for a new series of Leucadia $125.0 million 3.25% Cumulative Convertible Preferred Shares. In addition, each restricted share and restricted stock unit of Jefferies Group, Inc. common stock was converted at the Exchange Ratio, into an equivalent award of shares of Leucadia, with all such awards for Leucadia shares subject to the same terms and conditions, including, without limitation, vesting and, in the case of performance-based restricted stock units, performance being measured at existing targets.

Leucadia did not assume or guarantee any of our outstanding debt securities, but our 3.875% Convertible senior Debentures due 2029 with an aggregate principal amount of $345.0 million became convertible into common shares of Leucadia. Other than the conversion into Leucadia common shares, the terms of the debenture remain the same.

The Leucadia Transaction resulted in a change in our ownership and was recorded under the acquisition method of accounting by Leucadia and pushed-down to us by allocating the total purchase consideration of $4.8 billion to the cost of the assets

 

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acquired, including intangible assets, and liabilities assumed based on their estimated fair values. The excess of the total purchase price over the fair value of assets acquired and the liabilities assumed is recorded as goodwill. The goodwill arising from the Leucadia Transaction consists largely of our commercial potential and the value of our assembled workforce.

In connection with the Leucadia Transaction, we recognized $2.1 million in transaction costs during the three months ended February 28, 2013.

The summary computation of the purchase price and the fair values assigned to the assets and liabilities are presented as follows (in thousands except share amounts):

 

Purchase Price       

Jefferies common stock outstanding

     205,368,031   

Less: Jefferies common stock owned by Leucadia

     (58,006,024
  

 

 

 

Jefferies common stock acquired by Leucadia

     147,362,007   

Exchange ratio

     0.81   
  

 

 

 

Leucadia’s shares issued (excluding for Jefferies shares held by Leucadia)

     119,363,226   

Less: restricted shares issued for share-based payment awards (1)

     (6,894,856
  

 

 

 

Leucadia’s shares issued, excluding share-based payment awards

     112,468,370   

Closing price of Leucadia’s common stock (2)

   $ 26.90   
  

 

 

 

Fair value of common shares acquired by Leucadia

     3,025,399   

Fair value of 3.25% cumulative convertible preferred shares (3)

     125,000   

Fair value of shares-based payment awards (4)

     343,811   

Fair value of Jefferies shares owned by Leucadia (5)

     1,259,891   
  

 

 

 

Total purchase price

   $ 4,754,101   
  

 

 

 

 

(1) Represents shares of restricted stock included in Jefferies common stock outstanding that contained a future service requirement as of March 1, 2013.
(2) The value of the shares of common stock exchanged with Jefferies shareholders was based upon the closing price of Leucadia’s common stock at February 28, 2013, the last trading day prior to the date of acquisition.
(3) Represents Leucadia’s 3.25% Cumulative Convertible Preferred Shares issued in exchange for Jefferies Group, Inc.’s 3.25% Series A-1 Convertible Cumulative Preferred Stock.
(4) The fair value of share-based payment awards is calculated in accordance with ASC 718, Compensation – Stock Compensation. Share-based payment awards attributable to pre-combination service are included as part of the total purchase price. Share-based payment awards attributable to pre-combination service is estimated based on the ratio of the pre-combination service performed to the original service period of the award.
(5) The fair value of Jefferies shares owned by Leucadia was based upon a price of $21.72, the closing price of Jefferies common stock at February 28, 2013.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Assets acquired:

  

Cash and cash equivalents

   $ 3,017,958   

Cash and securities segregated

     3,728,742   

Financial instruments owned, at fair value

     16,413,535   

Investments in managed funds

     59,976   

Loans to and investments in related parties

     766,893   

Securities borrowed

     5,315,488   

Securities purchased under agreements to resell

     3,578,366   

Securities received as collateral

     25,338   

Receivables:

  

Brokers, dealers and clearing organizations

     2,444,085   

Customers

     1,045,251   

Fees, interest and other

     225,555   

Premises and equipment

     192,603   

Indefinite-lived intangible exchange memberships and licenses (1)

     15,551   

Finite-lived intangible customer relationships (1)

     136,002   

Finite-lived trade name (1)

     131,299   

Other assets

     939,600   
  

 

 

 

Total assets

   $ 38,036,242   
  

 

 

 

Liabilities assumed:

  

Short-term borrowings

   $ 100,000   

Financial instruments sold, not yet purchased, at fair value

     9,766,876   

Securities loaned

     1,902,687   

Securities sold under agreements to repurchase

     7,976,492   

Other secured financings

     122,294   

Obligation to return securities received as collateral

     25,338   

Payables:

  

Brokers, dealers and clearing organizations

     1,787,055   

Customers

     5,450,781   

Accrued expenses and other liabilities

     793,843   

Long-term debt

     6,362,024   

Mandatorily redeemable preferred interests

     358,951   
  

 

 

 

Total liabilities

   $ 34,646,341   
  

 

 

 

Noncontrolling interests

     356,180   
  

 

 

 

Fair value of net assets acquired, excluding goodwill

   $ 3,033,721   
  

 

 

 
  
  

 

 

 

Goodwill

   $ 1,720,380   
  

 

 

 

 

(1) Intangible assets are recorded within Other assets on the Consolidated Statements of Financial Condition.

Intangible assets, not including goodwill, totaling approximately $282.9 million were identified and recognized as part of the acquisition accounting. The goodwill of $1.7 billion is not deductible for tax purposes.

Reorganization of Jefferies High Yield Holdings, LLC

On March 1, 2013, we commenced a reorganization of our high yield joint venture with Leucadia, conducted through Jefferies High Yield Holdings, LLC (“JHYH”) (the parent of Jefferies High Yield Trading, LLC (our high yield trading broker-dealer)). On March 1, 2013, we redeemed the outstanding third party noncontrolling interests in JHYH of $347.6 million. On March 31, 2013, Leucadia contributed its mandatorily redeemable preferred interests in JHYH of $362.3 million to Jefferies Group LLC as member’s equity. On April 1, 2013, we redeemed the mandatorily redeemable preferred interests in JHYH received from Leucadia. In addition, on April 1, 2013, our high yield trading broker-dealer was merged into Jefferies LLC (our U.S. securities broker-dealer).

 

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Note 5. Cash, Cash Equivalents and Short-Term Investments

We generally invest our excess cash in money market funds and other short-term instruments. Cash equivalents include highly liquid investments not held for resale and with original maturities of three months or less. The following are financial instruments classified as cash and cash equivalents that are deemed by us to be generally readily convertible into cash as of February 28, 2014 and November 30, 2013 (in thousands):

 

     February 28,
2014
     November 30,
2013
 

Cash and cash equivalents:

     

Cash in banks

   $ 670,082       $ 830,438   

Certificate of deposit

     50,004         50,005   

Money market investments

     2,144,824         2,680,676   
  

 

 

    

 

 

 

Total cash and cash equivalents

   $ 2,864,910       $ 3,561,119   
  

 

 

    

 

 

 

Cash and securities segregated (1)

   $ 3,801,517       $ 3,616,602   
  

 

 

    

 

 

 

 

(1) Consists of deposits at exchanges and clearing organizations, as well as deposits in accordance with Rule 15c3-3 of the Securities Exchange Act of 1934, which subjects Jefferies as a broker-dealer carrying client accounts to requirements related to maintaining cash or qualified securities in a segregated reserve account for the exclusive benefit of its clients, and Jefferies Bache, LLC which, as a futures commission merchant, is subject to the segregation requirements pursuant to the Commodity Exchange Act.

 

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Note 6. Fair Value Disclosures

The following is a summary of our financial assets and liabilities that are accounted for at fair value on a recurring basis as of February 28, 2014 and November 30, 2013 by level within the fair value hierarchy (in thousands):

 

     February 28, 2014  
     Level 1      Level 2      Level 3      Counterparty and
Cash Collateral
Netting (1)
    Total  

Assets:

             

Financial instruments owned:

             

Corporate equity securities

   $ 2,197,314       $ 400,134       $ 12,341       $ —        $ 2,609,789   

Corporate debt securities

     —           3,231,323         29,315         —          3,260,638   

Collateralized debt obligations

     —           251,416         66,028         —          317,444   

U.S. government and federal agency securities

     2,098,286         138,695         —           —          2,236,981   

Municipal securities

     —           563,190         —           —          563,190   

Sovereign obligations

     1,751,744         877,387         —           —          2,629,131   

Residential mortgage-backed securities

     —           3,384,620         116,992         —          3,501,612   

Commercial mortgage-backed securities

     —           1,209,978         17,486         —          1,227,464   

Other asset-backed securities

     —           34,937         2,375         —          37,312   

Loans and other receivables

     —           1,165,264         128,832         —          1,294,096   

Derivatives

     40,304         2,352,971         2,940         (2,172,516     223,699   

Investments at fair value

     —           10         118,268         —          118,278   

Physical commodities

     —           105,982         —           —          105,982   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial instruments owned

   $ 6,087,648       $ 13,715,907       $ 494,577       $ (2,172,516   $ 18,125,616   
  

 

 

    

 

 

       

 

 

   

 

 

 

Cash and cash equivalents

   $ 2,864,910       $ —         $ —         $ —        $ 2,864,910   

Investments in managed funds

   $ —         $ 11,614       $ 59,528       $ —        $ 71,142   

Cash and securities segregated and on deposit for regulatory purposes (2)

   $ 3,801,517       $ —         $ —         $ —        $ 3,801,517   

Securities received as collateral

   $ 1,051       $ —         $ —         $ —        $ 1,051   
        

 

 

      

Total Level 3 assets

         $ 554,105        
        

 

 

      

Liabilities:

             

Financial instruments sold, not yet purchased:

             

Corporate equity securities

   $ 1,531,598       $ 68,558       $ 1,015       $ —        $ 1,601,171   

Corporate debt securities

     —           1,773,525         —           —          1,773,525   

U.S. government and federal agency securities

     2,578,965         —           —           —          2,578,965   

Sovereign obligations

     1,532,088         949,468         —           —          2,481,556   

Residential mortgage-backed securities

     —           7,230         —           —          7,230   

Loans

     —           695,847         10,260         —          706,107   

Derivatives

     60,012         2,341,346         8,713         (2,221,566     188,505   

Physical commodities

     —           41,545         —           —          41,545   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

   $ 5,702,663       $ 5,877,519       $ 19,988       $ (2,221,566   $ 9,378,604   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Obligation to return securities received as collateral

   $ 1,051       $ —         $ —         $ —        $ 1,051   

Other secured financings

   $ —         $ 20,000       $ 30,394       $ —        $ 50,394   

Embedded conversion option

   $ —         $ 7,607       $ —         $ —        $ 7,607   

 

(1) Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.
(2) Cash and securities segregated and on deposit for regulatory purposes include U.S. government securities with a fair value of $749.2 million.

 

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(Unaudited)

 

     November 30, 2013  
     Level 1 (1)      Level 2 (1)      Level 3      Counterparty and
Cash Collateral
Netting (2)
    Total  

Assets:

             

Financial instruments owned:

             

Corporate equity securities

   $ 1,913,220       $ 175,493       $ 9,884       $ —        $ 2,098,597   

Corporate debt securities

     —           2,957,102         25,666         —          2,982,768   

Collateralized debt obligations

     —           182,095         37,216         —          219,311   

U.S. government and federal agency securities

     2,293,221         40,389         —           —          2,333,610   

Municipal securities

     —           664,054         —           —          664,054   

Sovereign obligations

     1,458,803         889,685         —           —          2,348,488   

Residential mortgage-backed securities

     —           2,932,268         105,492         —          3,037,760   

Commercial mortgage-backed securities

     —           1,130,410         17,568         —          1,147,978   

Other asset-backed securities

     —           55,475         12,611         —          68,086   

Loans and other receivables

     —           1,203,238         145,890         —          1,349,128   

Derivatives

     40,952         2,472,237         1,493         (2,253,589     261,093   

Investments at fair value

     —           40         101,242         —          101,282   

Physical commodities

     —           37,888         —           —          37,888   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial instruments owned

   $ 5,706,196       $ 12,740,374       $ 457,062       $ (2,253,589   $ 16,650,043   
  

 

 

    

 

 

       

 

 

   

 

 

 

Cash and cash equivalents

   $ 3,561,119       $ —         $ —         $ —        $ 3,561,119   

Investments in managed funds

   $ —         $ —         $ 57,285       $ —        $ 57,285   

Cash and securities segregated and on deposit for regulatory purposes (3)

   $ 3,616,602       $ —         $ —         $ —        $ 3,616,602   

Securities received as collateral

   $ 11,063       $ —         $ —         $ —        $ 11,063   
        

 

 

      

Total Level 3 assets

         $ 514,347        
        

 

 

      

Liabilities:

             

Financial instruments sold,

             

Corporate equity securities

   $ 1,782,903       $ 40,358       $ 38       $ —        $ 1,823,299   

Corporate debt securities

     —           1,346,078         —           —          1,346,078   

U.S. government and federal agency securities

     1,324,326         —           —           —          1,324,326   

Sovereign obligations

     1,360,269         471,088         —           —          1,831,357   

Residential mortgage-backed securities

     —           34,691         —           —          34,691   

Loans

     —           672,838         22,462         —          695,300   

Derivatives

     43,829         2,480,463         8,398         (2,352,611     180,079   

Physical commodities

     —           36,483         —           —          36,483   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

   $ 4,511,327       $ 5,081,999       $ 30,898       $ (2,352,611   $ 7,271,613   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Obligation to return securities received as collateral

   $ 11,063       $ —         $ —         $ —        $ 11,063   

Other secured financings

   $ —         $ 31,000       $ 8,711       $ —        $ 39,711   

Embedded conversion option

   $ —         $ 9,574       $ —         $ —        $ 9,574   

 

(1) During the nine months ended November 30, 2013, we transferred listed equity options with a fair value of $403.0 million within Financial instruments owned and $423.0 million within Financial instruments sold, not yet purchased from Level 1 to Level 2 as adjustments to the exchange closing price are necessary to best reflect the fair value of the population at its exit price.
(2) Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.
(3) Cash and securities segregated and on deposit for regulatory purposes include U.S. government securities with a fair value of $304.2 million.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

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 or Level 3 of the fair value hierarchy.

 

  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 for 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/EBITDA, price/book value), discounted cash flow analyses and transaction prices observed for subsequent financing or capital issuance by the company. 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 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 for 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 comprise 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 for recently executed market transactions of comparable 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 financings or recapitalizations, models incorporating financial ratios and projected cash flows of the issuer and market prices for comparable issuers.

 

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Collateralized Debt Obligations

Collateralized debt obligations are measured based on prices observed for recently executed market transactions or based on valuations received from third party brokers and are categorized within Level 2 or Level 3 of the fair value hierarchy depending on the observability and significance of the pricing inputs.

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

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

Foreign 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. Foreign sovereign government obligations are classified in Level 1, 2 or Level 3 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 interest-only 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 Inverse Interest-Only Securities (“Agency Inverse IOs”): The fair value of agency inverse IOs 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 for 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 inverse IOs are categorized within Level 2 or Level 3 of the fair value hierarchy. We also use vendor data in developing our assumptions, as appropriate.

 

  Non-Agency Residential Mortgage-Backed Securities: Fair values are 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.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Commercial Mortgage-Backed Securities

 

  Agency Commercial Mortgage-Backed Securities: GNMA project loan bonds and FNMA Delegated Underwriting and Servicing (“DUS”) mortgage-backed securities are generally measured by using prices observed for 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 for 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 and student loans and are categorized within Level 2 and Level 3 of the fair value hierarchy. Valuations are determined using pricing data obtained from external pricing services and prices observed for recently executed market transactions.

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 market transaction data. Corporate loans categorized within Level 3 of the fair value hierarchy are measured based on market 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 GNMA Project and Construction Loans: Valuations of participation certificates in GNMA project and construction loans are based on observed market prices of recently executed purchases of similar loans which are then used to derive a market implied spread, which in turn is used as the primary input in estimating the fair value of loans at the measurement date. The loan participation certificates are categorized within Level 2 of the fair value hierarchy given the observability and volume of recently executed transactions.

 

  Project Loans: Valuation of project loans are based on benchmarks of prices for recently executed transactions of related realized collateralized securities and are categorized within Level 2 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 security.

Derivatives

 

  Listed Derivative Contracts: Listed derivative contracts that are actively traded are measured based on quoted exchange prices, which are generally obtained from external pricing services, and are categorized within Level 1 of the fair value hierarchy. Listed derivatives for which there is limited trading activity are measured based on incorporating the closing auction price of the underlying equity security, use similar valuation approaches as those applied to over-the-counter derivative contracts and are categorized within Level 2 of the fair value hierarchy.

 

 

OTC Derivative Contracts: Over-the-counter (“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 period transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC

 

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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 and commodity options measured using various valuation models, such as the Black-Scholes, with key inputs impacting the valuation including the underlying security, foreign exchange spot rate or 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, which incorporate observable inputs related to commodity spot prices and forward curves. 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 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.

Physical Commodities

Physical commodities include base and precious metals and are measured using observable inputs including spot prices and published indices. Physical commodities are categorized within Level 2 of the fair value hierarchy. To facilitate the trading in precious metals we undertake leasing of such precious metals. The fees earned or paid for such leases are recorded as Principal transaction revenues on the Consolidated Statements of Earnings.

Investments at Fair Value and Investments in Managed Funds

Investments at fair value and Investments in managed funds include investments in hedge funds, fund of funds, private equity funds, convertible bond funds and commodity funds, which are measured at fair value based on the net asset value of the funds provided by the fund managers and are categorized within Level 2 or Level 3 of 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 our defined benefit plan in Germany and at November 30, 2012, shares in non-U.S. exchanges and clearing houses. Fair value for the insurance contracts is determined using a third party and is categorized within Level 3 of the fair value hierarchy. Fair value for the shares in non-U.S. exchanges and clearing houses is determined based on recent transactions or third party model valuations and is categorized within Level 2 or Level 3 of the fair value hierarchy.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables present information about our investments in entities that have the characteristics of an investment company at February 28, 2014 and November 30, 2013 (in thousands):

 

     February 28, 2014
      Fair Value (6)       Unfunded
Commitments
     Redemption Frequency
(if currently eligible)

Equity Long/Short Hedge Funds (1)

   $ 37,078       $ —         Monthly, Quarterly

High Yield Hedge Funds(2)

     244         —         —  

Fund of Funds(3)

     315         94       —  

Equity Funds(4)

     65,878         38,714       —  

Convertible Bond Funds(5)

     3,703         —         At Will
  

 

 

    

 

 

    

Total(7)

   $ 107,218       $ 38,808      
  

 

 

    

 

 

    

 

     November 30, 2013
      Fair Value (6)       Unfunded
Commitments
     Redemption Frequency
(if currently eligible)

Equity Long/Short Hedge Funds (1)

   $ 20,927       $ —         Monthly, Quarterly

High Yield Hedge Funds(2)

     244         —         —  

Fund of Funds(3)

     494         94       —  

Equity Funds(4)

     66,495         40,816       —  

Convertible Bond Funds(5)

     3,473         —         At Will
  

 

 

    

 

 

    

Total(7)

   $ 91,633       $ 40,910      
  

 

 

    

 

 

    

 

(1) This category includes investments in hedge funds that invest, long and short, in equity securities in domestic and international markets in both the public and private sectors. At February 28, 2014 and November 30, 2013, investments representing approximately 99% and 98%, respectively, of the fair value of investments in this category are redeemable with 30 - 65 days prior written notice, and includes an investment in a private asset management fund managed by us with a fair value of $14.7 million at February 28, 2014. The remaining investments in this category cannot be redeemed as they are in liquidation and distributions will be received through the liquidation of the underlying assets of the funds. We are unable to estimate when the underlying assets will be liquidated.
(2) Includes investments in funds that invest in domestic and international public high yield debt, private high yield investments, senior bank loans, public leveraged equities, distressed debt, and private equity investments. There are no redemption provisions. The underlying assets of the funds are being liquidated and we are unable to estimate when the underlying assets will be fully liquidated.
(3) Includes investments in fund of funds that invest in various private equity funds. At February 28, 2014 and November 30, 2013, approximately 97% and 98%, respectively, of the fair value of investments in this category are managed by us and have no redemption provisions, instead distributions are received through the liquidation of the underlying assets of the fund of funds, which are estimated to be liquidated in approximately two years. For the remaining investments we have requested redemption; however, we are unable to estimate when these funds will be received.
(4) At February 28, 2014 and November 30, 2013, investments representing approximately 99% and 99%, respectively of the fair value of investments in this category include investments in equity funds that invest in the equity of various U.S. and foreign private companies in the energy, technology, internet service and telecommunication service industries. These investments cannot be redeemed, instead distributions are received through the liquidation of the underlying assets of the funds which are expected to liquidate in one to eight years. The remaining investments are in liquidation and we are unable to estimate when the underlying assets will be fully liquidated. At February 28, 2014 and November 30, 2013, this category includes investments in equity funds managed by us with a fair value of $53.6 million and $54.4 million and unfunded commitments of $37.1 million and $39.2 million, respectively.
(5) Investment in the Jefferies Umbrella Fund, an open-ended investment company managed by us that invests primarily in convertible bonds. The investment is redeemable with 5 days prior written notice.
(6) Fair value has been estimated using the net asset value derived from each of the funds’ capital statements.
(7) Investments at fair value in the Consolidated Statements of Financial Condition at February 28, 2014 and November 30, 2013 include $82.2 million and $66.9 million, respectively, of direct investments which do not have the characteristics of investment companies and therefore not included within this table. We have unfunded commitments to such investments of $3.3 million and $3.3 million in aggregate at February 28, 2014 and November 30, 2013, respectively.

 

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Other Secured Financings

Other secured financings include the notes issued by consolidated VIEs, which are classified as Level 2 within the fair value hierarchy. Fair value is based on recent transaction prices. In addition, at February 28, 2014, Other secured financings includes $30.4 million related to transfers of loans accounted for as secured financings rather than as sales and classified as Level 3 within the fair value hierarchy.

Embedded Conversion Option

The embedded conversion option presented within long-term debt represents the fair value of the conversion option on Leucadia shares within our 3.875% Convertible Senior Debentures, due November 1, 2029 and categorized as Level 2 within the fair value hierarchy. The conversion option was valued using a convertible bond model using as inputs the price of Leucadia’s common stock, the conversion strike price, 252-day historical volatility, a maturity date of November 1, 2017 (the first put date), dividend yield and the risk-free interest rate curve.

Pricing Information

At February 28, 2014 and November 30, 2013, our Financial instruments owned and Financial instruments sold, not yet purchased are measured using different valuation bases as follows:

 

     February 28, 2014     November 30, 2013  
     Financial
Instruments Owned
    Financial
Instruments Sold,
Not Yet
Purchased
    Financial
Instruments Owned
    Financial
Instruments Sold,
Not Yet
Purchased
 

Exchange closing prices

     12     16     12     25

Recently observed transaction prices

     6     5     5     4

External pricing services

     68     74     68     66

Broker quotes

     3     3     3     3

Valuation techniques

     11     2     12     2
  

 

 

   

 

 

   

 

 

   

 

 

 
     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

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The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the three months ended February 28, 2014 (in thousands):

 

    Three Months Ended February 28, 2014  
    Balance,
November 30,
2013
    Total gains/
losses
(realized and
unrealized) (1)
    Purchases     Sales     Settlements     Issuances     Net
transfers
into/ (out
of)
Level 3
    Balance,
February 28,
2014
    Change in
unrealized gains/
(losses) relating
to instruments
still held at
February 28,
2014 (1)
 

Assets:

                 

Financial instruments owned:

                 

Corporate equity securities

  $ 9,884      $ (1,393   $ 134      $ —        $ —        $ —        $ 3,716      $ 12,341      $ (1,319

Corporate debt securities

    25,666        (2,014     4,136        (624     —          —          2,151        29,315        193   

Collateralized debt obligations

    37,216        10,184        76,511        (78,081     (144     —          20,342        66,028        5,662   

Residential mortgage-backed securities

    105,492        (1,626     9,637        (13,703     (1,755     —          18,947        116,992        (2,097

Commercial mortgage-backed securities

    17,568        (3,032     8,933        (14,645     (50     —          8,712        17,486        (958

Other asset-backed securities

    12,611        72        2,250        (2,048     (83     —          (10,427     2,375        7   

Loans and other receivables

    145,890        (3,902     36,213        (49,475     (935     —          1,041        128,832        (3,807

Investments, at fair value

    101,242        24,889        22,500        (29,587     —          —          (776     118,268        24,889   

Investments in managed funds

    57,285        (2,859     5,102        —          —          —          —          59,528        (2,859

Liabilities:

                 

Financial instruments sold, not yet purchased:

                 

Corporate equity securities

  $ 38      $ 8      $ —        $ 411      $ —        $ —        $ 558      $ 1,015      $ (8

Net derivatives (2)

    6,905        1,267        (1,327     2,169        197        —          (3,438     5,773        (1,267

Loans

    22,462        (153     (18,913     4,887        —          —          1,977        10,260        (153

Other secured financings

    8,711        —          —          —          —          21,683        —          30,394        —     

 

(1) Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.
(2) Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.

Analysis of Level 3 Assets and Liabilities for the Three Months Ended February 28, 2014

During the three months ended February 28, 2014, transfers of assets of $91.0 million from Level 2 to Level 3 of the fair value hierarchy are attributed to:

 

  Non-agency residential mortgage-backed securities of $38.1 million, commercial mortgage backed-securities of $9.0 million and other asset-backed securities of $1.8 million for which no recent trade activity was observed for purposes of determining observable inputs;

 

  Loans and other receivables of $8.9 million due to a lower number of contributors comprising vendor quotes to support classification within Level 2.

 

  Corporate equity securities of $7.4 million and corporate debt securities of $2.3 million due to lack of observable market transactions;

 

  Collateralized debt obligations of $23.5 million which have little to no transparency in trade activity;

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

During the three months ended February 28, 2014, transfers of assets of $47.3 million from Level 3 to Level 2 are attributed to:

 

  Non-agency residential mortgage-backed securities of $19.1 million, commercial mortgage-backed securities of $0.2 million and other asset-backed securities of $12.2 million for which market trades were observed in the period for either identical or similar securities;

 

  Collateralized debt obligations of $3.3 million, loans and other receivables of $7.9 million and investments at fair value of $0.8 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2;

 

  Corporate equity securities of $3.6 million and corporate debt securities of $0.2 million due to an increase in observable market transactions.

During the three months ended February 28, 2014, there were transfers of loan liabilities of $2.9 million from Level 3 to Level 2 and transfers of $4.8 million from Level 2 to Level 3 due to an increase and decrease in observable inputs in the valuation, respectively. There were $3.4 million transfers of net derivative liabilities from Level 3 to Level 2 due to an increase in observable inputs used in the valuing of derivative contracts.

Net gains on Level 3 assets were $20.3 million and net losses on Level 3 liabilities were $1.1 million for the three months ended February 28, 2014. Net gains on Level 3 assets were primarily due to increased valuations of certain collateralized debt obligations and investments at fair value, partially offset by a decrease in valuation of certain corporate equity securities, corporate debt securities, residential and commercial mortgage-backed securities, loans and other receivables and investments in managed funds. Net losses on Level 3 liabilities were primarily due to increased valuations of certain derivative instruments, partially offset by decrease in valuation of certain loan positions.

The following is a summary of changes in fair value of our financial assets and liabilities that have been categorized within Level 3 of the fair value hierarchy for the three months ended February 28, 2013 (in thousands):

 

    Predecessor  
    Three Months Ended February 28, 2013 (3)  
    Balance,
November 30,
2012
    Total gains/
losses
(realized and
unrealized) (1)
    Purchases     Sales     Settlements     Net
transfers
into/ (out
of)
Level 3
    Balance,
February 28,
2013
    Change in
unrealized gains/
(losses) relating
to instruments
still held at
February 28,
2013 (1)
 

Assets:

               

Financial instruments owned:

               

Corporate equity securities

  $ 16,815      $ 200      $ 707      $ 109      $ —        $ (4,597   $ 13,234      $ 172   

Corporate debt securities

    3,631        7,836        11,510        (1,918     —          10,761        31,820        7,833   

Collateralized debt obligations

    31,255        3,584        4,406        (17,374     —          2,865        24,736        (1,165

Residential mortgage-backed securities

    156,069        11,906        132,773        (130,143     (6,057     4,878        169,426        4,511   

Commercial mortgage-backed securities

    30,202        (995     2,280        (2,866     (1,188     (9,639     17,794        (2,059

Other asset-backed securities

    1,114        90        1,627        (1,342     (19     (178     1,292        39   

Loans and other receivables

    180,393        (8,682     105,650        (29,828     (61,407     (15,140     170,986        (12,374

Investments, at fair value

    83,897        961        5,952        (4,923     (9,721     (1,099     75,067        1,171   

Investments in managed funds

    57,763        (363     11,068        —          (8,492     —          59,976        (363

Liabilities:

               

Financial instruments sold, not yet purchased:

               

Corporate equity securities

  $ 38      $ —        $ —        $ —        $ —        $ —        $ 38      $ —     

Residential mortgage-backed securities

    —          25        (73,846     75,363        —          —          1,542        (19

Net derivatives (2)

    9,188        2,648        —          —          —          (651     11,185        2,648   

Loans

    1,711        —          (1,711     7,398        —          —          7,398        —     

 

(1) Realized and unrealized gains/losses are reported in Principal transactions in the Consolidated Statements of Earnings.
(2) Net derivatives represent Financial instruments owned – Derivatives and Financial instruments sold, not yet purchased – Derivatives.
(3) There were no issuances during the three months ended February 28, 2013.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Analysis of Level 3 Assets and Liabilities for the Three Months Ended February 28, 2013

During the three months ended February 28, 2013, transfers of assets of $100.5 million from Level 2 to Level 3 of the fair value hierarchy are attributed to:

 

  Non-agency residential mortgage-backed securities of $78.4 million and commercial mortgage-backed securities of $1.3 million for which no recent trade activity was observed for purposes of determining observable inputs;

 

  Corporate debt securities of $10.8 million and corporate equity securities of $0.1 million due to lack of observable market transactions;

 

  Collateralized debt obligations of $5.3 million which have little to no transparency in trade activity;

 

  Loans and other receivables of $4.8 million due to a lower number of contributors comprising vendor quotes to support classification within Level 2.

During the three months ended February 28, 2013, transfers of assets of $112.7 million from Level 3 to Level 2 are attributed to:

 

  Non-agency residential mortgage-backed securities of $73.5 million, commercial mortgage-backed securities of $10.9 million and $0.2 million of other asset-backed securities for which market trades were observed in the period for either identical or similar securities;

 

  Loans and other receivables of $19.9 million and collateralized debt obligations of $2.4 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2;

 

  Corporate equity securities of $4.7 million due to an increase in observable market transactions.

During the three months ended February 28, 2013, there were no transfers of liabilities from Level 2 to Level 3 and there were $0.7 million transfers of net derivative liabilities from Level 3 to Level 2 due to an increase in observable significant inputs used in valuing the derivative contracts.

Net gains on Level 3 assets were $14.5 million and net losses on Level 3 liabilities were $2.7 million for the three months ended February 28, 2013. Net gains on Level 3 assets were primarily due to increased valuations of certain residential mortgage-backed securities, corporate debt securities, collateralized debt obligations and investments at fair value partially offset by a decrease in valuation of certain loans and other receivables, commercial mortgage backed securities and investments in managed funds. Net losses on Level 3 liabilities were primarily due to increased valuations of certain derivative instruments.

Components or portions of interest rate and credit risk related to mortgage-backed securities categorized within Level 3 of the fair value hierarchy are frequently economically hedged with U.S. Treasury and Eurodollar futures and short U.S. Treasury securities, which are categorized within Level 1 liabilities, and with interest rate swaps and, to a lesser extent, index credit default swaps categorized within Level 2 assets or liabilities. Accordingly, a portion of the gains and losses on mortgage-backed securities reported in Level 3 are offset by gains and losses from the economic hedges attributed to instruments categorized within Level 1 and Level 2. Economic hedging is often executed on a macro-basis for a given asset class rather than an instrument-specific basis. Valuation inputs and prices for hedging instruments categorized within Level 1 and Level 2 provide a level of observability used in valuing Level 3 mortgage-backed securities; however, other inputs, such as prepayment, default rates and other credit specific factors are significant to the valuation and are not derived from the prices of the hedging instruments. Basis risk differences may also arise between the Level 3 mortgage-backed securities and the Level 1 and Level 2 hedging instruments due to the underlying interest rates and the underlying credits comprising the referenced credit index. Hedge effectiveness is limited by factors that include idiosyncratic collateral performance and basis risk as well as the sizing of the macro-hedge.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Quantitative Information about Significant Unobservable Inputs used in Level 3 Fair Value Measurements at February 28, 2014 and November 30, 2013

The tables below present information on the valuation techniques, significant unobservable inputs and their ranges for our financial assets and liabilities, subject to threshold levels related to the market value of the positions held, measured at fair value on a recurring basis with a significant Level 3 balance. The range of unobservable inputs could differ significantly across different firms given the range of products across different firms in the financial services sector. The inputs are not representative of the inputs that could have been used in the valuation of any one financial instrument; i.e., the input used for valuing one financial instrument within a particular class of financial instruments may not be appropriate for valuing other financial instruments within that given class. Additionally, the ranges of inputs presented below should not be construed to represent uncertainty regarding the fair values of our financial instruments; rather the range of inputs is reflective of the differences in the underlying characteristics of the financial instruments in each category.

For certain categories, we have provided a weighted average of the inputs allocated based on the fair values of the financial instruments comprising the category. We do not believe that the range or weighted average of the inputs is indicative of the reasonableness of uncertainty of our Level 3 fair values. The range and weighted average are driven by the individual financial instruments within each category and their relative distribution in the population. The disclosed inputs when compared with the inputs as disclosed in other quarters should not be expected to necessarily be indicative of changes in our estimates of unobservable inputs for a particular financial instrument as the population of financial instruments comprising the category will vary from period to period based on purchases and sales of financial instruments during the period as well as transfers into and out of Level 3 each period.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

February 28, 2014

 

Financial Instruments Owned

  Fair Value
(in thousands)
   

Valuation Technique

 

Significant Unobservable Input(s)

  Input / Range   Weighted
Average
 

Corporate equity securities

  $ 4,988           

Non-exchange traded securities

    Market approach  

EBITDA (a) multiple

  3.3     —     

Corporate debt securities

  $ 25,644           
    Scenario analysis  

Estimated recovery percentage

  20% to 31%     26.0
    Market approach  

Yield

  11.7% to 11.8%     11.7

Collateralized debt obligations

  $ 63,778           
    Discounted cash flows  

Constant prepayment rate

  0% to 20%     14
     

Constant default rate

  0% to 2%     1
     

Loss severity

  30% to 70%     50
     

Yield

  4% to 81%     20

Residential mortgage-backed securities

  $ 116,992           
    Discounted cash flows  

Constant prepayment rate

  2% to 50%     10
     

Constant default rate

  2% to 100%     25
     

Loss severity

  0% to 85%     55
     

Yield

  1% to 14%     8

Commercial mortgage-backed securities

  $ 17,486           
    Discounted cash flows  

Yield

  4% to 11%     8
     

Cumulative loss rate

  0% to 8%     5

Other asset-backed securities

  $ 2,375           
    Discounted cash flows  

Constant prepayment rate

  0%     —     
     

Constant default rate

  0%     —     
     

Yield

  5%     —     

Loans and other receivables

  $ 111,642           
    Comparable pricing  

Comparable bond or loan price

  $97 to $101   $ 100   
    Market approach  

Yield

  2.6% to 3.3%     2.9
     

EBITDA (a) multiple

  7     —     
    Scenario analysis  

Estimated recovery percentage

  10% to 79%     71

Derivatives

  $ 2,940           

Forward contract

    Comparable pricing  

Comparable loan price

  $68 to $104   $ 89   

Investments at fair value

         

Private equity securities

  $ 33,785           
    Comparable pricing  

Comparable share price

  $27     —     
    Net asset value  

Discount to net asset value

  10%     —     

Financial Instruments Sold, Not Yet
Purchased

  Fair Value
(in thousands)
   

Valuation Technique

 

Significant Unobservable Input(s)

  Input / Range   Weighted
Average
 

Derivatives

  $ 8,713           

Loan commitments

    Comparable pricing  

Comparable bond or loan price

  $100     —     

Loans

  $ 10,260           
    Comparable pricing  

Comparable bond or loan price

  $100.50     —     

 

(a) Earnings before interest, taxes, depreciation and amortization (“EBITDA”).

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

November 30, 2013

 

Financial Instruments Owned

  Fair Value
(in thousands)
    Valuation Technique  

Significant Unobservable
Input(s)

  Input / Range   Weighted
Average
 

Corporate equity securities

  $ 8,034           

Non-exchange traded securities

    Market approach  

EBITDA (a) multiple

  4.0 to 5.5     4.53   

Warrants

    Option model   Volatility   36%  

Corporate debt securities

  $ 17,699           
    Scenario analysis  

Estimated recovery percentage

  24%  
    Comparable pricing  

Comparable bond or loan price

  $69.10 to $70.50     $69.91   
    Market approach  

Yield

  13%  

Collateralized debt obligations

  $ 34,316           
    Discounted cash
flows
 

Constant prepayment rate

  0% to 20%     13%   
     

Constant default rate

  2% to 3%     2%   
     

Loss severity

  30% to 85%     38%   
     

Yield

  3% to 91%     28%   

Residential mortgage-backed securities

  $ 105,492           
    Discounted cash
flows
 

Constant prepayment rate

  2% to 50%     11%   
     

Constant default rate

  1% to 100%     17%   
     

Loss severity

  30% to 90%     48%   
     

Yield

  0% to 20%     7%   

Commercial mortgage-backed securities

  $ 17,568           
    Discounted cash
flows
 

Yield

  12% to 20%     14%   
     

Cumulative loss rate

  5% to 28.2%     11%   

Other asset-backed securities

  $ 12,611           
    Discounted cash
flows
 

Constant prepayment rate

  4% to 30%     17%   
     

Constant default rate

  2% to 11%     7%   
     

Loss severity

  40% to 92%     64%   
     

Yield

  3% to 29%     18%   

Loans and other receivables

  $ 101,931           
    Comparable pricing  

Comparable bond or loan price

  $91 to $101     $98.90   
    Market approach  

Yield

  8.75% to 13.5%     10%   
     

EBITDA (a) multiple

  6.9  
    Scenario analysis  

Estimated recovery percentage

  16.9% to 92%     74%   

Derivatives

  $ 1,493           

Loan commitments

    Comparable pricing  

Comparable bond or loan price

  $100.875  

Investments at fair value

  $ 30,203           

Private equity securities

    Comparable pricing  

Comparable share price

  $414  
    Market approach  

Discount rate

  15% to 30%     23%   

Financial Instruments Sold,
Not Yet Purchased

  Fair Value
(in thousands)
    Valuation Technique  

Significant Unobservable
Input(s)

  Input / Range   Weighted
Average
 

Derivatives

  $ 8,398           

Equity options

    Option model   Volatility   36.25% to 41%     39%   

Loans

    8,106           
    Comparable pricing   Comparable bond or loan price   $101.88     —     

 

(a) Earnings before interest, taxes, depreciation and amortization (“EBITDA”).

The fair values of certain Level 3 assets and liabilities that were determined based on third-party pricing information, unadjusted past transaction prices, reported net asset value or a percentage of the reported enterprise fair value are excluded from the above table. At February 28, 2014 and November 30, 2013, asset exclusions consisted of $114.9 million and $127.7 million, respectively, primarily comprised of investments in private equity securities, investments in reinsurance contracts and certain corporate loans. At February 28, 2014 and November 30, 2013, liability exclusions consisted of $1.0 million and $14.4 million, respectively of corporate loan commitments.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

Sensitivity of Fair Values to Changes in Significant Unobservable Inputs

For recurring fair value measurements categorized within Level 3 of the fair value hierarchy, the sensitivity of the fair value measurement to changes in significant unobservable inputs and interrelationships between those unobservable inputs (if any) are described below:

 

    Private equity securities, corporate debt securities, loans and other receivables and loan commitments using comparable pricing valuation techniques. A significant increase (decrease) in the comparable share, bond or loan price in isolation would result in a significant higher (lower) fair value measurement.

 

    Non-exchange traded securities, corporate debt securities and loans and other receivables using a market approach valuation technique. A significant increase (decrease) in the EBITDA or other multiples in isolation would result in a significantly higher (lower) fair value measurement. A significant increase (decrease) in the yield of a corporate debt security, loan and other receivable would result in a significantly lower (higher) fair value measurement. A significant increase (decrease) in the discount rate of a private equity security would result in a significantly lower (higher) fair value measurement.

 

    Corporate debt securities and loans and other receivables using scenario analysis. A significant increase (decrease) in the possible recovery rates of the cash flow outcomes underlying the investment would result in a significantly higher (lower) fair value measurement for the financial instrument.

 

    Collateralized debt obligations, residential and commercial mortgage-backed securities and other asset-backed securities using a discounted cash flow valuation technique. A significant increase (decrease) in isolation in the constant default rate, loss severities or cumulative loss rate and discount rate would result in a significantly lower (higher) fair value measurement. The impact of changes in the constant prepayment rate would have differing impacts depending on the capital structure of the security. A significant increase (decrease) in the loan or bond yield would result in a significant lower (higher) fair value measurement.

 

    Derivative equity options and equity warrants using an option model. A significant increase (decrease) in volatility would result in a significant higher (lower) fair value measurement.

 

    Private equity securities using a net asset value technique. A significant increase (decrease) in the discount applied to net asset value would result in a significant (lower) higher fair value measurement.

Fair Value Option Election

We have elected the fair value option for all loans and loan commitments made by our capital markets businesses. These loans and loan commitments include loans entered into by our investment banking division in connection with client bridge financing and loan syndications, loans purchased by our leveraged credit trading desk as part of its bank loan trading activities and mortgage loan commitments and fundings in connection with mortgage-backed securitization activities. Loans and loan commitments originated or purchased by our leveraged credit and mortgage-backed businesses are managed on a fair value basis. Loans are included in Financial instruments owned and loan commitments are included in Financial instruments owned-derivatives and Financial instruments sold, not yet purchased – derivatives on the Consolidated Statements of Financial Condition. The fair value option election is not applied to loans made to affiliate entities as such loans are entered into as part of ongoing, strategic business ventures. Loans to affiliate entities are included within Loans to and investments in related parties on the Consolidated Statements of Financial Condition and are accounted for on an amortized cost basis. We have elected the fair value option for our investment in Knight Capital Group, Inc., which is included in Financial Instruments owned – Corporate equity securities on the Consolidated Statement of Financial Condition. See Note 11, Investments for further details regarding our investment in Knight Capital Group, Inc. We have also elected the fair value option for certain financial instruments held by subsidiaries as the investments are risk managed by us on a fair value basis. The fair value option has also been elected for certain secured financings that arise in connection with our securitization activities and other structural financings. Other secured financings, Receivables – Brokers, dealers and clearing

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

organizations, Receivables – Customers, Receivables – Fees, interest and other, Payables – Brokers, dealers and clearing organizations and Payables – Customers, are not accounted for at fair value; however, the recorded amounts approximate fair value due to their liquid or short-term nature.

The following is a summary of gains (losses) due to changes in instrument specific credit risk on loans and other receivables and loan commitments measured at fair value under the fair value option (in thousands):

 

     Successor               Predecessor  
     Three Months Ended
February 28, 2014
              Three Months Ended
February 28, 2013
 

Financial Instruments Owned:

           

Loans and other receivables

   $ 4,467             $ 3,924   
 

Financial Instruments Sold:

           

Loans

   $ (462          $ —     

Loan commitments

     (2,357            (2,746

The following is a summary of the amount by which contractual principal exceeds fair value for loans and other receivables measured at fair value under the fair value option (in thousands):

 

     Successor  
     February 28,
2014
     November 30,
2013
 

Financial Instruments Owned:

     

Loans and other receivables (2)

   $ 255,398       $ 264,896   

Loans greater than 90 days past due (1) (2)

     —           —     

 

(1) The aggregate fair value of loans that were 90 or more days past due was $-0- million and $-0- at February 28, 2014 and November 30, 2013.
(2) Interest income is recognized separately from other changes in fair value and is included within Interest revenues on the Consolidated Statements of Earnings.

There were no loan receivables on nonaccrual status at February 28, 2014 and November 30, 2013.

 

Note 7. Derivative Financial Instruments

Off-Balance Sheet Risk

We have contractual commitments arising in the ordinary course of business for securities loaned or purchased under agreements to resell, repurchase agreements, future purchases and sales of foreign currencies, securities transactions on a when-issued basis and underwriting. Each of these financial instruments and activities contains varying degrees of off-balance sheet risk whereby the fair values of the securities underlying the financial instruments may be in excess of, or less than, the contract amount. The settlement of these transactions is not expected to have a material effect upon our consolidated financial statements.

Derivative Financial Instruments

Our derivative activities are recorded at fair value in the Consolidated Statements of Financial Condition in Financial instruments owned – derivatives and Financial instruments sold, not yet purchased – derivatives net of cash paid or received under credit support agreements and on a net counterparty basis when a legally enforceable right to offset

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

exists under a master netting agreement. Net realized and unrealized gains and losses are recognized in Principal transactions in the Consolidated Statements of Earnings on a trade date basis and as a component of cash flows from operating activities in the Consolidated Statements of Cash Flows. Acting in a trading capacity, we may enter into derivative transactions to satisfy the needs of our clients and to manage our own exposure to market and credit risks resulting from our trading activities. (See Note 6, Fair Value Disclosures and Note 21, Commitments, Contingencies and Guarantees for additional disclosures about derivative instruments.)

Derivatives are subject to various risks similar to other financial instruments, including market, credit and operational risk. The risks of derivatives should not be viewed in isolation, but rather should be considered on an aggregate basis along with our other trading-related activities. We manage the risks associated with derivatives on an aggregate basis along with the risks associated with proprietary trading as part of our firm wide risk management policies.

In connection with our derivative activities, we may enter into International Swaps and Derivative Association, Inc. (“ISDA”) master netting agreements or similar agreements with counterparties. A master agreement creates a single contract under which all transactions between two counterparties are executed allowing for trade aggregation and a single net payment obligation. Master agreements provide protection in bankruptcy in certain circumstances and, where legally enforceable, enable receivables and payables with the same counterparty to be settled or otherwise eliminated by applying amounts due against all or a portion of an amount due from the counterparty or a third party. In addition, we enter into customized bilateral trading agreements and other customer agreements that provide for the netting of receivables and payables with a given counterparty as a single net obligation.

Under our ISDA master netting agreements, we typically also execute credit support annexes, which provide for collateral, either in the form of cash or securities, to be posted by or paid to a counterparty based on the fair value of the derivative receivable or payable based on the rates and parameters established in the credit support annex. In the event of the counterparty’s default, provisions of the master agreement permit acceleration and termination of all outstanding transactions covered by the agreement such that a single amount is owed by, or to, the non-defaulting party. In addition, any collateral posted can be applied to the net obligations, with any excess returned; and the collateralized party has a right to liquidate the collateral. Any residual claim after netting is treated along with other unsecured claims in bankruptcy court.

The conditions supporting the legal right of offset may vary from one legal jurisdiction to another and the enforceability of master netting agreements and bankruptcy laws in certain countries or in certain industries is not free from doubt. The right of offset is dependent both on contract law under the governing arrangement and consistency with the bankruptcy laws of the jurisdiction where the counterparty is located. Industry legal opinions with respect to the enforceability of certain standard provisions in respective jurisdictions are relied upon as a part of managing credit risk. In cases where we have not determined an agreement to be enforceable, the related amounts are not offset. Master netting agreements are a critical component of our risk management processes as part of reducing counterparty credit risk and managing liquidity risk.

We are also a party to clearing agreements with various central clearing parties. Under these arrangements, the central clearing counterparty facilitates settlement between counterparties based on the net payable owed or receivable due and, with respect to daily settlement, cash is generally only required to be deposited to the extent of the net amount. In the event of default, a net termination amount is determined based on the market values of all outstanding positions and the clearing organization or clearing member provides for the liquidation and settlement of the net termination amount among all counterparties to the open derivative contracts.

The following tables present the fair value and related number of derivative contracts at February 28, 2014 and November 30, 2013 categorized by type of derivative contract and the platform on which these derivatives are transacted. The fair value of assets/liabilities represents our receivable/payable for derivative financial instruments, gross of counterparty netting and cash collateral received and pledged. The following tables also provide information regarding 1) the extent to which, under enforceable master netting arrangements, such balances are presented net in the statement of financial condition as appropriate under GAAP and 2) the extent to which other rights of setoff

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

associated with these arrangements exist and could have an effect on our financial position (in thousands, except contract amounts). See Note 8, Collateralized Transactions, for information related to offsetting of certain secured financing transactions.

 

     February 28, 2014 (1)  
     Assets      Liabilities  
     Fair Value     Number of
Contracts
     Fair Value     Number of
Contracts
 

Interest rate contracts

         

Exchange-traded

   $ 4,265        40,007       $ 7,670        47,510   

Cleared OTC

     519,964        2,222         523,532        1,964   

Bilateral OTC

     711,837        1,190         677,525        612   

Foreign exchange contracts

         

Exchange-traded

     29        56,669         68        66,613   

Bilateral OTC

     582,894        9,665         622,707        11,809   

Equity contracts

         

Exchange-traded

     423,076        1,441,414         421,531        1,446,583   

Bilateral OTC

     3,640        96         13,418        104   

Commodity contracts

         

Exchange-traded

     26,851        678,154         27,547        698,329   

Bilateral OTC

     106,004        4,062         88,289        3,173   

Credit contracts

         

Cleared OTC

     13,695        17         15,545        14   

Bilateral OTC

     3,961        19         12,239        26   
  

 

 

      

 

 

   

Total gross derivative assets/ liabilities:

         

Exchange-traded

     454,221           456,816     

Cleared OTC

     533,659           539,077     

Bilateral OTC

     1,408,336           1,414,178     

Amounts offset in the Consolidated Statements of Financial Condition (2):

         

Exchange-traded

     (448,484        (448,484  

Cleared OTC

     (522,286        (514,335  

Bilateral OTC

     (1,201,747        (1,258,747  
  

 

 

      

 

 

   

Net amounts per Consolidated Statements of Financial Condition (3)

   $ 223,699         $ 188,505     
  

 

 

      

 

 

   

 

(1) Exchange traded derivatives include derivatives executed on an organized exchange. Cleared OTC derivatives include derivatives executed bilaterally and subsequently novated to and cleared through central clearing counterparties. Bilateral OTC derivatives include derivatives executed and settled bilaterally without the use of an organized exchange or central clearing counterparty.
(2) Amounts netted include both netting by counterparty and for cash collateral paid or received.
(3) We have not received or pledged additional collateral under master netting agreements and/ or other credit support agreements that is eligible to be offset beyond what has been offset in the Consolidated Statements of Financial Condition.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

     November 30, 2013 (1)  
     Assets      Liabilities  
     Fair Value     Number of
Contracts
     Fair Value     Number of
Contracts
 

Interest rate contracts

         

Exchange-traded

   $ 8,696        57,344       $ 3,846        68,268   

Cleared OTC

     432,667        5,402         396,422        7,730   

Bilateral OTC

     724,613        1,221         730,897        1,340   

Foreign exchange contracts

         

Exchange-traded

     33        111,229         40        104,205   

Bilateral OTC

     653,739        7,478         693,618        8,212   

Equity contracts

         

Exchange-traded

     495,069        1,742,195         465,110        1,800,467   

Bilateral OTC

     6,715        148         9,875        136   

Commodity contracts

         

Exchange-traded

     27,185        785,718         33,661        780,358   

Bilateral OTC

     114,095        11,811         139,458        8,359   

Credit contracts

         

Cleared OTC

     49,531        49         51,632        46   

Bilateral OTC

     2,339        16         8,131        19   
  

 

 

      

 

 

   

Total gross derivative assets/ liabilities:

         

Exchange-traded

     530,983           502,657     

Cleared OTC

     482,198           448,054     

Bilateral OTC

     1,501,501           1,582,979     

Amounts offset in the Consolidated Statements of Financial Condition (2):

         

Exchange-traded

     (489,375        (489,375  

Cleared OTC

     (446,520        (445,106  

Bilateral OTC

     (1,317,694        (1,418,130  
  

 

 

      

 

 

   

Net amounts per Consolidated Statements of Financial Condition (3)

   $ 261,093         $ 180,079     
  

 

 

      

 

 

   

 

(1) Exchange traded derivatives include derivatives executed on an organized exchange. Cleared OTC derivatives include derivatives executed bilaterally and subsequently novated to and cleared through central clearing counterparties. Bilateral OTC derivatives include derivatives executed and settled bilaterally without the use of an organized exchange or central clearing counterparty.
(2) Amounts netted include both netting by counterparty and for cash collateral paid or received.
(3) We have not received or pledged additional collateral under master netting agreements and/ or other credit support agreements that is eligible to be offset beyond what has been offset in the Consolidated Statements of Financial Condition.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following table presents unrealized and realized gains (losses) on derivative contracts for the three months ended February 28, 2014 and 2013 (in thousands):

 

     Three Months Ended  
Gains (Losses)    February 28, 2014     February 28, 2013  

Interest rate contracts

   $ (208   $ 38,936   

Foreign exchange contracts

     5,437        11,895   

Equity contracts

     (91,101     (22,021

Commodity contracts

     16,186        19,585   

Credit contracts

     (3,889     (3,742
  

 

 

   

 

 

 

Total

   $ (73,575   $ 44,653   
  

 

 

   

 

 

 

OTC Derivatives. The following tables set forth by remaining contract maturity the fair value of OTC derivative assets and liabilities as of February 28, 2014 (in thousands):

 

     OTC Derivative Assets (1) (2) (4)  
     0 – 12 Months      1 – 5 Years      Greater Than
5 Years
     Cross-Maturity
Netting (3)
    Total  

Commodity swaps, options and forwards

   $ 41,185       $ 132       $ —         $ —        $ 41,317   

Credit default swaps

     —           436         —           —          436   

Equity swaps and options

     1,446         —           —           —          1,446   

Total return swaps

     3,612         —           —           (34     3,578   

Foreign currency forwards, swaps and options

     117,738         18,721         36         (17,246     119,249   

Interest rate swaps, options and forwards

     67,280         108,067         116,922         (60,576     231,693   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 231,261       $ 127,356       $ 116,958       $ (77,856     397,719   
  

 

 

    

 

 

    

 

 

    

 

 

   

Cross product counterparty netting

                (9,332
             

 

 

 

Total OTC derivative assets included in Financial instruments owned

              $ 388,387   
             

 

 

 

 

(1) At February 28, 2014, we held exchange traded derivative assets and other credit agreements with a fair value of $11.1 million, which are not included in this table.
(2) OTC derivative assets in the table above are gross of collateral received. OTC derivative assets are recorded net of collateral received on the Consolidated Statements of Financial Condition. At February 28, 2014, cash collateral received was $176.1 million.
(3) Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.
(4) Derivative fair values include counterparty netting within product category.

 

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     OTC Derivative Liabilities (1) (2) (4)  
     0 – 12 Months      1 – 5 Years      Greater Than
5 Years
     Cross-Maturity
Netting (3)
    Total  

Commodity swaps, options and forwards

   $ 23,585       $ 108       $ —         $ —        $ 23,693   

Credit default swaps

     2,116         4,512         66         —          6,694   

Equity swaps and options

     —           —           11,006         —          11,006   

Total return swaps

     1,706         34         —           (34     1,706   

Foreign currency forwards, swaps and options

     153,068         23,466         —           (17,246     159,288   

Interest rate swaps, options and forwards

     24,764         108,398         132,889         (60,576     205,475   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 205,239       $ 136,518       $ 143,961       $ (77,856     407,862   
  

 

 

    

 

 

    

 

 

    

 

 

   

Cross product counterparty netting

                (9,332
             

 

 

 

Total OTC derivative liabilities included in Financial instruments sold, not yet purchased

              $ 398,530   
             

 

 

 

 

(1) At February 28, 2014, we held exchange traded derivative liabilities and other credit agreements with a fair value of $15.2 million, which are not included in this table.
(2) OTC derivative liabilities in the table above are gross of collateral pledged. OTC derivative liabilities are recorded net of collateral pledged on the Consolidated Statements of Financial Condition. At February 28, 2014, cash collateral pledged was $225.2 million.
(3) Amounts represent the netting of receivable balances with payable balances for the same counterparty within product category across maturity categories.
(4) Derivative fair values include counterparty netting within product category.

At February 28, 2014, the counterparty credit quality with respect to the fair value of our OTC derivatives assets was as follows (in thousands):

Counterparty credit quality (1):

 

A- or higher

   $ 242,672   

BBB- to BBB+

     8,093   

BB+ or lower

     80,870   

Unrated

     56,752   
  

 

 

 

Total

   $ 388,387   
  

 

 

 

 

(1) We utilize internal credit ratings determined by our Risk Management. Credit ratings determined by Risk Management use methodologies that produce ratings generally consistent with those produced by external rating agencies.

Contingent Features

Certain of our derivative instruments contain provisions that require our debt to maintain an investment grade credit rating from each of the major credit rating agencies. If our debt were to fall below investment grade, it would be in violation of these provisions and the counterparties to the derivative instruments could request immediate payment or demand immediate and ongoing full overnight collateralization on our derivative instruments in liability positions. The aggregate fair value of all derivative instruments with such credit-risk-related contingent features that are in a liability position at February 28, 2014 and November 30, 2013 is $110.7 million and $170.2 million, respectively, for which we have posted collateral of $72.9 million and $127.7 million, respectively, in the normal course of business. If the

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

credit-risk-related contingent features underlying these agreements were triggered on February 28, 2014 and November 30, 2013, we would have been required to post an additional $42.5 million and $49.4 million, respectively, of collateral to our counterparties.

 

Note 8. Collateralized Transactions

We enter into secured borrowing and lending arrangements to obtain collateral necessary to effect settlement, finance inventory positions, meet customer needs or re-lend as part of our dealer operations. We monitor the fair value of the securities loaned and borrowed on a daily basis as compared with the related payable or receivable, and request additional collateral or return excess collateral, as appropriate. We pledge financial instruments as collateral under repurchase agreements, securities lending agreements and other secured arrangements, including clearing arrangements. Our agreements with counterparties generally contain contractual provisions allowing the counterparty the right to sell or repledge the collateral. Pledged securities owned that can be sold or repledged by the counterparty are included within Financial instruments owned and noted parenthetically as Securities pledged on our Consolidated Statements of Financial Condition.

We receive securities as collateral under resale agreements, securities borrowing transactions and customer margin loans. We also receive securities as collateral in connection with securities-for-securities transactions in which we are the lender of securities. In many instances, we are permitted by contract or custom to rehypothecate the securities received as collateral. These securities may be used to secure repurchase agreements, enter into securities lending transactions, satisfy margin requirements on derivative transactions or cover short positions. At February 28, 2014 and November 30, 2013, the approximate fair value of securities received as collateral by us that may be sold or repledged was $23.5 billion and $21.9 billion, respectively. The fair value of securities received as collateral at February 28, 2014 and November 30, 2013 that pertains to our securities financing activities at February 28, 2014 and November 30, 2013 are as follows (in thousands):

 

     February 28,
2014
     November 30,
2013
 

Carrying amount:

     

Securities purchased under agreements to resell

   $ 4,448,531       $ 3,746,920   

Securities borrowed

     6,119,935         5,359,846   

Securities received as collateral

     1,051         11,063   
  

 

 

    

 

 

 

Total assets on Consolidated Statement of Financial Condition

     10,569,517         9,117,829   

Netting of securities purchased under agreements to resell (1)

     8,572,185         8,968,529   
  

 

 

    

 

 

 
     19,141,702         18,086,358   

Fair value of additional collateral received (2)

     4,321,796         3,866,577   
  

 

 

    

 

 

 

Fair value of securities received as collateral

   $ 23,463,498       $ 21,952,935   
  

 

 

    

 

 

 

 

(1) Represents the netting of securities purchased under agreements to resell with securities sold under agreements to repurchase balances for the same counterparty under legally enforceable netting agreements.
(2) Includes 1) collateral received from customers for margin balances unrelated to arrangements for securities purchased under agreements to resell or securities borrowed with a fair value of $1,498.6 million and $1,182.1 million at February 28, 2014 and November 30, 2013, respectively, of which $600.0 million and $596.2 million had been rehypothecated, 2) collateral received on securities for securities transactions of $2,877.5 million and $2,656.9 million at February 28, 2014 and November 30, 2013, respectively and 3) differences in collateral required as compared to reverse repurchase and securities borrowed contract amounts.

At February 28, 2014 and November 30, 2013, a substantial portion of the securities received by us had been sold or repledged.

 

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(Unaudited)

 

In instances where we receive securities as collateral in connection with securities-for-securities transactions in which we are the lender of securities and are permitted to sell or repledge the securities received as collateral, we report the fair value of the collateral received and the related obligation to return the collateral in the Consolidated Statements of Financial Condition. At February 28, 2014 and November 30, 2013, $1.1 million and $11.1 million, respectively, were reported as Securities received as collateral and as Obligation to return securities received as collateral.

Offsetting of Securities Financing Agreements

To manage our exposure to credit risk associated with securities financing transactions, we may enter into master netting agreements and collateral arrangements with counterparties. Generally, transactions are executed under standard industry agreements, including, but not limited to, master securities lending agreements (securities lending transactions) and master repurchase agreements (repurchase transactions). A master agreement creates a single contract under which all transactions between two counterparties are executed allowing for trade aggregation and a single net payment obligation. Master agreements provide protection in bankruptcy in certain circumstances and, where legally enforceable, enable receivables and payables with the same counterparty to be settled or otherwise eliminated by applying amounts due against all or a portion of an amount due from the counterparty or a third party. In addition, we enter into customized bilateral trading agreements and other customer agreements that provide for the netting of receivables and payables with a given counterparty as a single net obligation.

In the event of the counterparty’s default, provisions of the master agreement permit acceleration and termination of all outstanding transactions covered by the agreement such that a single amount is owed by, or to, the non-defaulting party. In addition, any collateral posted can be applied to the net obligations, with any excess returned; and the collateralized party has a right to liquidate the collateral. Any residual claim after netting is treated along with other unsecured claims in bankruptcy court.

The conditions supporting the legal right of offset may vary from one legal jurisdiction to another and the enforceability of master netting agreements and bankruptcy laws in certain countries or in certain industries is not free from doubt. The right of offset is dependent both on contract law under the governing arrangement and consistency with the bankruptcy laws of the jurisdiction where the counterparty is located. Industry legal opinions with respect to the enforceability of certain standard provisions in respective jurisdictions are relied upon as a part of managing credit risk. Master netting agreements are a critical component of our risk management processes as part of reducing counterparty credit risk and managing liquidity risk.

We are also a party to clearing agreements with various central clearing parties. Under these arrangements, the central clearing counterparty facilitates settlement between counterparties based on the net payable owed or receivable due and, with respect to daily settlement, cash is generally only required to be deposited to the extent of the net amount. In the event of default, a net termination amount is determined based on the market values of all outstanding positions and the clearing organization or clearing member provides for the liquidation and settlement of the net termination amount among all counterparties to the open repurchase and/or securities lending transactions.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables provide information regarding repurchase agreements and securities borrowing and lending arrangements that are recognized in the Consolidated Statement of Financial Condition and 1) the extent to which, under enforceable master netting arrangements, such balances are presented net in the Consolidated Statement of Financial Condition as appropriate under GAAP and 2) the extent to which other rights of setoff associated with these arrangements exist and could have an effect on our financial position. See Note 7, Derivative Financial Instruments, for information related to offsetting of derivatives.

 

     February 28, 2014  
(in thousands)    Gross
Amounts
     Netting in
Consolidated
Statement of
Financial
Condition
    Net Amounts in
Consolidated
Statement of
Financial
Condition
     Additional
Amounts
Available for
Setoff (1)
    Available
Collateral (2)
    Net Amount (3)  

Assets

              

Securities borrowing arrangements

   $ 6,119,935         —          6,119,935         (655,539     (1,197,430   $ 4,266,966   

Reverse repurchase agreements

   $ 13,020,716         (8,572,185     4,448,531         (196,671     (4,197,094   $ 54,766   

Liabilities

              

Securities lending arrangements

   $ 3,082,032         —          3,082,032         (655,539     (2,384,307   $ 42,186   

Repurchase agreements

   $ 19,349,250         (8,572,185     10,777,065         (196,671     (9,247,075   $ 1,333,319   

 

(1) Under master netting agreements with our counterparties, we have the legal right of offset with a counterparty, which incorporates all of the counterparty’s outstanding rights and obligations under the arrangement. These balances reflect additional credit risk mitigation that is available by counterparty in the event of a counterparty’s default, but which are not netted in the balance sheet because other netting provisions of U.S. GAAP are not met.
(2) Includes securities received or paid under collateral arrangements with counterparties that could be liquidated in the event of a counterparty default and thus offset against a counterparty’s rights and obligations under the respective repurchase agreements or securities borrowing or lending arrangements.
(3) Amounts include $4,202.5 million of securities borrowing arrangements, for which we have received securities collateral of $4,076.5 million, and $1,325.0 million of repurchase agreements, for which we have pledged securities collateral of $1,358.3 million, which are subject to master netting agreements but we have not yet determined the agreements to be legally enforceable.

 

     November 30, 2013  
(in thousands)    Gross
Amounts
     Netting in
Consolidated
Statement of
Financial
Condition
    Net Amounts in
Consolidated
Statement of
Financial
Condition
     Additional
Amounts
Available for
Setoff (1)
    Available
Collateral (2)
    Net Amount (3)  

Assets

              

Securities borrowing arrangements

   $ 5,359,846         —          5,359,846         (530,293     (957,140   $ 3,872,413   

Reverse repurchase agreements

   $ 12,715,449         (8,968,529     3,746,920         (590,754     (3,074,540   $ 81,626   

Liabilities

              

Securities lending arrangements

   $ 2,506,122         —          2,506,122         (530,293     (1,942,271   $ 33,558   

Repurchase agreements

   $ 19,748,374         (8,968,529     10,779,845         (590,754     (8,748,641   $ 1,440,450   

 

(1) Under master netting agreements with our counterparties, we have the legal right of offset with a counterparty, which incorporates all of the counterparty’s outstanding rights and obligations under the arrangement. These balances reflect additional credit risk mitigation that is available by counterparty in the event of a counterparty’s default, but which are not netted in the balance sheet because other netting provisions of U.S. GAAP are not met.
(2) Includes securities received or paid under collateral arrangements with counterparties that could be liquidated in the event of a counterparty default and thus offset against a counterparty’s rights and obligations under the respective repurchase agreements or securities borrowing or lending arrangements.
(3) Amounts include $3,818.4 million of securities borrowing arrangements, for which we have received securities collateral of $3,721.8 million, and $1,410.0 million of repurchase agreements, for which we have pledged securities collateral of $1,438.9 million, which are subject to master netting agreements but we have not yet determined the agreements to be legally enforceable.

 

Note 9. Securitization Activities

We engage in securitization activities related to corporate loans, commercial mortgage loans and mortgage-backed and other asset-backed securities. In our securitization transactions, we transfer these assets to special purpose entities (“SPEs”) and act as the placement or structuring agent for the beneficial interests sold to investors by the SPE. A significant portion of our securitization transactions are securitization of assets issued or guaranteed by U.S. government agencies. These SPEs generally meet the criteria of variable interest entities; however we generally do not consolidate the SPEs as we are not considered the primary beneficiary for these SPEs. See Note 10, Variable Interest Entities for further discussion on variable interest entities and our determination of the primary beneficiary.

 

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(Unaudited)

 

We account for our securitization transactions as sales provided we have relinquished control over the transferred assets. Transferred assets are carried at fair value with unrealized gains and losses reflected in Principal transactions revenues in the Consolidated Statement of Earnings prior to the identification and isolation for securitization. Revenues subsequent to such identification and isolation, including revenues recognized from the sales of the beneficial interests to investors, are reflected as net underwriting revenues. If we have not relinquished control over the transferred assets, the assets continue to be recognized in Financial instruments owned and a corresponding secured borrowing is recognized in Other secured financings. The carrying value of assets and liabilities resulting from transfers made as part of our securitization activities for which we have not relinquished control over the related assets was $30.4 million and $30.4 million, respectively, at February 28, 2014 and $8.7 million and $8.7 million, respectively, at November 30, 2013. The related liabilities do not have recourse to our general credit.

We generally receive cash proceeds in connection with the transfer of assets to an SPE. We may, however, have continuing involvement with the transferred assets, which is limited to retaining one or more tranches of the securitization (primarily senior and subordinated debt securities), which are included within Financial instruments owned. We apply fair value accounting to the securities.

The following table presents activity related to our securitizations that were accounted for as sales in which we had continuing involvement (in millions):

 

     Successor               Predecessor  
     Three Months Ended
February 28, 2014
              Three Months Ended
February 28, 2013
 
 

Transferred assets

   $ 1,626.9             $ 2,735.2   

Proceeds on new securitizations

     1,628.1               2,751.3   

Net revenues

     0.7               12.9   
 

Cash flows received on retained interests

   $ 8.5             $ 32.3   

Assets received as proceeds in the form of mortgage-backed-securities or collateralized loan obligations issued by the SPEs have been initially categorized as Level 2 within the fair value hierarchy. For further information on fair value measurements and the fair value hierarchy, refer to Note 2, Summary of Significant Accounting Policies and Note 6, Fair Value Disclosures. We have no explicit or implicit arrangements to provide additional financial support to these SPEs and have no liabilities related to these SPEs at February 28, 2014 and November 30, 2013. Although not obligated, in connection with secondary market-making activities we may make a market in the securities issued by these SPEs. In these market-making transactions, we buy these securities from and sell these securities to investors. Securities purchased through these market-making activities are not considered to be continuing involvement in these SPEs, although the securities are included in Financial instruments owned – Mortgage- and asset-backed securities. To the extent the securities purchased through these market-marking activities meet specific thresholds and we are not deemed to be the primary beneficiary of the variable interest entity, these securities are included in agency and non-agency mortgage- and asset-backed securitizations in the nonconsolidated variable interest entities table presented in Note 10, Variable Interest Entities.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

The following tables summarize our retained interests in SPEs where we transferred assets and have continuing involvement and received sale accounting treatment (in millions):

 

     As of February 28, 2014  

Securitization Type

   Total Assets      Retained
Interests
 

U.S. government agency residential mortgage-backed securities

   $ 11,130.8       $ 237.0   

U.S. government agency commercial mortgage-backed securities

     6,830.7         245.5   

Collateralized loan obligations

     728.5         8.9   

 

     As of November 30, 2013  

Securitization Type

   Total Assets      Retained
Interests
 

U.S. government agency residential mortgage-backed securities

   $ 11,518.4       $ 281.3   

U.S. government agency commercial mortgage-backed securities

     5,385.6         96.8   

Collateralized loan obligations

     728.5         9.0   

We do not have any outstanding derivative contracts executed in connection with these securitization activities. Total assets represent the unpaid principal amount of assets in the SPEs in which we have continuing involvement and are presented solely to provide information regarding the size of the transaction and the size of the underlying assets supporting our retained interests, and are not considered representative of the risk of potential loss. Assets retained in connection with a securitization transaction represent the fair value of the securities of one or more tranches issued by an SPE, including senior and subordinated tranches. Our risk of loss is limited to this fair value amount which is included within total Financial instruments owned - Mortgage- and asset-backed securities on our Consolidated Statements of Financial Condition.

 

Note 10. Variable Interest Entities

Variable interest entities (“VIEs”) are entities in which equity investors lack the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support. VIEs are consolidated by the primary beneficiary. The primary beneficiary is the party who has the power to direct the activities of a variable interest entity that most significantly impact the entity’s economic performance and who has an obligation to absorb losses of the entity or a right to receive benefits from the entity that could potentially be significant to the entity.

We determine whether we are the primary beneficiary of a VIE upon our initial involvement with the VIE and we reassess whether we are the primary beneficiary of a VIE on an ongoing basis. Our determination of whether we are the primary beneficiary of a VIE is based upon the facts and circumstances for each VIE and requires significant judgment. In determining whether we are the party with the power to direct the VIE’s most significant activities, we first identify the activities of the VIE that most significantly impact its economic performance. Our considerations in determining the VIE’s most significant activities primarily include, but are not limited to, the VIE’s purpose and design and the risks passed through to investors. We then assess whether we have the power to direct those significant activities. Our considerations in determining whether we have the power to direct the VIE’s most significant activities include, but are not limited to, voting interests of the VIE, management, service and/or other agreements of the VIE, involvement in the VIE’s initial design and the existence of explicit or implicit financial guarantees. In situations where we have determined that the power over the VIE’s most significant activities is shared, we assess whether we are the party with the power over the majority of the significant activities. If we are the party with the power over the majority of the significant activities, we meet the “power” criteria of the primary beneficiary. If we do not have the power over a majority of the significant activities or we determine that decisions require consent of each sharing party, we do not meet the “power” criteria of the primary beneficiary.

 

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

We assess our variable interests in a VIE both individually and in aggregate to determine whether we have an obligation to absorb losses of or a right to receive benefits from the VIE that could potentially be significant to the VIE. The determination of whether our variable interest is significant to the VIE requires significant judgment. In determining the significance of our variable interest, we consider the terms, characteristics and size of the variable interests, the design and characteristics of the VIE, our involvement in the VIE and our market-making activities related to the variable interests. Our variable interests in VIEs include debt and equity interests, commitments and certain fees. Our involvement with VIEs arises primarily from:

 

    Purchases of mortgage-backed securities and collateralized debt and loan obligations in connection with our trading and secondary market making activities,

 

    Retained interests held as a result of securitization activities as part of primary market making activities, including the resecuritizations of mortgage-backed securities and the securitization of corporate loans,

 

    Financing of agency and non-agency mortgage-securities through financing vehicles utilizing master repurchase agreements,

 

    Management and performance fees in the Jefferies Umbrella Fund, and

 

    Loans to and investments in investment fund vehicles.

Consolidated VIEs

The following table presents information about the assets and liabilities of our consolidated VIEs, which are presented within our Consolidated Statements of Financial Condition in the respective asset and liability categories, as of February 28, 2014 and November 30, 2013. The assets and liabilities in the tables below are presented prior to consolidation and thus a portion of these assets and liabilities are eliminated in consolidation. We have aggregated our consolidated VIEs based upon principal business activity.

 

(in millions)    February 28, 2014      November 30, 2013  
     Securitization
Vehicles
     Other      Securitization
Vehicles
     Other  

Cash

   $ —         $ 0.2       $ —         $ 0.2   

Financial instruments owned

     97.5         0.4         97.5         0.4   

Securities purchased under agreement to resell (1)

     220.0         —           195.1         —     

Other assets

     3.2         —           2.3         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 320.7       $ 0.6       $ 294.9       $ 0.6   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other secured financings (2)

   $ 317.5       $ —         $ 292.5       $ —     

Other liabilities

     3.0         0.2         2.1         0.2   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 320.5       $ 0.2       $ 294.6       $ 0.2   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Securities purchased under agreement to resell represent an amount due under a collateralized transaction on a related consolidated entity, which is eliminated in consolidation.
(2) Approximately $77.5 million and $66.5 million of the secured financing represents an amount held by us in inventory and is eliminated in consolidation at February 28, 2014 and November 30, 2013, respectively.

Securitization Vehicles. We are the primary beneficiary of a securitization vehicle to which we transferred a corporate loan and retained a portion of the securities issued by the securitization vehicle. Our variable interests in this vehicle consists of the securities retained. The assets of the VIE consist of a corporate loan, which is available for the benefit of the vehicle’s beneficial interest holders. The creditors of the VIE do not have recourse to our general credit.

 

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(Unaudited)

 

We are the primary beneficiary of mortgage-backed financing vehicles to which we sell agency and non-agency residential and commercial mortgage-backed securities pursuant to the terms of a master repurchase agreement. We manage the assets within these vehicles. Our variable interests in these vehicles consist of our collateral margin maintenance obligations under the master repurchase agreement. The assets of these VIEs consist of reverse repurchase agreements, which are available for the benefit of the vehicle’s debt holders. The creditors of these VIEs do not have recourse to our general credit.

Other. We are the primary beneficiary of certain investment vehicles set up for the benefit of our employees. We manage and invest alongside our employees in these vehicles. The assets of these VIEs consist of private equity securities, and are available for the benefit of the entities’ equity holders. Our variable interests in these vehicles consist of equity securities. The creditors of these VIEs do not have recourse to our general credit.

Nonconsolidated VIEs

We also hold variable interests in VIEs in which we are not the primary beneficiary and do not have the power to direct the activities that most significantly impact their economic performance and, accordingly, do not consolidate. We have not provided financial or other support to these VIEs during the three months ended February 28, 2014 and 2013. We have no explicit or implicit arrangements to provide additional financial support to these VIEs at February 28, 2014 and November 30, 2013.

The following tables present information about nonconsolidated VIEs in which we had variable interests aggregated by principal business activity. The tables include VIEs where we have determined that the maximum exposure to loss is greater than specific thresholds or meets certain other criteria.

 

     February 28, 2014  
(in millions)    Carrying Amount      Maximum        
     Assets      Liabilities      Exposure to loss     VIE Assets  

Collateralized loan obligations (2)

   $ 24.2       $ 2.3       $ 281.1      $ 2,076.8   

Agency mortgage- and asset-backed securitizations (1) (3)

     1,733.2         —           1,733.2 (5)      3,463.3   

Non-agency mortgage- and asset-backed securitizations (1) (3)

     862.4         —           862.4 (5)      89,546.7   

Asset management vehicle (4)

     3.7         —           3.7 (5)      470.0   

Private equity vehicles (4)

     41.3         —           67.5        88.1   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 2,664.8       $ 2.3       $ 2,947.9      $ 95,644.9   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) VIE assets represent the unpaid principal balance of the assets in these vehicles at February 28, 2014, and represent the underlying assets that provide the cash flows supporting our variable interests.
(2) Assets consist of debt securities and participation interests in corporate loans accounted for at fair value, which are included within Financial instruments owned. Liabilities consist of forward sale agreements and a guarantee provided to a CLO managed by Jefferies Finance, which are accounted for at fair value and included within Financial instruments sold, not yet purchased.
(3) Assets consist of debt securities accounted for at fair value, which are included within Financial instruments owned.
(4) Assets consist of equity interests, which are included within Investments in managed funds.
(5) Our maximum exposure to loss in these non-consolidated VIEs is limited to our investment, which is represented by the financial statement carrying amount of our purchased or retained interests.

 

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     November 30, 2013  
(in millions)    Carrying Amount      Maximum        
     Assets      Liabilities      Exposure to loss     VIE Assets  

Collateralized loan obligations (2)

   $ 11.9       $ 0.2       $ 88.8      $ 1,122.3   

Agency mortgage- and asset-backed securitizations (1) (3)

     1,226.0         —           1,226.0 (5)      5,857.3   

Non-agency mortgage- and asset-backed securitizations (1) (3)

     840.1         —           840.1 (5)      78,070.8   

Asset management vehicle (4)

     3.5         —           3.5 (5)      454.2   

Private equity vehicles (4)

     40.8         —           68.8        89.4   
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 2,122.3       $ 0.2       $ 2,227.2      $ 85,594.0   
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) VIE assets represent the unpaid principal balance of the assets in these vehicles at November 30, 2013 and represent the underlying assets that provide the cash flows supporting our variable interests.
(2) Assets consist of debt securities accounted for at fair value, which are included within Financial instruments owned. Liabilities consist of forward sale agreements accounted for at fair value, which are included within Financial instruments sold, not yet purchased.
(3) Assets consist of debt securities accounted for at fair value, which are included within Financial instruments owned.
(4) Assets consist of equity interests, which are included within Investments in managed funds.
(5) Our maximum exposure to loss in these non-consolidated VIEs is limited to our investment, which is represented by the financial statement carrying amount of our purchased or retained interests.

Collateralized Loan Obligations. We act as transferor and underwriter in collateralized loan obligation (“CLOs”) transactions and retain securities representing variable interests in the CLOs. Assets collateralizing the CLOs include bank loans, participation interests and sub-investment grade and senior secured U.S. loans. We also enter into forward sale agreements and master participation agreements with CLOs. Under forward sale agreements, we commit to sell, at a fixed price, corporate loans and ownership interests in an entity holding such corporate loans to a CLO. Under master participation agreements, we purchase participation interests in corporate loans held by a CLO.

In addition, we own variable interests in CLOs previously managed by us. Our variable interests consist of debt securities and a right to a portion of the CLOs’ management and incentive fees. Our exposure to loss from these CLOs is limited to our investments in the debt securities held. Management and incentives fees are accrued as the amounts become realizable. These CLOs represent interests in assets consisting primarily of senior secured loans, unsecured loans and high yield bonds. We also have provided a guarantee to a CLO managed by Jefferies Finance, whereby we guarantee certain of the obligations of Jefferies Finance to the CLO.

 

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Mortgage- and Asset-Backed Vehicles. In connection with our trading and market making activities, we buy and sell mortgage- and asset-backed securities. Mortgage- and asset-backed securities issued by securitization entities are generally considered variable interests in VIEs. A substantial portion of our variable interests in mortgage- and asset-backed VIEs are sponsored by unrelated third parties. The variable interests consist entirely of mortgage- and asset-backed securities and are accounted for at fair value and included in Financial instruments owned on our Consolidated Statements of Financial Condition. In addition to the agency mortgage- and asset-backed securities, non-agency mortgage- and asset-backed securities and collateralized loan obligations presented in the above table, we owned additional securities issued by securitization SPEs for which the maximum exposure to loss is less than specific thresholds. These additional securities were acquired in connection with our secondary market making activities and our securitization activities. Total securities issued by securitization SPEs at February 28, 2014 consist of the following (in millions):

 

     Nonagency      Agency      Total  

Variable interests in collateralized loan obligations

   $ 24.2       $ —         $ 24.2   

Variable interests in agency mortgage- and asset-backed securitizations

     —           1,733.2         1,733.2   

Variable interests in nonagency mortgage- and asset-backed securitizations

     862.4         —           862.4   

Additional securities in connection with trading and market making activities:

        

Residential mortgage-backed securities

     40.9         1,750.2         1,791.1   

Commercial mortgage-backed securities

     31.0         613.1         644.1   

Collateralized debt obligations

     22.7         —           22.7   

Other asset-backed securities

     18.2         —           18.2   
  

 

 

    

 

 

    

 

 

 

Total mortgage- and asset-backed securities on the Consolidated Statements of Financial Condition

   $ 999.4       $ 4,096.5       $ 5,095.9   
  

 

 

    

 

 

    

 

 

 

Asset Management Vehicle. We manage the Jefferies Umbrella Fund, an “umbrella structure” company that invests primarily in convertible bonds and enables investors to choose between one or more investment objectives by investing in one or more sub-funds within the same structure. Accounting changes to consolidation standards under generally accepted accounting principles have been deferred for entities that are considered to be investment companies; accordingly, consolidation continues to be determined under a risk and reward model. The Jefferies Umbrella Fund is subject to the deferral guidance and we are not the primary beneficiary as of February 28, 2014 and November 30, 2013 under the risk and reward model. Our variable interests in the Jefferies Umbrella Fund consist of equity interests, management fees and performance fees.

Private Equity Vehicles. On July 26, 2010, we committed to invest equity of up to $75.0 million in Jefferies SBI USA Fund L.P. (the “SBI USA Fund”). As of February 28, 2014 and November 30, 2013, we funded approximately $48.8 million and $47.0 million, respectively, of our commitment. The carrying amount of our equity investment was $39.7 million and $39.2 million at February 28, 2014 and November 30, 2013, respectively. Our exposure to loss is limited to our equity commitment. The SBI USA Fund has assets consisting primarily of private equity and equity related investments.

We have a variable interest in Jefferies Employees Partners IV, LLC (“JEP IV”) consisting of an equity investment. The carrying amount of our equity investment was $1.6 million and $1.6 million at February 28, 2014 and November 30, 2013, respectively. Our exposure to loss is limited to our equity investment. JEP IV has assets consisting primarily of private equity and equity related investments.

 

Note 11. Investments

We have investments in Jefferies Finance, LLC (“Jefferies Finance”), Jefferies LoanCore LLC (“Jefferies LoanCore”) and KCG Holdings, Inc. (“Knight”). Our investment in Knight is accounted for at fair value by electing the fair value option available under U.S. GAAP and is included in Financial instruments owned, at fair value – Corporate equity securities on the Consolidated Statements of Financial Condition with changes in fair value recognized in Principal transaction revenues on the Consolidated Statements of Earnings. Our investments in Jefferies Finance and Jefferies LoanCore are accounted for under the equity method and are included in Loans to and investments in related parties on the Consolidated Statements of Financial Condition with our share of the investees’ earnings recognized in Other revenues in the Consolidated Statements of Earnings.

Jefferies Finance

On October 7, 2004, we entered into an agreement with Babson Capital Management LLC (“Babson Capital”) and Massachusetts Mutual Life Insurance Company (“MassMutual”) to form Jefferies Finance, a joint venture entity. Jefferies Finance is a commercial finance company whose primary focus is the origination and syndication of senior secured debt to middle market and growth companies in the form of term and revolving loans. Loans are originated

 

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primarily through the investment banking efforts of Jefferies, with Babson Capital providing primary credit analytics and portfolio management services. Jefferies Finance can also originate other debt products such as second lien term, bridge and mezzanine loans, as well as related equity co-investments. Jefferies Finance also purchases syndicated loans in the secondary market, including loans that are performing, stressed and distressed loan obligations.

As of February 28, 2014, we and MassMutual each have equity commitments to Jefferies Finance of $600.0 million for a combined total commitment of $1.2 billion. As of February 28, 2014, we have funded $352.1 million of our $600.0 million commitment, leaving $247.9 million unfunded. The investment commitment is scheduled to expire on March 1, 2016 with automatic one year extensions absent a 60 day termination notice by either party.

Jefferies Finance has executed a Secured Revolving Credit Facility with us and MassMutual, to be funded equally, to support loan underwritings by Jefferies Finance. The Secured Revolving Credit Facility bears interest based on the interest rates of the related Jefferies Finance underwritten loans and is secured by the underlying loans funded by the proceeds of the facility. The total committed Secured Revolving Credit Facility is $700.0 million at February 28, 2014. The facility is scheduled to mature on March 1, 2016 with automatic one year extensions absent a 60 day termination notice by either party. At February 28, 2014 and November 30, 2013, we have funded $175.0 million and $123.8 million, respectively, of our $350.0 million commitment. During the three months ended February 28, 2014 and 2013, $0.5 million and $4.1 million of interest income and $0.7 million and $0.3 million of unfunded commitment fees, respectively, are included in the Consolidated Statements of Earnings related to the Secured Revolving Credit Facility.

The following is a summary of selected financial information for Jefferies Finance as of February 28, 2014 and November 30, 2013 (in millions):

 

     February 28,
2014
     November 30,
2013
 

Total assets

   $ 3,790.5       $ 3,271.9   

Total liabilities

     3,086.4         2,597.0   

Total equity

     704.1         674.9   

Our total equity balance

     352.1         337.3   

The net earnings of Jefferies Finance were $29.2 million and $36.7 million for the three months ended February 28, 2014 and 2013, respectively.

We engage in debt capital markets transactions with Jefferies Finance related to the originations of loans by Jefferies Finance. In connection with such transactions, we earned net underwriting fees of $47.6 million and $39.9 million during the three months ended February 28, 2014 and 2013, respectively, recognized in Investment banking revenues on the Consolidated Statements of Earnings. In addition, we paid fees to Jefferies Finance regarding certain loans originated by Jefferies Finance of $4.3 million and $0.8 million during the three months ended February 28, 2014 and 2013, respectively, which are recognized as Business development expenses on the Consolidated Statements of Earnings. Under a service agreement, we charged Jefferies Finance $21.7 million and $15.7 million for services provided during the three months ended February 28, 2014 and 2013, respectively. Receivables from Jefferies Finance, included within Other assets on the Consolidated Statements of Financial Condition, were $19.0 million and $31.1 million at February 28, 2014 and November 30, 2013, respectively.

Jefferies LoanCore

On February 23, 2011, we entered into a joint venture agreement with the Government of Singapore Investment Corporation and LoanCore, LLC and formed Jefferies LoanCore, a commercial real estate finance company. Jefferies

 

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LoanCore originates and purchases commercial real estate loans throughout the United States with the support of the investment banking and securitization capabilities of Jefferies and the real estate and mortgage investment expertise of the Government of Singapore Investment Corporation and LoanCore, LLC. Jefferies LoanCore has aggregate equity commitments of $600.0 million. As of February 28, 2014 and November 30, 2013, we have funded $129.5 million and $175.5 million, respectively, of our $291.0 million equity commitment and have a 48.5% voting interest in Jefferies LoanCore.

The following is a summary of selected financial information for Jefferies LoanCore as of February 28, 2014 and November 30, 2013 (in millions):

 

     February 28,
2014
     November 30,
2013
 

Total assets

   $ 768.3       $ 974.9   

Total liabilities

     396.2         507.9   

Total equity

     372.1         467.0   

Our total equity balance

     180.5         226.5   

The net earnings of Jefferies LoanCore were $5.0 million and $7.3 million for the three months ended February 28, 2014 and 2013, respectively.

Under a service agreement, we charged Jefferies LoanCore $0.1 million and $0.6 million for the three months ended February 28, 2014 and 2013, respectively. Receivables from Jefferies LoanCore, included within Other assets on the Consolidated Statements of Financial Condition, were $20,000 and $230,000 at February 28, 2014 and November 30, 2013, respectively.

In connection with the securitization of commercial real estate loans originated by Jefferies LoanCore, we earned placement fees of $0.3 million during the three months ended February 28, 2014. In addition, Jefferies LoanCore enters into derivative transactions with us to hedge its loan portfolio.

Knight Capital

On August 6, 2012, we entered into a Securities Purchase Agreement with Knight Capital Group, Inc., a publicly-traded global financial services firm, (“the Agreement”). Under the Agreement, we purchased preferred stock, which contained certain conversion options, in exchange for cash consideration of $125.0 million. On August 29, 2012, we exercised our conversion options and converted our holding of Series A Securities to common stock. On July 1, 2013, Knight Capital Group, Inc. merged with GETCO Holding Company, LLC (the merged company referred to as “KCG Holdings, Inc.”). In connection with the consummation of the merger, we received cash consideration of $3.75 per share, or approximately $192.0 million, with respect to approximately 63% of our holdings in Knight Capital Group, Inc. and stock consideration of one third of a share of KCG Holdings, Inc. common stock for each share of Knight Capital Group Inc. common stock for the remainder of our holdings. As of February 28, 2014, we owned approximately 13% of the outstanding common stock of Knight. During March 2014, we acquired 6.0 million additional shares of Knight, resulting in our ownership of approximately 19.6% of Knight’s outstanding common stock.

We elected to record our investment in Knight at fair value under the fair value option as the investment was acquired as part of our capital markets activities. The valuation of our investment at February 28, 2014 is based on the closing exchange price of Knight’s common stock and included within Level 1 of the fair value hierarchy. Changes in the fair value of our investment of $(1.0) million and $26.5 million for three months ended February 28, 2014 and 2013, respectively, are recognized in Revenues - Principal transactions on the Consolidated Statement of Earnings.

 

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The following is a summary of selected financial information for Knight as of December 31, 2013, the most recently available public financial information for the company (in millions):

 

     December 31,
2013
 

Total assets

   $ 6,991.3   

Total liabilities

     5,484.0   

Total equity

     1,507.3   

Knight’s net income attributable to common shareholders was $141.7 million for the year ended December 31, 2013.

We have separately entered into securities lending transactions with Knight in the normal course of our capital markets activities. At February 28, 2014, the balances of securities borrowed and securities loaned were $12.9 million and $23.6 million, respectively, and at November 30, 2013, $11.0 million and $22.7 million, respectively.

 

Note 12. Goodwill and Other Intangible Assets

In connection with the Leucadia Transaction, goodwill of $1.7 billion was recorded on March 1, 2013. In addition, as of March 1, 2013, certain existing intangible assets and new intangible assets were identified and recorded at their fair values. See Note 4, Leucadia and Related Transactions for further information.

Goodwill

Goodwill resulting from the Leucadia Transaction attributed to our reportable segments are as follows (in thousands):

 

     February 28, 2014      November 30, 2013  

Capital Markets

   $ 1,719,783       $ 1,717,246   

Asset Management

     5,100         5,100   
  

 

 

    

 

 

 

Total goodwill

   $ 1,724,883       $ 1,722,346   
  

 

 

    

 

 

 

The following table is a summary of the changes to goodwill for the three months ended February 28, 2014, nine months ended November 30, 2013, and three months ended February 28, 2013 (in thousands):

 

     Successor           Predecessor  
     Three Months Ended
February 28, 2014
     Nine Months Ended
November 30, 2013
          Three Months Ended
February 28, 2013
 
 

Balance, at beginning of period

   $ 1,722,346       $ 1,720,380           $ 365,670   

Less: Disposal

     —           (5,700 )(1)           —     

Add: Contingent consideration

     —           —               2,394 (2) 

Add: Translation adjustments

     2,537         7,666             (1,287
  

 

 

    

 

 

        

 

 

 
 

Balance, at end of period

   $ 1,724,883       $ 1,722,346           $ 366,777 (3) 
  

 

 

    

 

 

        

 

 

 

 

(1) As a result of a restructuring of our ownership interest in the commodities asset management business, we no longer hold a controlling interest and accordingly do not consolidate this business. In addition, we sold Jefferies International Management Limited to Leucadia. Goodwill associated with these entities was included in the net assets disposed of in the transactions.
(2) Contingent consideration recorded during the three months ended February 28, 2013 relates to the lapse of certain conditions as specified in the purchase agreements associated with an acquisition in 2007.
(3) Predecessor Company goodwill as of February 28, 2013 was reduced to $-0- as of March 1, 2013, as a result of purchase accounting adjustments.

 

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Intangible Assets

The following tables present the gross carrying amount, accumulated amortization, net carrying amount and weighted average amortization period of identifiable intangible assets as of February 28, 2014 and November 30, 2013 (in thousands):

 

     February 28, 2014  
     Gross cost      Accumulated
amortization
    Net carrying
amount
     Weighted
average
remaining
lives (years)
 

Customer relationships

   $ 137,119       $ (19,843   $ 117,276         14.6   

Trade name

     133,469         (3,970     129,499         34.0   

Exchange and clearing organization membership interests and registrations

     14,962         —          14,962         N/A   
  

 

 

    

 

 

   

 

 

    
   $ 285,550       $ (23,813   $ 261,737      
  

 

 

    

 

 

   

 

 

    

 

     November 30, 2013  
     Gross cost      Impairment
losses
    Accumulated
amortization
    Net carrying
amount
     Weighted
average
remaining
lives (years)
 

Customer relationships (1)

   $ 136,740       $ —        $ (17,567   $ 119,173         14.8   

Trade name

     132,967         —          (2,966     130,001         34.3   

Exchange and clearing organization membership interests and registrations (2)

     15,294         (378     —          14,916         N/A   
  

 

 

    

 

 

   

 

 

   

 

 

    
   $ 285,001       $ (378   $ (20,533   $ 264,090      
  

 

 

    

 

 

   

 

 

   

 

 

    

 

(1) The gross cost and accumulated amortization of customer relationships has been reduced by $132,000 and $5,500 respectively, as these customer relationships related to our commodity asset management business, which we restructured in September 2013 and for which we no longer own a controlling financial interest and do not consolidate at November 30, 2013.
(2) The gross cost of exchange and clearing organization membership interests and registrations has been reduced by $255,000 as these registrations relate to asset management businesses which we restructured or sold during the nine months ended November 30, 2013.

We performed our annual impairment testing of intangible assets with an indefinite useful life, which consists of exchange and clearing organization membership interests and registrations, as of August 1, 2013. We elected to perform a quantitative assessment of membership interests and registrations that have available quoted sales prices, and a qualitative assessment of the remainder of our intangible assets. In applying our quantitative assessment, we recognized an impairment loss of $378,000 on certain exchange memberships based on a decline in fair value at August 1, 2013 as observed based on quoted sales prices. With regard to our qualitative assessment of the remaining indefinite-life intangible assets, based on our assessment of market conditions, the utilization of the assets and the replacement costs associated with the assets since the most recent valuation date of March 1, 2013 as part of acquisition accounting, we have concluded that it is not more likely than not that the intangible assets are impaired. Prior to the Leucadia Transaction, our annual impairment testing date was June 1.

For intangible assets with a finite life, aggregate amortization expense amounted to $3.2 million and $0.4 million for the three months ended February 28, 2014 and 2013, respectively, which is included in Other expenses on the Consolidated Statements of Earnings.

 

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Estimated future amortization expense for the next five fiscal years are as follows (in thousands):

 

Period ended

   Estimated future
amortization expense
 

9 months ended November 30, 2014

   $ 9,501   

Year ended November 30, 2015

     12,668   

Year ended November 30, 2016

     12,668   

Year ended November 30, 2017

     12,668   

Year ended November 30, 2018

     12,668   

 

Note 13. Short-Term Borrowings

Bank loans represent short-term borrowings that are payable on demand and generally bear interest at a spread over the federal funds rate. Bank loans are typically overnight loans used to finance financial instruments owned or clearing related balances, but are not part of our systemic funding model. Bank loans at February 28, 2014 and November 30, 2013 were $12.0 million and $12.0 million, respectively. At February 28, 2014, the interest rate on short-term borrowings outstanding is 0.64% per annum. Average daily bank loans outstanding for the three months ended February 28, 2014 and three months ended February 28, 2013 were $12.0 million and $110.0 million, respectively.

 

Note 14. Long-Term Debt

In conjunction with pushdown accounting for the Leucadia Transaction, we recorded our long-term debt at its then current fair value of $6.1 billion, which included $536.5 million of excess of the fair value over the total principal amount of our debt at March 1, 2013, in aggregate. The premium is being amortized to interest expense using the effective yield method over the remaining lives of the underlying debt obligations. See Note 4, Leucadia and Related Transactions for further information.

 

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The following summarizes our long-term debt carrying values (including unamortized discounts and premiums and valuation adjustment, where applicable) at February 28, 2014 and November 30, 2013 (in thousands):

 

     February 28,
2014
     November 30,
2013
 

Unsecured Long-Term Debt

     

5.875% Senior Notes, due June 8, 2014 (effective interest rate of 1.51%)

   $ 252,964       $ 255,676   

3.875% Senior Notes, due November 9, 2015 (effective interest rate of 2.17%)

     514,156         516,204   

5.5% Senior Notes, due March 15, 2016 (effective interest rate of 2.52%)

     370,714         373,178   

5.125% Senior Notes, due April 13, 2018 (effective interest rate of 3.46%)

     851,136         854,011   

8.5% Senior Notes, due July 15, 2019 (effective interest rate of 4.00%)

     852,113         858,425   

6.875% Senior Notes, due April 15, 2021 (effective interest rate of 4.40%)

     863,430         866,801   

2.25% Euro Medium Term Notes, due July 13, 2022 (effective rate of 4.08%)

     4,809         4,792   

5.125% Senior Notes, due January 20, 2023 (effective interest rate of 4.55%)

     625,057         625,626   

6.45% Senior Debentures, due June 8, 2027 (effective interest rate of 5.46%)

     382,806         383,224   

3.875% Convertible Senior Debentures, due November 1, 2029 (effective interest rate of 3.50%) (1)

     357,032         359,281   

6.25% Senior Debentures, due January 15, 2036 (effective interest rate of 6.03%)

     513,271         513,343   

6.50% Senior Notes, due January 20, 2043 (effective interest rate of 6.09%)

     422,176         422,245   
  

 

 

    

 

 

 
   $ 6,009,664       $ 6,032,806   
  

 

 

    

 

 

 

Secured Long-Term Debt

     

Credit facility, due August 26, 2014

     250,000         200,000   
  

 

 

    

 

 

 
   $ 6,259,664       $ 6,232,806   
  

 

 

    

 

 

 

 

(1) As a result of the Leucadia Transaction on March 1, 2013, the value of the 3.875% Convertible Senior debentures at February 28, 2014 and November 30, 2013 includes the fair value of the conversion feature of $7.6 million and $9.6 million, respectively. The change in fair value of the conversion feature is included within Revenues – Principal transactions in the Consolidated Statement of Earnings and amounted to a gain of $2.0 million for the three months ended February 28, 2014.

On January 15, 2013, we issued $1.0 billion in senior unsecured long-term debt, comprising 5.125% Senior Notes, due 2023 and 6.5% Senior Notes, due 2043. The 5.125% Senior Notes were issued with a principal amount of $600.0 million and we received proceeds of $595.6 million. The 6.5% Senior Notes were issued with a principal amount of $400.0 million and we received proceeds of $391.7 million.

Upon completion of the Leucadia Transaction, our 3.875% convertible debentures due 2029 (principal amount of $345.0 million) (the “debentures”) remain issued and outstanding but are now convertible into common shares of Leucadia. Other than the conversion into Leucadia common shares, the terms of the debenture remain the same. As of March 13, 2014, each $1,000 debenture is currently convertible into 22.0242 shares of Leucadia’s common stock (equivalent to a conversion price of approximately $45.40 per share of Leucadia’s common stock). The debentures are convertible at the holders’ option any time beginning on August 1, 2029 and convertible at any time if: 1) Leucadia’s common stock price is greater than or equal to 130% of the conversion price for at least 20 trading days in a period of 30 consecutive trading days; 2) if the trading price per debenture is less than 95% of the price of the common stock times the conversion ratio for any 10 consecutive trading days; 3) if the debentures are called for redemption; or 4) upon the occurrence of specific corporate actions. The debentures may be redeemed for par, plus accrued interest, on or after November 1, 2012 if the price of Leucadia’s common stock is greater than 130% of the conversion price for at least 20 days in a period of 30 consecutive trading days and we may redeem the debentures for par, plus accrued interest, at our election any time on or after November 1, 2017. Holders may require us to repurchase the debentures for par, plus accrued interest, on November 1, 2017, 2019 and 2024. In addition to ordinary interest, commencing November 1, 2017, contingent interest will accrue at 0.375% if the average trading price of a debenture for 5 trading days ending on and including the third trading day immediately preceding a six-month interest period equals or exceed $1,200 per $1,000 debenture. As of March 1, 2013, the conversion option to Leucadia common shares embedded within the debentures meets the definition of a derivative contract, does not qualify to be accounted for within member’s equity and is not clearly and closely related to the economic interest rate or credit risk characteristics of our debt.

 

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(Unaudited)

 

Accordingly, as of March 1, 2013, the conversion option is accounted for on a standalone basis at fair value with changes in fair value recognized in Principal transaction revenues and is presented within Long-term debt on the Consolidated Statement of Financial Condition.

Secured Long-Term Debt - On August 26, 2011, we entered into a committed senior secured revolving credit facility (“Credit Facility”) with a group of commercial banks in U.S. dollars, Euros and Sterling, for an aggregate committed amount of $950.0 million with availability subject to one or more borrowing bases and of which $250.0 million can be borrowed by Jefferies Bache Limited without a borrowing base requirement. The borrowers under the Credit Facility are Jefferies Bache Financial Services, Inc., Jefferies Bache, LLC and Jefferies Bache Limited. The Credit Facility is guaranteed by Jefferies Group LLC and contains certain financial covenants, including, but not limited to, restrictions on future indebtedness of our subsidiaries, requires Jefferies Group LLC and certain of our subsidiaries to maintain specified level of tangible net worth and liquidity amounts and to maintain specified levels of regulated capital interest is based on, in the case of U.S. dollar borrowings, the Federal funds rate or the London Interbank Offered Rate or, in the case of Euro and Sterling borrowings, the Euro Interbank Offered Rate and the London Interbank Offered Rate, respectively. At February 28, 2014 and November 30, 2013, borrowings under the Credit Facility were denominated in U.S. dollar and we were in compliance with debt covenants under the Credit Facility. The Credit Facility terminates on August 26, 2014. We are currently in discussions with the lead bank and facility providers to extend the maturity of the Credit Facility and expect to finalize an amended facility agreement before the August 2014 maturity date.

 

Note 15. Mandatorily Redeemable Convertible Preferred Stock

On March 1, 2013, pursuant to the Leucadia Transaction, the Series A Convertible Cumulative Preferred Stock was exchanged for a comparable series of convertible preferred shares of Leucadia. The assumption by Leucadia of our convertible cumulative preferred stock is considered part of the purchase price and resulted in an increase in member’s equity. See Note 4. Leucadia and Related Transactions for further details.

Prior to the Leucadia Transaction, we had issued and outstanding 125,000 shares of 3.25% Series A Convertible Cumulative Preferred Stock, all of which was held by controlled affiliates of MassMutual. The preferred stock was callable beginning in 2016 at a price of $1,000 per share plus accrued interest and matured in 2036. Dividends paid on the Series A Convertible Cumulative Preferred Stock were recorded as a component of Interest expense as the preferred stock was treated as debt for accounting purposes. For tax purposes, the dividend was not tax-deductible because the Series A Convertible Cumulative Preferred Stock were considered “equity”.

 

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Note 16. Noncontrolling Interests and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries

Noncontrolling Interests

Noncontrolling interests represent equity interests in consolidated subsidiaries, comprised primarily of asset management entities and investment vehicles set up for the benefit of our employees, that are not attributable, either directly or indirectly, to us (i.e., minority interests). The following table presents noncontrolling interests at February 28, 2014 and November 30, 2013 (in thousands):

 

     February 28,
2014
     November 30,
2013
 

Jefferies Structured Alpha Fund B, LLC (1)

   $ —         $ 115,958   

Global Equity Event Opportunity Fund, LLC (2)

     25,140         —     

Other

     5,268         1,196   
  

 

 

    

 

 

 

Noncontrolling interests

   $ 30,408       $ 117,154   
  

 

 

    

 

 

 

 

(1) During the first quarter of 2014, the entity was deconsolidated due to substantive investments in the entity by third parties. No gain or loss was recognized upon deconsolidation. At November 30, 2013, noncontrolling interests include $75.0 million invested by Leucadia.
(2) At February 28, 2014, all noncontrolling interests are attributed to Leucadia.

Noncontrolling ownership interests in consolidated subsidiaries are presented in the accompanying Consolidated Statements of Financial Condition within Equity as a component separate from Member’s equity. Net Earnings in the accompanying Consolidated Statements of Earnings includes earnings attributable to both our equity investor and the noncontrolling interests. There has been no other comprehensive income or loss attributed to noncontrolling interests for the Successor period three months ended February 28, 2014 and Predecessor period three months ended February 28, 2013, because all other comprehensive income or loss is attributed to us.

Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries

Interests in consolidated subsidiaries that meet the definition of mandatorily redeemable financial instruments require liability classification and remeasurement at the estimated amount of cash that would be due and payable to settle such interests under the applicable entity’s organization agreement. On April 1, 2013, mandatorily redeemable financial instruments, representing Leucadia’s member’s equity interests held in Jefferies High Yield Holdings, LLC (“JHYH”), were redeemed and subsequently contributed back to us by Leucadia as additional equity in Jefferies Group LLC.

Prior to redemption, the mandatorily redeemable financial instruments, representing equity interests in JHYH and entitled to a pro rata share of the profits and losses of JHYH, were reported within liabilities as Mandatorily redeemable preferred interests of consolidated subsidiaries on the Consolidated Statement of Financial Condition. Changes to these mandatorily redeemable financial instruments were reflected as Interest on mandatorily redeemable preferred interests of consolidated subsidiaries within Net revenues on our Consolidated Statements of Earnings.

 

Note 17. Benefit Plans

U.S. Pension Plan

We maintain a defined benefit pension plan, Jefferies Group LLC Employees’ Pension Plan (the “U.S. Pension Plan”), which is subject to the provisions of the Employee Retirement Income Security Act of 1974, as amended, and covers certain of our employees. Under the U.S. Pension Plan, benefits to participants are based on years of service and the employee’s career average pay. Effective December 31, 2005, benefits under the U.S. Pension Plan were frozen with no further benefit accruing to participants for future service after December 31, 2005.

German Pension Plan

In connection with the acquisition of Jefferies Bache from Prudential on July 1, 2011, we acquired a defined benefits pension plan located in Germany (the “German Pension Plan”) for the benefit of eligible employees of Jefferies Bache

 

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in that territory. The German Pension Plan has no plan assets and is therefore unfunded. We have purchased insurance contracts from multi-national insurers held in the name of Jefferies Bache Limited to provide for the plan’s future obligations. The investment in these insurance contracts are included in Financial Instruments owned – Investments at fair value in the Consolidated Statements of Financial Condition and has a fair value of $19.7 million and $19.7 million at February 28, 2014 and November 30, 2013, respectively. We expect to pay our pension obligations from the cash flows available to us under the insurance contracts. All costs relating to the plan (including insurance premiums and other costs as computed by the insurers) are paid by us. In connection with the acquisition, it was agreed with Prudential that any insurance premiums and funding obligations related to pre-acquisition date service will be reimbursed to us by Prudential.

The components of net periodic pension (income)/cost for the plans are as follows (in thousands):

 

U.S. Pension Plan    Successor           Predecessor  
     Three Months Ended
February 28, 2014
          Three Months Ended
February 28, 2013
 

Components of net periodic pension (income) cost:

         

Service cost

   $ 56           $ 56   

Interest cost on projected benefit obligation

     607             529   

Expected return on plan assets

     (789          (665

Net amortization

     (36          300   
  

 

 

        

 

 

 
 

Net periodic pension (income)/cost

   $ (162        $ 220   
  

 

 

        

 

 

 

 

German Pension Plan    Successor            Predecessor  
     Three Months Ended
February 28, 2014
           Three Months Ended
February 28, 2013
 

Components of net periodic pension cost:

          

Service cost

   $ 11            $ 16   

Interest cost on projected benefit obligation

     221              220   

Net amortization

     62              45   
  

 

 

         

 

 

 

Net periodic pension cost

   $ 294            $ 281   
  

 

 

         

 

 

 

Employer Contributions – Our funding policy is to contribute to the plans at least the minimum amount required for funding purposes under applicable employee benefit and tax laws. We did not contribute to the U.S. Pension Plan during the three months ended February 28, 2014 and we expect to make $1.0 million in contributions to the plan during the remainder of the 2014 fiscal year. We did not contribute to the German Pension Plan during the three months ended February 28, 2014 and do not expect to make any contributions to the German Pension Plan for the remainder of the fiscal year.

 

Note 18. Compensation Plans

Prior to the Leucadia Transaction, we sponsored the following share-based compensation plans: incentive compensation plan, employee stock purchase plan and the deferred compensation plan. Subsequently, sponsorship of share-based compensation plans was transferred to Leucadia, with outstanding share-based awards relating to Leucadia common shares and future awards to relate to Leucadia common shares. The fair value of share-based awards is estimated on the date of grant based on the market price of the underlying common stock less the impact of selling restrictions subsequent to vesting, if any, and is amortized as compensation expense over the related requisite service periods. We are allocated costs associated with awards granted to our employees under such plans.

In addition, we sponsor non-share-based compensation plans. Non-share-based compensation plans sponsored by us include a profit sharing plan and other forms of restricted cash awards.

 

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The following are descriptions of the compensation plans and the activity of such plans for the three months ended February 28, 2014 and 2013:

Incentive Compensation Plan. The Incentive Compensation Plan (“Incentive Plan”) allows awards in the form of incentive stock options (within the meaning of Section 422 of the Internal Revenue Code), nonqualified stock options, stock appreciation rights, restricted stock, unrestricted stock, performance awards, restricted stock units, dividend equivalents or other share-based awards. Restricted stock units (“RSUs”) give a participant the right to receive fully vested common shares at the end of a specified deferral period allowing a participant to hold an interest tied to common stock on a tax deferred basis. Prior to settlement, RSUs carry no voting or dividend rights associated with the stock ownership, but dividend equivalents are accrued to the extent there are dividends declared on the underlying common shares as cash amounts or as deemed reinvestments in additional RSUs. In connection with the Leucadia Transaction, the Incentive Plan was amended to provide for awards to be issued relating to shares of Leucadia, our parent company as of March 1, 2013. Share-based awards outstanding at March 1, 2013 were converted into awards for shares of Leucadia at the Exchange Ratio, with all such awards subject to the same terms and conditions that previously existed (except for the elimination of fractional shares).

Restricted stock and RSUs may be granted to new employees as “sign-on” awards, to existing employees as “retention” awards and to certain executive officers as awards for multiple years. Sign-on and retention awards are generally subject to annual ratable vesting over a four-year service period and are amortized as compensation expense on a straight line basis over the related four years. Restricted stock and RSUs are granted to certain senior executives with both performance and service conditions. These awards granted to senior executives are amortized over the service period as we have determined that it is probable that the performance condition will be achieved.

The total compensation cost associated with restricted stock and RSUs amounted to $31.9 million and $22.3 million for the three months ended February 28, 2014 and 2013, respectively. Total compensation cost includes the amortization of sign-on, retention and senior executive awards, less forfeitures and clawbacks.

The fair values of outstanding restricted stock and RSUs with future service requirements were remeasured as part of the acquisition accounting, resulting in an increase of approximately $45.1 million to the unrecognized compensation cost allocated to us at March 1, 2013. As of February 28, 2014, we had $150.5 million of total unrecognized compensation cost allocated to us related to nonvested share-based awards, which is expected to be recognized over a remaining weighted average vesting period of approximately 2.5 years.

Employee Stock Purchase Plan. There is also an Employee Stock Purchase Plan (“ESPP”) which we consider noncompensatory effective January 1, 2007. The ESPP permits all regular full-time employees and employees who work part time over 20 hours per week to purchase, at a discount, Leucadia common shares (since the Leucadia Transaction) and permitted purchase of Jefferies Group, Inc. common stock (prior to the Leucadia Transaction). Annual employee contributions are limited to $21,250, are voluntary and made through payroll deduction. The stock purchase price is equal to 95% of the closing price of common stock on the last day of the applicable session (monthly).

Deferred Compensation Plan. There is also a Deferred Compensation Plan, which was established in 2001. Eligible employees are able to defer compensation on a pre-tax basis, with deferred amounts deemed invested at a discount in Leucadia common shares and, prior to the Leucadia Transaction, in Jefferies Group, Inc. common stock (“DCP shares”), or by allocating among any combination of other investment funds available under the Deferred Compensation Plan. In connection with the transaction with Leucadia on March 1, 2013, the Deferred Compensation Plan was amended and deferrals denominated as DCP shares became settleable by delivery of Leucadia common shares. We often invest directly, as a principal, in investments corresponding to the other investment funds, relating to our obligations to perform under the Deferred Compensation Plan. The compensation deferred by our employees is expensed in the period earned. The change in fair value of our investments in assets corresponding to the specified other investment funds are recognized in Principal transactions and changes in the corresponding deferral compensation liability are reflected as Compensation and benefits expense in our Consolidated Statements of Earnings.

 

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Additionally, we recognize compensation cost related to the discount provided to employees in electing to defer compensation in DCP shares. This compensation cost was approximately $38,000 for the Successor period three months ended February 28, 2014 and $72