XNYS:JEF Quarterly Report 10-Q Filing - 2/29/2012

Effective Date 2/29/2012

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 29, 2012

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, INC.

(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, 10th Floor,

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   x   Accelerated filer   ¨    Non-accelerated filer   ¨   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

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 205,917,515 shares as of the close of business on March 21, 2012.

 

 

 

 


Table of Contents

JEFFERIES GROUP, INC.

INDEX TO QUARTERLY REPORT ON FORM 10-Q

February 29, 2012

 

     PART I. FINANCIAL INFORMATION       

Item 1.

   Financial Statements:   
   Consolidated Statements of Financial Condition (Unaudited) - February 29, 2012 and November 30, 2011      2   
   Consolidated Statements of Earnings (Unaudited) - Three Months Ended February 29, 2012 and February 28, 2011      5   
   Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) - Three Months Ended February  29, 2012 and Twelve Months Ended November 30, 2011      6   
   Consolidated Statements of Comprehensive Income (Unaudited) - Three Months Ended February 29, 2012 and February 28, 2011      7   
   Consolidated Statements of Cash Flows (Unaudited) - Three Months Ended February 29, 2012 and February 28, 2011      8   
   Notes to Consolidated Financial Statements (Unaudited)      10   

Item 2.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      64   

Item 3.

   Quantitative and Qualitative Disclosures About Market Risk      104   

Item 4.

   Controls and Procedures      104   
   PART II. OTHER INFORMATION   

Item 1.

   Legal Proceedings      104   

Item 1A.

   Risk Factors      104   

Item 2.

   Unregistered Sales of Equity Securities and Use of Proceeds      104   

Item 6.

   Exhibits      105   

 

1


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Financial Statements

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION (UNAUDITED)

(In thousands)

 

     February 29,
2012
     November 30,
2011
 

ASSETS

     

Cash and cash equivalents

   $ 2,589,193       $ 2,393,797   

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

     3,636,531         3,344,960   

Financial instruments owned, at fair value, including securities pledged of $11,614,619 and $12,452,970 at February 29, 2012 and November 30, 2011, respectively:

     

Corporate equity securities

     1,486,405         1,235,079   

Corporate debt securities

     3,087,846         2,868,304   

Government, federal agency and other sovereign obligations

     5,052,529         7,471,563   

Mortgage- and asset-backed securities

     3,423,647         3,923,303   

Loans and other receivables

     427,134         376,146   

Derivatives

     312,156         525,893   

Investments, at fair value

     105,719         105,585   

Physical commodities

     205,112         172,668   
  

 

 

    

 

 

 

Total financial instruments owned, at fair value

     14,100,548         16,678,541   

Investments in managed funds

     73,015         70,740   

Loans to and investments in related parties

     547,893         594,538   

Securities borrowed

     5,036,447         5,169,689   

Securities purchased under agreements to resell

     4,434,611         2,893,043   

Securities received as collateral

     984         21,862   

Receivables:

     

Brokers, dealers and clearing organizations

     1,720,976         1,235,393   

Customers

     857,654         1,116,982   

Fees, interest and other

     206,864         163,092   

Premises and equipment

     173,446         175,139   

Goodwill

     365,508         365,574   

Other assets

     820,070         748,072   
  

 

 

    

 

 

 

Total assets

   $ 34,563,740       $ 34,971,422   
  

 

 

    

 

 

 

 

Continued on next page.

 

2


Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION — CONTINUED (UNAUDITED)

(In thousands)

 

     February 29,
2012
    November 30,
2011
 

LIABILITIES AND STOCKHOLDERS’ EQUITY

    

Short-term borrowing

   $ 100,000      $ 52,721   

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

    

Corporate equity securities

     1,517,197        1,330,096   

Corporate debt securities

     1,893,280        1,614,493   

Government, federal agency and other sovereign obligations

     4,279,673        3,209,713   

Mortgage- and asset-backed securities

     16,712        50,517   

Loans

     93,606        151,117   

Derivatives

     201,245        249,037   
  

 

 

   

 

 

 

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

     8,001,713        6,604,973   

Securities loaned

     1,829,111        1,706,308   

Securities sold under agreements to repurchase

     8,576,917        9,620,663   

Obligation to return securities received as collateral

     984        21,862   

Payables:

    

Brokers, dealers and clearing organizations

     1,316,673        2,816,877   

Customers

     5,305,110        4,763,364   

Accrued expenses and other liabilities

     609,856        803,219   

Long-term debt

     4,746,077        4,608,926   

Mandatorily redeemable convertible preferred stock

     125,000        125,000   

Mandatorily redeemable preferred interest of consolidated subsidiaries

     332,378        310,534   
  

 

 

   

 

 

 

Total liabilities

     30,943,819        31,434,447   
  

 

 

   

 

 

 

STOCKHOLDERS’ EQUITY

    

Common stock, $.0001 par value. Authorized 500,000,000 shares; issued 209,061,653 shares at February 29, 2012 and 197,197,848 shares at November 30, 2011

     21        20   

Additional paid-in capital

     2,253,641        2,207,410   

Retained earnings

     1,128,120        1,067,858   

Less:

    

Treasury stock, at cost, 3,242,869 shares at February 29, 2012 and 37,842 shares at November 30, 2011

     (49,106     (486

Accumulated other comprehensive loss:

    

Currency translation adjustments

     (34,029     (39,520

Additional minimum pension liability

     (10,970     (10,970
  

 

 

   

 

 

 

Total accumulated other comprehensive loss

     (44,999     (50,490
  

 

 

   

 

 

 

Total common stockholders’ equity

     3,287,677        3,224,312   

Noncontrolling interests

     332,244        312,663   
  

 

 

   

 

 

 

Total stockholders’ equity

     3,619,921        3,536,975   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 34,563,740      $ 34,971,422   
  

 

 

   

 

 

 

 

Continued on next page.

 

3


Table of Contents

JEFFERIES GROUP, INC. 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.

 

CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
     February 29,
2012
     November 30,
2011
 

Assets

     

Cash and cash equivalents

   $ 455,673       $ 345,959   

Financial instruments owned, at fair value

     

Corporate equity securities

     83,009         61,670   

Corporate debt securities

     255,110         326,549   

Mortgage- and asset-backed securities

     39,457         41,004   

Loans and other receivables

     274,679         281,416   

Derivatives

     191         569   

Investments, at fair value

     1,570         1,570   
  

 

 

    

 

 

 

Total financial instruments owned, at fair value

     654,016         712,778   

Receivables:

     

Brokers, dealers and clearing organizations

     82,452         150,592   

Fees, interest and other

     5,849         7,396   

Other assets

     304         385   
  

 

 

    

 

 

 

Total assets

     1,198,294         1,217,110   
  

 

 

    

 

 

 

Liabilities

     

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

     

Corporate equity securities

     7,648         7,122   

Corporate debt securities

     268,184         200,223   

Loans

     76,365         117,958   

Derivatives

     665         935   
  

 

 

    

 

 

 

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

     352,862         326,238   

Payables:

     

Brokers, dealers and clearing organizations

     79,587         105,165   

Accrued expenses and other liabilities

     11,376         9,740   

Mandatorily redeemable preferred interest of consolidated subsidiaries

     332,378         310,534   
  

 

 

    

 

 

 

Total liabilities

   $ 776,203       $ 751,677   
  

 

 

    

 

 

 

 

See accompanying unaudited notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF EARNINGS (UNAUDITED)

(In thousands, except per share amounts)

 

     Three Months Ended  
     February 29,
2012
     February 28,
2011
 

Revenues:

     

Commissions

   $ 117,499       $ 119,921   

Principal transactions

     280,835         290,151   

Investment banking

     285,795         239,059   

Asset management fees and investment income from managed funds

     5,634         23,868   

Interest

     274,708         273,216   

Other

     42,340         20,461   
  

 

 

    

 

 

 

Total revenues

     1,006,811         966,676   

Interest expense

     226,845         208,294   
  

 

 

    

 

 

 

Net revenues

     779,966         758,382   

Interest on mandatorily redeemable preferred interest of consolidated subsidiaries

     21,844         16,438   
  

 

 

    

 

 

 

Net revenues, less mandatorily redeemable preferred interest

     758,122         741,944   
  

 

 

    

 

 

 

Non-interest expenses:

     

Compensation and benefits

     446,462         442,892   

Floor brokerage and clearing fees

     27,838         28,132   

Technology and communications

     61,450         43,675   

Occupancy and equipment rental

     22,565         17,979   

Business development

     22,247         19,938   

Professional services

     13,693         13,276   

Other

     14,998         13,121   
  

 

 

    

 

 

 

Total non-interest expenses

     609,253         579,013   
  

 

 

    

 

 

 

Earnings before income taxes

     148,869         162,931   

Income tax expense

     52,152         60,886   
  

 

 

    

 

 

 

Net earnings

     96,717         102,045   

Net earnings to noncontrolling interests

     19,581         14,704   
  

 

 

    

 

 

 

Net earnings to common shareholders

   $ 77,136       $ 87,341   
  

 

 

    

 

 

 

Earnings per common share:

     

Basic

   $ 0.33       $ 0.42   

Diluted

   $ 0.33       $ 0.42   

Weighted average common shares:

     

Basic

     218,049         199,141   

Diluted

     222,162         203,257   

 

See accompanying unaudited notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (UNAUDITED)

(In thousands, except per share amounts)

 

     Three Months
Ended
February 29,
2012
    Twelve Months
Ended
November 30,
2011
 

Common stock, par value $0.0001 per share

    

Balance, beginning of period

   $ 20      $ 20   

Issued

     1        2   

Retired

            (2
  

 

 

   

 

 

 

Balance, end of period

     21        20   
  

 

 

   

 

 

 

Additional paid-in capital

    

Balance, beginning of period

     2,207,410        2,218,123   

Benefit plan share activity(1)

     1,791        31,176   

Share-based expense, net of forfeitures and claw backs

     23,885        134,076   

Proceeds from exercise of stock options

            95   

Acquisitions and contingent consideration

            419   

Tax benefit for issuance of share-based awards

     19,713        32,200   

Equity component of convertible debt, net of tax

     (427     (217

Dividend equivalents on share-based plans

     1,269        8,883   

Issuance of treasury stock

            97,770   

Retirement of treasury stock

            (315,115
  

 

 

   

 

 

 

Balance, end of period

     2,253,641        2,207,410   
  

 

 

   

 

 

 

Retained earnings

    

Balance, beginning of period

     1,067,858        850,654   

Net earnings to common shareholders

     77,136        284,618   

Dividends

     (16,874     (67,414
  

 

 

   

 

 

 

Balance, end of period

     1,128,120        1,067,858   
  

 

 

   

 

 

 

Treasury stock, at cost

    

Balance, beginning of period

     (486     (539,530

Purchases

     (47,930     (152,827

Returns / forfeitures

     (690     (20,368

Issued

            397,122   

Retirement of treasury stock

            315,117   
  

 

 

   

 

 

 

Balance, end of period

     (49,106     (486
  

 

 

   

 

 

 

Accumulated other comprehensive loss

    

Balance, beginning of period

     (50,490     (51,278

Currency adjustment

     5,491        3,339   

Pension adjustment, net of tax

            (2,551
  

 

 

   

 

 

 

Balance, end of period

     (44,999     (50,490
  

 

 

   

 

 

 

Total common stockholders’ equity

     3,287,677        3,224,312   
  

 

 

   

 

 

 

Noncontrolling interests

    

Balance, beginning of period

     312,663        332,976   

Net earnings to noncontrolling interests

     19,581        1,750   

Contributions

            1,713   

Distributions

            (22,056

Deconsolidation of asset management entity

            (1,720
  

 

 

   

 

 

 

Balance, end of period

     332,244        312,663   
  

 

 

   

 

 

 

Total stockholders’ equity

   $ 3,619,921      $ 3,536,975   
  

 

 

   

 

 

 

 

(1) Includes grants related to the Incentive Plan, Deferred Compensation Plan, and Directors’ Plan.

 

See accompanying unaudited notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

(In thousands)

 

     Three Months
Ended
 
     February 29,
2012
     February 28,
2011
 

Net earnings to common shareholders

   $ 77,136       $ 87,341   
  

 

 

    

 

 

 

Other comprehensive income:

     

Currency translation adjustments

     5,491         14,512   
  

 

 

    

 

 

 

Total other comprehensive income(1)

     5,491         14,512   
  

 

 

    

 

 

 

Comprehensive income

   $ 82,627       $ 101,853   
  

 

 

    

 

 

 

 

(1) Total other comprehensive income, net of tax, is attributable to common shareholders. No other comprehensive income is attributable to noncontrolling interests.

 

See accompanying unaudited notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

(In thousands)

 

     Three Months
Ended
 
     February 29,
2012
    February 28,
2011
 

Cash flows from operating activities:

    

Net earnings

   $ 96,717      $ 102,045   
  

 

 

   

 

 

 

Adjustments to reconcile net earnings to net cash provided by (used in) operating activities:

    

Depreciation and amortization

     17,693        12,841   

Bargain purchase gain

     (3,368       

Gain on repurchase of long-term debt

     (9,898       

Fees related to assigned management agreements

     (739     (740

Interest on mandatorily redeemable preferred interests of consolidated subsidiaries

     21,844        16,438   

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

     24,987        16,230   

Increase in cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations

     (290,223     (157,690

(Increase) decrease in receivables:

    

Brokers, dealers and clearing organizations

     (482,230     (1,110,309

Customers

     260,225        (537,179

Fees, interest and other

     (43,498     (73,977

Decrease in securities borrowed

     135,129        43,413   

Decrease (increase) in financial instruments owned

     2,591,767        (2,198,779

Decrease (increase) in loans to and investments in related parties

     46,441        (167,169

Increase in investments in managed funds

     (2,275     (5,142

Increase in securities purchased under agreements to resell

     (1,537,111     (130,021

Increase in other assets

     (76,800     (195,096

(Decrease) increase in payables:

    

Brokers, dealers and clearing organizations

     (1,501,144     1,179,043   

Customers

     538,234        546,704   

Increase (decrease) in securities loaned

     120,968        (101,186

Increase in financial instruments sold, not yet purchased

     1,387,536        834,651   

(Decrease) increase in securities sold under agreements to repurchase

     (1,047,485     1,232,264   

Decrease in accrued expenses and other liabilities

     (199,438     (306,560
  

 

 

   

 

 

 

Net cash provided by (used in) operating activities

     47,332        (1,000,219
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Net payments on premises and equipment

     (11,642     (14,104

Cash received from contingent consideration

     741        748   
  

 

 

   

 

 

 

Net cash used in investing activities

     (10,901     (13,356
  

 

 

   

 

 

 

 

Continued on next page.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS — CONTINUED (UNAUDITED)

(In thousands)

 

     Three Months
Ended
 
     February 29,
2012
    February 28,
2011
 

Cash flows from financing activities:

    

Excess tax benefits from the issuance of share-based awards

   $ 29,316      $ 33,763   

Proceeds from short-term borrowings

     109,513        907,000   

Payments on short-term borrowings

     (67,007     (907,000

Proceeds from secured credit facility

     160,000          

Payments on secured credit facility

     (10,000       

Payments on repurchase of long-term debt

     (1,435       

Payments on mandatorily redeemable preferred interest of consolidated subsidiaries

            (65

Payments on repurchase of common stock

     (47,930     (37,761

Payments on dividends

     (15,605     (13,395

Net proceeds from noncontrolling interest

            928   
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     156,852        (16,530
  

 

 

   

 

 

 

Effect of foreign currency translation on cash and cash equivalents

     2,113        5,440   
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     195,396        (1,024,665

Cash and cash equivalents at beginning of period

     2,393,797        2,188,998   
  

 

 

   

 

 

 

Cash and cash equivalents at end of period

   $ 2,589,193      $ 1,164,333   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid (received) during the period for:

    

Interest

   $ 214,800      $ 195,739   

Income taxes, net of refunds

     (1,785     55,263   

 

See accompanying unaudited notes to consolidated financial statements.

 

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Table of Contents

JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Index

 

Note

       Page  

Note 1.

 

Organization and Basis of Presentation

     11   

Note 2.

 

Summary of Significant Accounting Policies

     12   

Note 3.

 

Acquisitions

     18   

Note 4.

 

Cash, Cash Equivalents and Short-Term Investments

     20   

Note 5.

 

Financial Instruments

     20   

Note 6.

 

Derivative Financial Instruments

     32   

Note 7.

 

Collateralized Transactions

     36   

Note 8.

 

Securitization Activities

     37   

Note 9.

 

Variable Interest Entities

     38   

Note 10.

 

Equity Method Investments

     43   

Note 11.

 

Goodwill and Other Intangible Assets

     45   

Note 12.

 

Short-Term Borrowings

     48   

Note 13.

 

Long-Term Debt

     48   

Note 14.

 

Mandatorily Redeemable Convertible Preferred Stock

     49   

Note 15.

 

Noncontrolling Interest and Mandatorily Redeemable Preferred Interests of Consolidated Subsidiaries

     50   

Note 16.

 

Benefit Plans

     50   

Note 17.

 

Compensation Plans

     51   

Note 18.

 

Earnings per Share

     55   

Note 19.

 

Income Taxes

     57   

Note 20.

 

Commitments, Contingencies and Guarantees

     57   

Note 21.

 

Net Capital Requirements

     60   

Note 22.

 

Segment Reporting

     61   

Note 23.

 

Related Party Transactions

     62   

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

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Note 1. Organization and Basis of Presentation

Organization

The accompanying unaudited Consolidated Financial Statements include the accounts of Jefferies Group, Inc. and all our subsidiaries (together, “we” or “us”), including Jefferies & Company, Inc. (“Jefferies”), Jefferies Execution Services, Inc., (“Jefferies Execution”), Jefferies Bache, LLC, Jefferies International Limited, Jefferies Bache, Limited, Jefferies Hong Kong Limited, Jefferies Asset Management, LLC, Jefferies Bache Financial Services, Inc. and all other entities in which we have a controlling financial interest or are the primary beneficiary, including Jefferies High Yield Holdings, LLC (“JHYH”), Jefferies Special Opportunities Partners, LLC (“JSOP”) and Jefferies Employees Special Opportunities Partners, LLC (“JESOP”).

We operate in two business segments, Capital Markets and Asset Management. Capital Markets includes our securities, commodities, futures and foreign exchange trading (including the results of our indirectly partially owned subsidiary, Jefferies High Yield Trading, LLC) and investment banking activities, which provides the research, sales, trading and origination 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.

On February 1, 2012, we acquired the corporate broking business of Hoare Govett from The Royal Bank of Scotland Group plc (“RBS”). Total cash consideration paid by us to RBS for the acquisition was £1. In addition, RBS agreed to pay us under the terms of the purchase agreement a portion of any retention payments made to certain employees, up to a maximum amount of approximately £1.9 million, which constitutes a reduction of the final purchase price. The business acquired represents the corporate broking business carried on under the name RBS Hoare Govett in the United Kingdom and comprises corporate broking advice and services. On July 1, 2011, we acquired Prudential Bache’s Global Commodities Group (“Global Commodities Group” or “Jefferies Bache”) from Prudential Financial Inc. (“Prudential”). The Global Commodities Group provides execution and clearing services (including sales and trading activities) covering a wide variety of commodity, financial and foreign exchange futures, swaps and forward contracts to an institutional client base. See Note 3, Acquisitions for further details.

Basis of Presentation

The accompanying unaudited Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by U.S. GAAP for complete financial statements and should be read in conjunction with our Annual Report on Form 10-K for the year ended November 30, 2011.

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 the realizability of deferred tax assets. Although these and other estimates and assumptions are based on the best available information, actual results could be materially different from these estimates.

Consolidation

Our policy is to consolidate all entities in which we own more than 50% of the outstanding voting stock and have control. 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. In situations where we have significant influence but not control of an entity that does not qualify as a variable interest entity, we apply the equity method of accounting or fair value accounting. We also have formed

 

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nonconsolidated investment vehicles with third-party investors that are typically organized as partnerships or limited liability companies. 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.

 

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. Soft dollar expenses amounted to $8.2 million and $10.5 million for the three months ended February 29, 2012 and February 28, 2011, respectively. We account for the cost of these arrangements on an accrual basis. As we are not the primary obligor for these arrangements, expenses relating to soft dollars are netted against commission revenues. 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, securities pledged 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.

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. Out-of-pocket expenses are recorded net of client reimbursements. Revenues are presented net of related out-of-pocket unreimbursed expenses. Unreimbursed out-of-pocket 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 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 in Principal transactions in the Consolidated Statements of Earnings and are not recognized as a component of interest revenue or expense. We account for our short-term, long-term borrowings and our mandatorily redeemable convertible preferred stock on an accrual basis with related interest recorded as Interest expense. In addition, we recognize interest revenue related to our securities borrowed and securities purchased under agreements to resell

 

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activities and interest expense related to our securities loaned and securities sold under agreements to repurchase activities on an accrual basis.

Cash Equivalents

Cash equivalents include highly liquid investments, including 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.

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.

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

 

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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.

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. 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. Accordingly, the degree of judgment exercised in determining fair value is greatest for instruments categorized in Level 3.

We use prices and inputs that are current as of the measurement date. 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.

Valuation Process for Financial Instruments

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, we allow for mid-market pricing and adjust to the point within the bid-ask range that meets our best estimate of fair value. For offsetting positions in the same financial instrument, the same price within the bid-ask spread is used to measure both the long and short positions.

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 process for financial instruments may include the use of valuation models and other techniques. Adjustments to valuations (such as counterparty, credit, concentration or liquidity) derived from valuation models may be made when, in management’s judgment, either the size of the position in the financial instrument in a nonactive market or other features of the financial instrument such as its complexity, or the market in which the financial instrument is traded require that an adjustment be made to the value derived from the models. An adjustment may be made if a financial instrument is subject to sales restrictions that would result in a price less than the quoted market price. 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 and are adjusted for assumptions about risk uncertainties and market conditions. Results from valuation models and valuation techniques in one period may not be indicative of future period fair value measurements.

See Note 5, Financial Instruments, for a description of valuation techniques applied to the classes of financial instruments at fair value.

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. Gains or losses on our investments in managed funds are included in Asset management fees and investment income from managed funds in the Consolidated Statements of Earnings.

 

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Loans to and Investments in Related Parties

Loans to and investments in related parties includes investments entered into where we exercise significant influence over operating and capital decisions in private equity and other operating entities in connection with our capital market activities 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 income in the Consolidated Statements of Earnings. See Note 10, Equity Method Investments, 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 repurchase amount. We earn and incur interest from this activity which is reflected in our Consolidated Statements of Earnings. 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. We carry repos on a net basis by counterparty when 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.

Goodwill and Intangible Assets

Goodwill.    At least annually, and more frequently if warranted, we assess whether goodwill has been impaired by comparing the estimated fair value of each reporting unit with its 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

 

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value, further analysis is necessary to determine the amount of impairment, if any. In estimating the fair value of reporting units we utilize methodologies that include market capitalization, price-to-book multiples of comparable exchange traded companies and multiples of merger and acquisitions of similar businesses. Periodically estimating the fair value of a reporting unit requires significant judgment and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Our annual goodwill impairment testing date is June 1. Refer to Note 11, Goodwill and Other Intangible Assets, for further details on our assessment of goodwill.

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 annually, or more frequently when certain events or circumstances exist, for impairment. Impairment exists when the carrying amount exceeds its fair value. 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. Subsequent reversal of impairment losses is not permitted.

Income Taxes

We file a consolidated U.S. federal income tax return, which includes all of our qualifying subsidiaries. We also are subject to income tax in various states and municipalities and those foreign jurisdictions in which we operate. Amounts provided for income taxes are based on income reported for financial statement purposes and do not necessarily represent amounts currently payable. 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 carry-forwards. 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 on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. Deferred income taxes are provided for temporary differences in reporting certain items, principally, share-based compensation, deferred compensation, unrealized gains and losses on investments and tax amortization of intangible assets. 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.

The tax benefit related to dividends and dividend equivalents paid on nonvested share based payment awards and outstanding equity options is 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 Stockholders’ Equity.

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 when the amount of loss can be reasonably estimated. When a range of probable loss can be estimated, we accrue the most likely amount of such loss, and if such amount is not determinable, then we accrue the minimum of the range of probable loss. The determination of the outcome and loss estimates requires significant judgment on the part of management.

 

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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.

Earnings per Common Share

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. Common shares outstanding and certain other shares committed to be, but not yet issued, include restricted stock and restricted stock units for which no future service is required. 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. We grant restricted stock and restricted stock units as part of our share-based compensation that contain nonforfeitable rights to dividends and dividend equivalents, respectively, and therefore, prior to the requisite service being rendered for the right to retain the award, restricted stock and restricted stock units meet the definition of a participating security. As such, we calculate Basic and Diluted earnings per share under the two-class method.

Securitization Activities

We engage in securitization activities related to 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, that transfer is treated as a secured borrowing. We continue to recognize the assets of a secured borrowing in Financial instruments owned and recognize the associated financing in Other liabilities in the Consolidated Statements of Financial Condition.

Accounting Developments

Balance Sheet Offsetting Disclosures.    In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”), Disclosures about Offsetting Assets and Liabilities (“ASU 2011-11”)

 

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to Topic 210, Balance Sheet. The update requires new disclosures regarding balance sheet offsetting and related arrangements. For derivatives and financial assets and liabilities, the amendments 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 balance sheet. The guidance is effective for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods, and is to be applied retrospectively. This guidance does not amend the existing guidance on when it is appropriate to offset; as a result, this guidance will not affect our financial condition, results of operation or cash flows.

Goodwill Testing.    In September 2011, the FASB issued ASU, Testing Goodwill for Impairment (“ASU 2011-08”) to Topic 350, Intangibles — Goodwill and Other. The update outlines amendments to the two step goodwill impairment test permitting an entity to first assess qualitative factors in determining whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step quantitative goodwill impairment test. The update is effective for annual and interim goodwill tests performed for fiscal years beginning after December 15, 2011, with early adoption permitted. The adoption of this guidance will not affect our financial condition, results of operation or cash flows.

Fair Value Measurements and Disclosures.    In May 2011, the FASB issued accounting updates to ASC 820, Fair Value Measurements Topic — Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS, which provide clarifying guidance on how to measure fair value and additional disclosure requirements. The amendments prohibit the use of blockage factors at all levels of the fair value hierarchy and provide guidance on measuring financial instruments that are managed on a net portfolio basis. Additional disclosure requirements include transfers between Levels 1 and 2; and for Level 3 fair value measurements, a description of our valuation processes and additional information about unobservable inputs impacting Level 3 measurements. The updates are effective March 1, 2012 and will be applied prospectively. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

Reconsideration of Effective Control for Repurchase Agreements.    In April 2011, the FASB issued accounting guidance that removes the requirement to consider whether sufficient collateral is held when determining whether to account for repurchase agreements and other agreements that both entitle and obligate the transferor to repurchase or redeem financial assets before their maturity as sales or as secured financings. The guidance is effective prospectively for transactions beginning on January 1, 2012. The adoption of this guidance did not have an impact on our financial condition, results of operations or cash flows.

 

Note 3. Acquisitions

Global Commodities Group

On July 1, 2011, we acquired Prudential Bache’s Global Commodities Group from Prudential. Total cash payments made as consideration for the acquisition were $422.0 million. The acquisition included 100% of the equity interests in Prudential Bache Commodities LLC, a US-based full-service futures commission merchant; Prudential Bache Securities LLC, a US-based registered broker dealer, which has since merged with Jefferies; Bache Commodities Limited, a UK-based global commodities and financial derivatives broker; Prudential Bache Asset Management, Inc., a US-based registered investment advisor and commodity trading advisor, Prudential Bache Financial Services, Inc., a global over-the-counter commodities dealer; and Bache Commodities (Hong Kong) Ltd., a Hong Kong-based licensed futures dealer. In addition, we acquired related information technology assets and contracts used by the Global Commodities Group.

We accounted for the acquisition under the acquisition method of accounting. Accordingly, the assets acquired, including identifiable intangible assets, and liabilities assumed were recorded at their respective fair values as of the date of acquisition.

 

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The fair values of the net assets acquired, including identifiable intangible assets, was approximately $474.5 million, which exceeded the purchase price of $422.0 million, resulting in a bargain purchase gain of approximately $52.5 million recognized in July 2011. The business of the Global Commodities Group is included within the Capital Markets business segment.

For further information on the acquisition of the Global Commodities Group see Note 3, Acquisition of the Global Commodities Group to the consolidated financial statements for the year ended November 30, 2011 included in our Annual Report on Form 10-K.

Hoare Govett

On February 1, 2012, we acquired the corporate broking business carried under the name of Hoare Govett from RBS. Total cash consideration paid by us to RBS for the acquisition was £1. In addition, RBS agreed to pay us under the terms of the purchase agreement a portion of any retention payments made to certain employees, up to a maximum amount of approximately £1.9 million, which constitutes a reduction of the final purchase price. The business acquired represents the corporate broking business carried on under the name RBS Hoare Govett in the United Kingdom and comprises corporate broking advice and services. The acquisition included the Hoare Govett trade name, domain name, client agreements and exclusive right to carry on the business in succession to RBS. The acquisition of Hoare Govett provides us with the opportunity to continue our growth in corporate broking and significantly expand the capabilities and reach of our established European Investment Banking and Equities businesses.

We accounted for the acquisition under the acquisition method of accounting. Accordingly, the assets acquired, including identifiable intangible assets, and liabilities assumed were recorded at their respective fair values as of the date of acquisition. The fair values of the net assets acquired, including identifiable intangible assets, was approximately $0.3 million, which exceeded the negative purchase price of $3.1 million (cash consideration paid of £1 less remittance from RBS of £1.9 million), resulting in a bargain purchase gain of approximately $3.4 million. The bargain purchase gain is included within Other Revenues in the Consolidated Statement of Earnings and is presented within the Capital Market’s business segment. Approximately $0.4 million was recognized at the date of acquisition as the fair value of the Hoare Govett trade name. See Note 11, Goodwill and Other Intangible Assets for further details. The fair value of the intangible asset will be amortized on a straight line basis over a useful life of 5 years. Additionally, we recognized a deferred tax liability of approximately $0.1 million, recorded within Accrued expenses and other liabilities on the Consolidated Statement of Financial Condition.

Our results of operations for the three months ended February 29, 2012 include the results of operations of Hoare Govett for the period from February 1, 2012 to February 29, 2012. There were no material revenues contributed by Hoare Govett for the three months ended February 29, 2012 and net earnings amounted to an immaterial loss, primarily as a result of compensation costs. The effect on our results for the quarters ended February 29, 2012 and February 28, 2011, had the acquisition Hoare Govett been completed on December 1, 2010 is not considered material. The acquisition closed on February 29, 2012.

 

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Note 4. Cash, Cash Equivalents and Short-Term Investments

We generally invest our excess cash in money market funds and in 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 29, 2012 and November 30, 2011 (in thousands):

 

 

     February 29,
2012
     November 30,
2011
 

Cash and cash equivalents:

     

Cash in banks

   $ 636,452       $ 846,990   

Money market investments

     1,952,741         1,546,807   
  

 

 

    

 

 

 

Total cash and cash equivalents

   $ 2,589,193       $ 2,393,797   
  

 

 

    

 

 

 

Cash and securities segregated(1)

   $ 3,636,531       $ 3,344,960   
  

 

 

    

 

 

 

 

(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.

 

Note 5. Financial Instruments

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 29, 2012 and November 30, 2011 by level within the fair value hierarchy (in thousands):

 

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     As of February 29, 2012  
     Level 1(1)      Level 2(1)      Level 3     Counterparty
and Cash
Collateral
Netting(2)
    Total  

Assets:

            

Financial instruments owned:

            

Corporate equity securities

   $ 1,353,650       $ 102,486       $ 30,269      $      $ 1,486,405   

Corporate debt securities

             3,054,240         33,606               3,087,846   

Collateralized debt obligations

             92,437         72,576               165,013   

U.S. government and federal agency securities

     1,733,090         149,347                       1,882,437   

Municipal securities

             550,652         1,176               551,828   

Sovereign obligations

     1,722,093         896,031         140               2,618,264   

Residential mortgage-backed securities

             2,773,880         128,751               2,902,631   

Commercial mortgage-backed securities

             309,009         35,792               344,801   

Other asset-backed securities

             5,813         5,389               11,202   

Loans and other receivables

             322,685         104,449               427,134   

Derivatives

     421,790         1,603,348         120        (1,713,102     312,156   

Investments at fair value

             27,609         78,110               105,719   

Physical commodities

             205,112                       205,112   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total financial instruments owned

   $ 5,230,623       $ 10,092,649       $ 490,378      $ (1,713,102   $ 14,100,548   
  

 

 

    

 

 

      

 

 

   

 

 

 

Level 3 financial instruments for which the firm does not bear economic exposure(4)

         $ (55,510    
        

 

 

     

Level 3 financial instruments for which the firm bears economic exposure

         $ 434,868       
        

 

 

     

Investments in managed funds

   $       $       $ 73,015      $      $ 73,015   

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

   $ 189,783       $       $      $      $ 189,783   

Securities received as collateral

   $ 984       $       $      $      $ 984   
        

 

 

     

Total Level 3 assets for which the firm bears economic exposure

         $ 507,883       
        

 

 

     

Liabilities:

            

Financial instruments sold, not yet purchased:

            

Corporate equity securities

   $ 1,485,750       $ 19,936       $ 11,511      $      $ 1,517,197   

Corporate debt securities

             1,893,206         74          1,893,280   

U.S. government and federal agency securities

     1,971,525                               1,971,525   

Sovereign obligations

     1,429,098         879,050                       2,308,148   

Residential mortgage-backed securities

             16,540                       16,540   

Commercial mortgage-backed securities

             172                       172   

Loans

             93,606                       93,606   

Derivatives

     384,282         1,622,580         8,430        (1,814,047     201,245   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

   $ 5,270,655       $ 4,525,090       $ 20,015      $ (1,814,047   $ 8,001,713   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Obligation to return securities received as collateral

   $ 984       $       $      $      $ 984   

 

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(1) There were no significant transfers between Level 1 and Level 2 for the three months ended February 29, 2012.

 

(2) Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

 

(3) Consists of U.S. government securities segregated for regulatory purposes and measured at fair value.

 

(4) Consists of Level 3 assets attributable to third party or employee noncontrolling interests in certain consolidated entities.

 

 

     As of November 30, 2011  
     Level 1(1)      Level 2(1)      Level 3     Counterparty
and Cash
Collateral
Netting(2)
    Total  

Assets:

            

Financial instruments owned:

            

Corporate equity securities

   $ 1,088,358       $ 133,232       $ 13,489      $      $ 1,235,079   

Corporate debt securities

     1,521         2,818,643         48,140               2,868,304   

Collateralized debt obligations

             102,209         47,988               150,197   

U.S. government and federal agency securities

     5,443,721         266,460                       5,710,181   

Municipal securities

             582,497         6,904               589,401   

Sovereign obligations

     737,082         434,759         140               1,171,981   

Residential mortgage-backed securities

             2,961,682         149,965               3,111,647   

Commercial mortgage-backed securities

             582,974         52,407               635,381   

Other asset-backed securities

             22,794         3,284               26,078   

Loans and other receivables

             278,855         97,291               376,146   

Derivatives

     632,148         2,344,625         124        (2,451,004     525,893   

Investments at fair value

             27,259         78,326               105,585   

Physical commodities

             172,668                       172,668   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total financial instruments owned

   $ 7,902,830       $ 10,728,657       $ 498,058      $ (2,451,004   $ 16,678,541   
  

 

 

    

 

 

      

 

 

   

 

 

 

Level 3 financial instruments for which the firm does not bear economic exposure(4)

         $ (45,901    
        

 

 

     

Level 3 financial instruments for which the firm bears economic exposure

         $ 452,157       
        

 

 

     

Investments in managed funds

   $       $       $ 70,740      $      $ 70,740   

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

   $ 115,000       $       $      $      $ 115,000   

Securities received as collateral

   $ 21,862       $       $      $      $ 21,862   
        

 

 

     

Total Level 3 assets for which the firm bears economic exposure

         $ 522,897       
        

 

 

     

Liabilities:

            

Financial instruments sold, not yet purchased:

            

Corporate equity securities

   $ 1,266,096       $ 64,000       $      $      $ 1,330,096   

Corporate debt securities

             1,614,419         74               1,614,493   

U.S. government and federal agency securities

     2,032,091         9,685                       2,041,776   

Municipal securities

             90                       90   

Sovereign obligations

     790,568         377,279                       1,167,847   

Residential mortgage-backed securities

             50,517                       50,517   

Loans

             140,960         10,157               151,117   

Derivatives

     535,503         2,289,759         9,409        (2,585,634     249,037   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total financial instruments sold, not yet purchased

   $ 4,624,258       $ 4,546,709       $ 19,640      $ (2,585,634   $ 6,604,973   
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Obligation to return securities received as collateral

   $ 21,862       $       $      $      $ 21,862   

 

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(1) There were no significant transfers between Level 1 and Level 2 for the twelve-months ended November 30, 2011.

 

(2) Represents counterparty and cash collateral netting across the levels of the fair value hierarchy for positions with the same counterparty.

 

(3) Consists of U.S. government securities segregated for regulatory purposes and measured at fair value.

 

(4) Consists of Level 3 assets attributable to third party or employee noncontrolling interests in certain consolidated entities.

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 exchange prices, which are generally obtained from pricing services, and are categorized within Level 1 of the fair value hierarchy.

 

   

Non-exchange Traded Equity Securities:     Non-exchange traded equity securities are measured primarily using broker quotations, pricing service data from external providers 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 financial instruments 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 service data from external providers and broker quotations, where available, prices observed for recently executed market transactions of comparable size, 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 service data from external providers, 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.

 

   

Auction Rate Securities:     Auction rate securities (“ARS”) included within corporate debt securities include ARS backed by pools of student loans and auction rate preferred securities issued by closed end mutual funds. ARS are measured using market data provided by external service providers, as available. The fair value of ARS is also determined by benchmarking to independent market data and adjusting for projected cash flows, level of seniority in the capital structure, leverage, liquidity and credit rating, as appropriate. ARS are categorized within Level 3 of the fair value hierarchy based on our assessment of the transparency of the external market data received.

 

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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 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 data providers and are generally categorized within Level 2 of the fair value hierarchy.

Sovereign Obligations

 

   

G-7 Government and Non-G-7 Government Bonds:     G-7 government and non-G-7 government bonds are measured based on quoted market prices obtained from external pricing services. G-7 government bonds are categorized within Level 1 of the fair value hierarchy and non-G-7 government bonds are generally categorized within Level 2 of the fair value hierarchy.

 

   

Emerging Market Sovereign Debt Securities:     Valuations are primarily based on market price quotations from external data providers, where available, or recently executed independent transactions of comparable size. To the extent market price quotations are not available or recent transactions have not been observed, valuation techniques incorporating foreign currency curves, interest rate yield curves and country spreads for bonds of similar issuers, seniority and maturity are used to determine fair value. Emerging market sovereign debt securities are generally categorized within Level 2 of the fair value hierarchy.

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, interest-only and principal-only securities and to-be-announced securities and are generally measured using market price quotations from external data providers 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 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 of the fair value hierarchy. We also use vendor data in developing 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 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.

 

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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.

Commercial Mortgage-Backed Securities

 

   

Agency Commercial Mortgage-Backed Securities:     GNMA project loan bonds and FNMA 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 third party 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 third party 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 from external data providers where sufficient observability exists as to the extent of market transaction data supporting the pricing 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. The market implied spread 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 measured based on quoted exchange prices, which are generally obtained from pricing services, 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 and are categorized within Level 2 of the fair value hierarchy.

 

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OTC Derivative Contracts:     OTC derivative contracts are generally valued using models, whose inputs reflect assumptions that we believe market participants would use in valuing the derivative in a current period transaction. Inputs to valuation models are appropriately calibrated to market data. For many OTC derivative contracts, the valuation models do not involve material subjectivity as the methodologies do not entail significant judgment and the inputs to valuation models do not involve a high degree of subjectivity as the valuation model inputs are readily observable or can be derived from actively quoted markets. OTC derivative contracts are primarily categorized within Level 2 of the fair value hierarchy given the observability of the inputs to the valuation models.

OTC options include OTC equity, foreign exchange and commodity options measured using Black-Scholes models 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 defaults 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 third parties.

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.

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 based on the net asset value of the funds provided by the fund managers and 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 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 3 of the fair value hierarchy. Additionally, investments at fair value include investments in insurance contracts relating to our German defined benefits pension plan and shares in non-US exchanges and clearing houses. Fair value for the insurance contracts is determined using a third party and are categorized within Level 3 of the fair value hierarchy. Fair value for the shares in non-US exchanges and clearing houses is determined based on recent transactions or third party model valuations and are categorized within Level 2 or Level 3 of the fair value hierarchy. The following tables provide further information about our investments in entities that have the characteristics of an investment company at February 29, 2012 and November 30, 2011 (in thousands):

 

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     February 29, 2012
     Fair Value
(7)
     Unfunded
Commitments
     Redemption
Frequency (if
currently eligible)

Equity Long/Short Hedge Funds(1)

   $ 28,009       $       Monthly,
Quarterly

High Yield Hedge Funds(2)

     898              

Fund of Funds(3)

     772         126      

Equity Funds(4)

     88,903         65,386      

Convertible Bond Funds(5)

     2,985               At Will

Other Investments(6)

     20               Bi-Monthly
  

 

 

    

 

 

    

Total(8)

   $ 121,586       $ 65,512      
  

 

 

    

 

 

    

 

     November 30, 2011
     Fair Value
(7)
     Unfunded
Commitments
     Redemption
Frequency (if
currently eligible)

Equity Long/Short Hedge Funds(1)

   $ 27,604       $       Monthly,
Quarterly

High Yield Hedge Funds(2)

     938              

Fund of Funds(3)

     772         126      

Equity Funds(4)

     88,294         74,283      

Convertible Bond Funds(5)

     2,827               At Will

Other Investments(6)

     19               Bi-Monthly
  

 

 

    

 

 

    

Total(8)

   $ 120,454       $ 74,409      
  

 

 

    

 

 

    

 

(1) This category includes investments in hedge funds that invest in both long and short equity securities in domestic and international markets in both public and private sectors. At February 29, 2012 and November 30, 2011, investments representing approximately 98%, of the fair value in this category are redeemable with 30 — 65 days prior written notice. At February 29, 2012 and November 30, 2011, investments representing approximately 2%, of fair value 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. At February 29, 2012 and November 30, 2011, an investment representing less than 1% of fair value has no redemption provisions; distributions are received through the liquidation of the underlying assets of the fund which is estimated to be within one to two years.

 

(2) This category 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. At February 29, 2012 and November 30, 2011, these investments are currently in liquidation and we are unable to estimate when the underlying assets will be fully liquidated.

 

(3) This category includes investments in fund of funds that invest in various private equity funds. At February 29, 2012 and November 30, 2011, approximately 99% and 95%, respectively, of the fair value of investments in this category is managed by us and has no redemption provisions. Distributions are received through the liquidation of the underlying assets of the fund of funds, which are estimated to be liquidated in one to two years. At February 29, 2012 and at November 30, 2011, we requested redemption for investments representing approximately 1% and 5% of fair value, respectively, however we are unable to estimate when these funds will be returned.

 

(4) At February 29, 2012 and November 30, 2011, investments representing approximately 96%, include investments in equity funds that invest in the equity of various private companies in the energy, technology, internet service and telecommunication service industries including acquired or restructured companies. At February 29, 2012 and November 30, 2011, a fund that invests in Croatian companies represents approximately 4% of the total investment in equity funds. These investments cannot be redeemed; distributions are received through the liquidation of the underlying assets of the funds and are expected to liquidate in one to eight years.

 

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(5) This category includes an investment in an open-ended investment company that invests primarily in convertible bonds. This investment is redeemable with 5 days prior written notice.

 

(6) Other investments at February 29, 2012 and November 30, 2011 included investments in funds that invest in commodities futures and options contracts.

 

(7) Fair value has been estimated using the net asset value derived from each of the funds’ capital statements.

 

(8) Investments at fair value in the Consolidated Statements of Financial Condition at February 29, 2012 and November 30, 2011 include $57.1 million and $55.9 million, respectively, of direct investments which are not investment companies and therefore are not part of this disclosure table.

At February 29, 2012 and November 30, 2011, our Financial instruments owned and Financial instruments sold, not yet purchased are measured using different valuation basis as follows:

 

 

     February 29, 2012     November 30, 2011  
     Financial
Instruments
Owned
    Financial
Instruments Sold,

Not Yet
Purchased
    Financial
Instruments
Owned
    Financial
Instruments Sold,

Not Yet
Purchased
 

Exchange closing prices

     7     14     7     19

Recently observed transaction prices

     4     2     2     1

Data providers/pricing services

     78     81     77     75

Broker quotes

     1     0     1     0

Valuation techniques

     10     3     13     5
  

 

 

   

 

 

   

 

 

   

 

 

 
     100     100     100     100
  

 

 

   

 

 

   

 

 

   

 

 

 

Pricing information obtained from external data providers 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 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 formalized process whereby we challenge the appropriateness of pricing information obtained from data providers and pricing services in order to validate the data for consistency with the definition of a fair value exit price. Our process includes understanding and evaluating the service providers’ valuation methodologies. For corporate, U.S. government and agency, and municipal debt securities (excluding auction rate securities), and loans, to the extent pricing services or broker quotes are utilized in our valuation process, the vendor services 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.

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 29, 2012 (in thousands):

 

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     Three Months Ended February 29, 2012(3)  
     Balance,
November 30,
2011
     Total gains/
losses (realized
and unrealized)
(1)
    Purchases     Sales     Settlements     Net
transfers
into/

(out of)
Level 3
    Balance,
February 29,
2012
     Change in
unrealized gains/
(losses) relating to
instruments

still held at
February 29,

2012
(1)
 

Assets:

                  

Financial instruments owned:

                  

Corporate equity securities

   $ 13,489       $ 1,684      $ 14,184      $      $      $ 912      $ 30,269       $ 1,685   

Corporate debt securities

     48,140         671        271        (22,300     (1,276     8,100        33,606         (737

Collateralized debt obligations

     47,988         (796            (14,063     (3,328     42,775        72,576         (1,488

Municipal securities

     6,904         (71            (740            (4,917     1,176         12   

Sovereign obligations

     140                                            140           

Residential mortgage-backed
securities

     149,965         (6,492     10,497        (44,282     (6,881     25,944        128,751         (5,995

Commercial mortgage-backed
securities

     52,407         (1,655            (3,593     (44     (11,323     35,792         (1,419

Other asset-backed securities

     3,284         (104            (197     (40     2,446        5,389         (76

Loans and other receivables

     97,291         1,899        48,309        (21,733     (25,729     4,412        104,449         643   

Investments, at fair value

     78,326         1,378        480        (1,797     (277            78,110         1,378   

Investments in managed funds

     70,740         (6,212     8,499        (12                   73,015         (6,212

Liabilities:

                  

Financial instruments sold,
not yet purchased:

                  

Corporate equity
securities

   $       $      $      $ 11,511      $      $      $ 11,511       $   

Corporate debt securities

     74                                            74           

Net derivatives(2)

     9,285         1,512        (295                   (2,192     8,310         2,736   

Loans

     10,157                (10,157                                    

 

(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 29, 2012.

Analysis of Level 3 Assets and Liabilities for the Three Months Ended February 29, 2012

During the three months ended February 29, 2012, transfers of assets of $109.9 million from Level 2 to Level 3 are attributed to:

 

   

Collateralized debt obligations of $42.8 million which have little to no transparency in trade activity;

 

   

Non-agency residential mortgage-backed securities of $32.5 million, Other asset-backed securities of $4.7 million, and Commercial mortgage-backed securities of $1.5 million for which no recent trade activity was observed for purposes of determining observable inputs;

 

   

Loans and other receivables of $18.4 million due to a lower number of contributors comprising vendor quotes to support classification within Level 2 as less market interest likely existed for the specific loans during the period; and

 

   

Corporate debt securities of $8.6 million, Corporate equity securities of $0.9 million, and Municipal securities of $0.5 million due to lack of observable market transactions.

During the three months ended February 29, 2012, transfers of assets of $41.5 million from Level 3 to Level 2 are attributed to:

 

   

Loans and other receivables of $13.9 million due to a greater number of contributors for certain vendor quotes supporting classification into Level 2 as greater market interest likely existed for the specific loans during the period;

 

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Commercial mortgage-backed securities of $12.8 million, Non-agency residential mortgage-backed securities of $6.6 million, and $2.3 million of Other asset-backed securities for which market trades were observed in the period for either identical or similar securities or for which vendor prices were corroborated to actual market transactions; and

 

   

Municipal securities of $5.4 million and Corporate debt securities of $0.5 million due to increased observability of trades in certain bonds.

During the three months ended February 29, 2012 there were no transfers of liabilities from Level 2 to Level 3 and there were $2.2 million transfers of net derivative liabilities from Level 3 to Level 2 due to available broker quotes for the significant inputs used in valuing the derivative contracts.

Net losses on Level 3 assets were $9.7 million and net losses on Level 3 liabilities were $1.5 million for the three months ended February 29, 2012. Net losses on Level 3 assets were primarily due to decreased valuations of certain residential mortgage-backed securities and investments in managed funds. Net losses on Level 3 liabilities were primarily due to decreased valuations of certain derivative instruments.

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, 2011 (in thousands):

 

 

     Three Months Ended February 28, 2011  
     Balance,
November 30,
2010
     Total gains/
losses (realized
and unrealized)

(1)
    Purchases,
sales,
settlements,
and
issuances
    Transfers
into

Level 3
     Transfers
out of

Level 3
    Balance,
February 28,
2011
     Change in
unrealized gains/
(losses) relating to
instruments

still held at
February 28,
2011
(1)
 

Assets:

                 

Financial instruments owned:

                 

Corporate equity securities

   $ 22,619       $ 5,167      $ 6,772      $       $ (1,277   $ 33,281       $ 4,581   

Corporate debt securities

     73,408         2,283        (293     106         (520     74,984         816   

Collateralized debt obligations

     31,121         10,310        60,299        1,216                102,946         10,087   

Municipal securities

     472         19        308                       799         19   

Residential mortgage-backed securities

     132,359         16,205        (64,301     12,886         (40     97,109         (2,745

Commercial mortgage-backed securities

     6,004         222        2,804                (2,729     6,301         (824

Other asset-backed securities

     567         (215     617        11,050         (567     11,452         (469

Loans and other receivables

     227,596         5,974        (17,025     1,574         (368     217,751         3,021   

Investments at fair value

     77,784         108        (7,010             (3,048     67,834         626   

Investments in managed funds

     131,585         8,726        (3,584                    136,727         8,350   

Liabilities:

                 

Financial instruments sold, not yet purchased:

                 

Corporate equity securities

   $ 38       $      $      $       $        38       $   

Net derivatives(2)

     2,346         2,611                              4,957         2,611   

Loans

     47,228                (29,452                    17,776           

 

(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.

 

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Analysis of Level 3 Assets and Liabilities for the Three Months Ended February 28, 2011

During the three months ended February 28, 2011, transfers of assets of $26.8 million from Level 2 to Level 3 are primarily attributed to:

 

   

Non-agency residential mortgage-backed securities and other asset-backed securities for which no recent trade activity was observed for purposes of determining observable inputs.

During the three months ended February 28, 2011, transfers of assets of $8.5 million from Level 3 to Level 2 are primarily attributed to:

 

   

Commercial mortgage-backed securities, for which market trades were observed in the period for either identical or similar securities; and

 

   

Corporate equity securities, for which market transactions were announced or market data on comparable securities used as a benchmark became more observable.

During the three months ended February 28, 2011 there were no transfers of liabilities from Level 2 to Level 3 or from Level 3 to Level 2.

Net gains on Level 3 assets were $48.8 million and net losses on Level 3 liabilities were $2.6 million for the three months ended February 28, 2011. Net gains on Level 3 assets were primarily due to increased valuations of various collateralized debt obligations, loans and other receivables and corporate equity securities and sales of certain residential mortgage-backed securities.

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.

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. Such affiliate loans are entered into as part of ongoing, strategic business ventures, are included within Loans to and investments in related parties and accounted for on an amortized cost basis. We also have elected the fair value option for certain investments held by subsidiaries that are not registered broker-dealers. Investments at fair value are included in Financial instruments owned. The fair value option was elected for investments held by subsidiaries that are not registered broker-dealers because they are risk managed by us on a fair value basis. We have also elected the fair value option for secured financings that arise in connection with our securitization activities. Cash and cash equivalents, the cash component of Cash and securities segregated and on deposit for regulatory purposes or deposited with clearing and depository organizations, Receivables — Brokers,

 

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dealers and clearing 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 and (losses) due to changes in instrument specific credit risk for loans and other receivables and loan commitments measured at fair value under the fair value option (in thousands):

 

 

     Three Months Ended
February 29, 2012
 

Financial Instruments Owned:

  

Loans and other receivables

   $ 7,811   

Financial Instruments Sold:

  

Loans

   $ 226   

Loan commitments

   $ (654

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):

 

 

     February 29,
2012
     November 30,
2011
 

Financial Instruments Owned:

     

Loans and other receivables(2)

   $ 256,906       $ 277,336   

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

   $       $ 2,253   

 

(1) The aggregate fair value of loans that were 90 or more days past due was $0.8 million and $5.5 million at February 29, 2012 and November 30, 2011.

 

(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 loans or other receivables on nonaccrual status at February 29, 2012 and November 30, 2011.

 

Note 6. 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 legal right to offset 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

 

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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 5, Financial Instruments and Note 20, 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. In addition, we may be exposed to legal risks related to derivative activities. 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 master netting agreements and collateral arrangements with counterparties. These agreements provide us with the ability to offset a counterparty’s rights and obligations, request additional collateral when necessary or liquidate the collateral in the event of counterparty default.

The following table presents the fair value and related number of derivative contracts at February 29, 2012 and November 30, 2011 categorized by predominant risk exposure. The fair value of assets/liabilities related to derivative contracts represents our receivable/payable for derivative financial instruments, gross of counterparty netting and cash collateral received and pledged (in thousands, except contract amounts):

 

 

     February 29, 2012  
     Assets      Liabilities  
     Fair Value     Number of
Contracts
     Fair Value     Number of
Contracts
 

Interest rate contracts

   $ 661,432        70,211       $ 761,325        91,670   

Foreign exchange contracts

     568,890        95,875         509,077        103,197   

Equity contracts

     430,378        2,290,852         375,577        1,532,515   

Commodity contracts

     343,201        398,344         346,624        403,997   

Credit contracts

     21,357        41         22,689        39   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

     2,025,258        2,855,323         2,015,292        2,131,418   
    

 

 

      

 

 

 

Counterparty/cash-collateral netting

     (1,713,102        (1,814,047  
  

 

 

      

 

 

   

Total per Consolidated Statement of Financial Condition

   $ 312,156         $ 201,245     
  

 

 

      

 

 

   

 

     November 30, 2011  
     Assets      Liabilities  
     Fair Value     Number of
Contracts
     Fair Value     Number of
Contracts
 

Interest rate contracts

   $ 542,221        63,751       $ 636,692        66,027   

Foreign exchange contracts

     1,009,765        102,578         1,015,900        119,780   

Equity contracts

     638,228        2,364,390         548,195        2,119,165   

Commodity contracts

     725,927        434,428         598,166        421,330   

Credit contracts

     60,756        59         35,718        39   
  

 

 

   

 

 

    

 

 

   

 

 

 

Total

     2,976,897        2,965,206         2,834,671        2,726,341   
    

 

 

      

 

 

 

Counterparty/cash-collateral netting

     (2,451,004        (2,585,634  
  

 

 

      

 

 

   

Total per Consolidated Statement of Financial Condition

   $ 525,893         $ 249,037     
  

 

 

      

 

 

   

The following table presents unrealized and realized gains and (losses) on derivative contracts for the three months ended February 29, 2012 and February 28, 2011 (in thousands):

 

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     Three Months Ended  
     February 29, 2012
Gains (Losses)
    February 28, 2011
Gains (Losses)
 

Interest rate contracts

   $ (16,235   $ 6,808   

Foreign exchange contracts

     1,161        (5,025

Equity contracts

     (30,112     (60,917

Commodity contracts

     20,680        20,531   

Credit contracts

     (15,227     (2,441
  

 

 

   

 

 

 

Total

   $ (39,733   $ (41,044
  

 

 

   

 

 

 

The following tables set forth the remaining contract maturity of the fair value of OTC derivative assets and liabilities as of February 29, 2012 (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

   $ 66,715       $ 3,098       $       $ (524   $ 69,289   

Credit default swaps

             9,300         7,155         (386     16,069   

Equity swaps and options

     1,357                                1,357   

Total return swaps

     473                 152                625   

Foreign currency forwards, swaps and options

     168,188         34,270                 (480     201,978   

Fixed income forwards

     2,261                                2,261   

Interest rate swaps and options

     14,838         31,688         127,825         (44,217     130,134   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 253,832       $ 78,356       $ 135,132       $ (45,607     421,713   
  

 

 

    

 

 

    

 

 

    

 

 

   

Cross product counterparty netting

                (18,033
             

 

 

 

Total OTC derivative assets included in Financial instruments owned

              $ 403,680   
             

 

 

 

 

(1) At February 29, 2012, we held exchange traded derivative assets and other credit enhancements of $69.0 million.

 

(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 29, 2012, cash collateral received was $160.5 million.

 

(3) Amounts represent the netting of receivable balances with payable balances within product category for the same counterparty 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

   $ 63,984       $ 5,630       $       $ (524   $ 69,090   

Equity swaps and options

     307         7,372                        7,679   

Credit default swaps

     386         5,627         9,502         (386     15,129   

Total return swaps

     571                                571   

Foreign currency forwards, swaps and options

     114,715         27,934                 (480     142,169   

Interest rate swaps and options

     29,164         95,693         155,837         (44,217     236,477   
  

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 209,127       $ 142,256       $ 165,339       $ (45,607     471,115   
  

 

 

    

 

 

    

 

 

    

 

 

   

Cross product counterparty netting

                (18,033
             

 

 

 

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

              $ 453,082   
             

 

 

 

 

(1) At February 29, 2012, we held exchange traded derivative liabilities and other credit enhancements of $9.5 million.

 

(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 29, 2012, cash collateral pledged was $261.4 million.

 

(3) Amounts represent the netting of receivable balances with payable balances within product category for the same counterparty across maturity categories.

 

(4) Derivative fair values include counterparty netting within product category.

At February 29, 2012, 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

   $ 253,270  

BBB- to BBB+

     54,596  

BB+ or lower

     89,835  

Unrated

     5,979  
  

 

 

 

Total

   $ 403,680  
  

 

 

 

 

(1) We utilize the credit ratings of external rating agencies when available. When external credit ratings are not available, we may utilize internal credit ratings determined by our credit risk management. Credit ratings determined by credit 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 29, 2012 and November 30, 2011, is $111.9 million and $141.2 million, respectively, for which we have posted collateral of $82.0 million and $129.8 million, respectively, in the normal course of business. If the credit-risk-related contingent features underlying these agreements were triggered on February 29, 2012 and November 30, 2011, we would have been required to post an additional $35.3 million and $19.5 million, respectively, of collateral to our counterparties.

 

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Note 7. 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 manage our exposure to credit risk associated with these transactions by entering into master netting agreements. We also monitor the fair value of the securities loaned and borrowed on a daily basis and request additional collateral or return of 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 provision allowing the counterparty the right to sell or repledge the collateral. Pledged securities 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. 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 or derivative transactions or cover short positions. At February 29, 2012 and November 30, 2011, the approximate fair value of securities received as collateral by us that may be sold or repledged was approximately $18.6 billion and $17.9 billion, respectively. The fair value of securities received as collateral at February 29, 2012 and November 30, 2011, pertains to our securities financing activities presented on our Consolidated Statements of Financial Condition at February 29, 2012 and November 30, 2011 as follows (in thousands):

 

 

     February 29, 2012      November 30, 2011  

Carrying amount:

     

Securities purchased under agreements to resell

   $ 4,434,611      $ 2,893,043  

Securities borrowed

     5,036,447        5,169,689  

Securities received as collateral

     984        21,862  
  

 

 

    

 

 

 

Total assets on Consolidated Statement of Financial Condition

     9,472,042        8,084,594  

Netting of securities purchased under agreements to resell(1)

     8,129,978        7,498,439  
  

 

 

    

 

 

 
     17,602,020        15,583,033  

Fair value of collateral received in excess of contract amount(2)

     971,817         2,386,921  
  

 

 

    

 

 

 

Fair value of securities received as collateral

   $ 18,573,837       $ 17,969,954  
  

 

 

    

 

 

 

 

(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 collateral received from customers for margin balances unrelated to arrangements for securities purchased under agreements to resell or securities borrowed.

At February 29, 2012 and November 30, 2011, a substantial portion of the securities received by us had been sold or repledged.

We also receive securities as collateral in connection with derivative transactions and in connection with certain securities for securities transactions in which we are the lender of securities. In instances where we 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 29, 2012 and November 30, 2011, $1.0 million and $21.9 million, respectively, were reported as Securities received as collateral and as Obligation to return securities received as collateral.

Additionally, we engage in securities for securities transactions in which we are the borrower of securities and provide other securities as collateral rather than cash. As no cash is provided under these types of transactions, we, as

 

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borrower, treat these as noncash transactions and do not recognize assets or liabilities on the Consolidated Statements of Financial Condition. The securities pledged as collateral under these transactions are included within the total amount of Financial instruments owned and noted as Securities pledged on our Consolidated Statements of Financial Condition.

 

Note 8. Securitization Activities

We engage in securitization activities related to 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 issued to investors by the SPE. A significant portion of our securitization transactions are securitization of assets issued or guaranteed by U.S. government agencies. Our securitization vehicles generally meet the criteria of variable interest entities; however we generally do not consolidate our securitization vehicles as we are not considered the primary beneficiary for these vehicles. See Note 9, Variable Interest Entities for further discussion on variable interest entities and our determination of the primary beneficiary.

We account for our securitization transactions as sales provided we have relinquished control over the transferred assets. 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 liabilities. Transferred assets are carried at fair value with unrealized gains and losses reflected in Principal transactions revenues prior to securitization. Net underwriting revenues are recognized in connection with the securitization activities.

We generally receive cash proceeds in connection with the transfer of assets as the security interests issued by the securitization vehicles are sold to investors. 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 and retaining servicing rights for military housing loan securitizations, which are included within Other assets. We apply fair value accounting to the securities. The servicing rights are amortized over the period of the estimated net servicing income.

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

 

 

     Three Months Ended  
     February 29, 2012      February 28, 2011  

Transferred assets

   $ 2,036.8       $ 2,141.7   

Proceeds on new securitizations

   $ 2,046.9       $ 2,153.3   

Net revenues

   $ 8.0       $ 8.3   

Cash flows received on retained interests

   $ 15.8       $ 19.4   

Assets received as proceeds in the form of mortgage-backed-securities issued by the securitization vehicles 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 5, Financial Instruments. We have no explicit or implicit arrangements to provide additional financial support to these securitization vehicles and have no liabilities related to these securitization vehicles at February 29, 2012 and November 30, 2011. Although not obligated, we may make a market in the securities issued by these securitization vehicles in connection with secondary market-making activities. In these market-making transactions, we buy these securities from and sell these securities to investors. Securities subsequently purchased through these market-making activities are not considered to be continuing involvement in these vehicles, although the securities are included in Financial instruments owned — Mortgage- and asset-backed securities.

 

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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 29, 2012  

Securitization Type

   Total Assets      Retained
Interests
 

U.S. government agency residential mortgage-backed securities

   $ 7,455.3       $ 156.1 (1) 

U.S. government agency commercial mortgage-backed securities

     1,962.6         27.8 (1) 

Military housing loans

     68.0         0.2 (2) 

 

(1) A portion of these securities have been subsequently sold in secondary-market transactions to third parties. As of March 23, 2012, we continue to hold approximately $99.8 million and $27.3 million of these Residential mortgage-backed securities and Commercial mortgage-backed securities, respectively, in inventory.

 

(2) Initial fair value of servicing rights received on transferred project loans.

 

     As of November 30, 2011  

Securitization Type

   Total Assets      Retained
Interests
 

U.S. government agency residential mortgage-backed securities

   $ 7,968.0       $ 517.9 (1) 

U.S. government agency commercial mortgage-backed securities

     2,574.3         49.9 (1) 

Military housing loans

     127.4         0.3 (2) 

 

(1) A significant portion of these securities have been subsequently sold in secondary-market transactions to third parties. As of March 23, 2012, we continue to hold approximately $87.8 million and $27.3 million of these Residential mortgage-backed securities and Commercial mortgage-backed securities, respectively, in inventory.

 

(2) Initial fair value of servicing rights received on transferred project loans.

We do not have any derivative contracts executed in connection with these securitization activities. Total assets represent the unpaid principal amount of assets in the securitization vehicles in which we have continued involvement and are presented solely to provide information regarding the size of the securitization and the size of the underlying assets supporting our retained interests, and are not considered representative of the risk of potential loss associated with the securitizations.

Assets retained in connection with securitization represent the fair value of the securities of one or more tranches of the securitization, including senior and subordinated tranches. Our risk of loss to these securitization vehicles 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 9. 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 initially determine whether we are the primary beneficiary of a VIE upon our initial involvement with the VIE. 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

 

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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.

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 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,

 

   

Servicing of military housing mortgage loans held by VIEs,

 

   

Ownership of debt, equity and partnership interests in Jefferies High Yield Holdings, LLC and related entities,

 

   

Management and performance fees in the Jefferies Umbrella Fund, and

 

   

Loans to and investments in investment fund vehicles.

We have not executed any derivative contracts with VIEs and have not provided any liquidity facilities to VIEs, other than Jefferies Employees Partners IV, LLC, as discussed below.

Consolidated VIEs

The following tables present 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 29, 2012 and November 30, 2011. 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.

 

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(in millions)

   February 29, 2012      November 30, 2011  
     High Yield      Mortgage- and
Asset-backed
Securitizations
     Other      High Yield      Mortgage- and
Asset-backed
Securitizations
     Other  

Cash

   $ 455.4       $       $ 0.3       $ 345.7       $       $ 0.3   

Financial instruments owned

     635.4         12.0         6.6         693.3         12.2         7.2   

Securities borrowed

     290.3                         195.3                   

Receivable from brokers and dealers

     82.5                         150.6                   

Other

     6.8                         8.5                   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,470.4       $ 12.0       $ 6.9       $ 1,393.4       $ 12.2       $ 7.5   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Financial instruments sold, not yet purchased

   $ 352.9       $       $       $ 326.2       $       $   

Payable to brokers and dealers

     79.6                         105.2                   

Mandatorily redeemable interests(1)

     1,016.2                         943.4                   

Promissory note(2)

                     4.2                         4.2   

Secured financing(3)

             12.0                         12.2           

Other

     23.8                 0.2         20.7                 0.2   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $ 1,472.5       $ 12.0       $ 4.4       $ 1,395.5       $ 12.2       $ 4.4   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) After consolidation, which eliminates our interests and the interests of our consolidated subsidiaries, JSOP and JESOP, the carrying amount of the mandatorily redeemable financial interests pertaining to the above VIEs included within Mandatorily redeemable preferred interests of consolidated subsidiaries was approximately $332.4 million and $310.5 million at February 29, 2012 and November 30, 2011, respectively. These amounts represent the portion of the mandatorily redeemable preferred interests held by our joint venture partner.

 

(2) The promissory note represents an amount due to us and is eliminated in consolidation.

 

(3) Secured financing is included within Accrued expenses and other liabilities. Approximately $9.2 million and $8.4 million of the secured financing represents an amount held by us in inventory and are eliminated in consolidation at February 29, 2012 and November 30, 2011, respectively.

High Yield.    We conduct our high yield secondary market trading activities through Jefferies High Yield Trading, LLC (“JHYT”), Jefferies High Yield Finance, LLC (“JHYF”), and Jefferies Leveraged Credit Products, LLC (“JLCP”). JHYT is a registered broker-dealer engaged in the secondary sales and trading of high yield and special situation securities, including bank debt, post-reorganization equity, public and private equity, equity derivatives and other financial instruments. JHYT makes markets in high yield and distressed securities and provides research coverage on these types of securities. JHYF is engaged in the trading of total return swaps. JLCP is engaged in the trading of bank debt, credit default swaps and trade claims. JHYT, JHYF and JLCP are wholly owned subsidiaries of JHYH.

We own voting and non-voting interests in JHYH and have entered into management, clearing, and other services agreements with JHYH. We and Leucadia National Corporation (“Leucadia”), a significant holder of our common stock, each have the right to nominate two of a total of four directors to JHYH’s board of directors. Two funds managed by us, JSOP and JESOP, are also investors in JHYH. The arrangement term is through April 2013, with an option to extend. We have determined that JHYH, JSOP and JESOP meet the definition of a variable interest entity. We are the primary beneficiary of JHYH, JSOP and JESOP and accordingly consolidate JHYH (and the assets, liabilities and results of operations of its wholly owned subsidiaries JHYT, JHYF and JLCP), JSOP and JESOP.

At February 29, 2012 and November 30, 2011, the carrying amount of our variable interests was $352.8 million and $322.0 million, respectively, which consist of our debt, equity and partnership interests in JHYH, JSOP and JESOP, which are eliminated in consolidation. In addition, the secondary market trading activity conducted through JHYT,

 

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JHYF and JLCP is a significant component of our overall brokerage platform, and while not contractually obligated, could require us to provide additional financial support and/ or expose us to further losses of JHYH, JSOP and JESOP. The assets of these VIEs are available for the benefit of the mandatorily redeemable interest holders and equity holders. The creditors of these VIEs do not have recourse to our general credit.

There have been no changes in our conclusion to consolidate JHYH, JSOP and JESOP since formation.

Mortgage and asset-backed securitizations.    We are the primary beneficiary of a mortgage-backed securitization vehicle to which we transferred a project loan and retained servicing rights over the loan as well as retained a portion of the securities issued by the securitization vehicle. Our variable interests in this vehicle consist of the securities and a contractual servicing fee. The asset of this VIE consists of a project loan, which is available for the benefit of the vehicles’ beneficial interest holders. The creditors of this VIE 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 or clients. We manage and invest alongside our employees or clients in these vehicles. The assets of these VIEs consist of private equity and debt securities, and are available for the benefit of the entities’ debt and equity holders. Our variable interests in these vehicles consist of equity securities and promissory notes. 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. Other than Jefferies Employees Partners IV, LLC, as discussed below, we have not provided financial or other support to these VIEs during the three months ended February 29, 2012 and the year ended November 30, 2011 and we have no explicit or implicit arrangements to provide additional financial support to these VIEs and have no liabilities related to these VIEs at February 29, 2012 and November 30, 2011.

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 29, 2012  
     Variable Interests        

(in millions)

   Financial Statement
Carrying Amount
    Maximum
exposure to loss
    VIE Assets  

Collateralized loan obligations

   $ 48.4 (2)    $ 48.4 (4)    $ 1,753.2   

Agency mortgage- and asset-backed securitizations(1)

     1,413.5 (2)      1,413.5 (4)      7,483.1   

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

     466.5 (2)      466.5 (4)      51,082.5   

Asset management vehicle

     3.0 (3)      3.0 (4)      895.8   

Private equity vehicles

     66.7 (3)      125.3        98.0   
  

 

 

   

 

 

   

 

 

 

Total

   $ 1,998.1      $ 2,056.7      $ 61,312.6   
  

 

 

   

 

 

   

 

 

 

 

(1) VIE assets represent the unpaid principal balance of the assets in these vehicles at February 29, 2012 and represent the underlying assets that provide the cash flows supporting our variable interests.

 

(2) Consists of debt securities accounted for at fair value, which are included within Financial instruments owned.

 

(3) Consists of equity interests and loans, which are included within Investments in managed funds and Loans to and investments in related parties.

 

(4) 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, 2011  
     Variable Interests        

(in millions)

   Financial Statement
Carrying  Amount
    Maximum
exposure to  loss
    VIE Assets  

Collateralized loan obligations

   $ 48.2 (2)    $ 48.2 (4)    $ 1,768.4   

Agency mortgage- and asset-backed securitizations(1)

     1,410.9 (2)      1,410.9 (4)      6,523.0   

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

     583.9 (2)      583.9 (4)      41,939.4   

Asset management vehicle

     2.8 (3)      2.8 (4)      903.9   

Private equity vehicles

     64.5 (3)      131.3        84.2   
  

 

 

   

 

 

   

 

 

 

Total

   $ 2,110.3      $ 2,177.1      $ 51,218.9   
  

 

 

   

 

 

   

 

 

 

 

(1) VIE assets represent the unpaid principal balance of the assets in these vehicles at November 30, 2011 and represent the underlying assets that provide the cash flows supporting our variable interests.

 

(2) Consists of debt securities accounted for at fair value, which are included within Financial instruments owned.

 

(3) Consists of equity interests and loans, which are classified within Investments in managed funds and Loans to and investments in related parties.

 

(4) 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.

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 Financial instruments owned on our Consolidated Statements of Financial Condition. In addition to the agency mortgage- and asset backed securities of $1,413.5 million and non-agency mortgage- and asset-backed securities of $466.5 million at February 29, 2012 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 29, 2012 consist of the following (in millions):

 

 

     Nonagency      Agency      Total  

Variable interests in collateralized loan obligations

   $ 48.4       $       $ 48.4   

Variable interests in agency mortgage- and asset backed securitizations

             1,413.5         1,413.5   

Variable interests in nonagency mortgage- and asset backed securitizations

     466.5                 466.5   

Additional securities in connection with trading and market making activities:

        

Residential mortgage-backed securities

     89.4         1,132.1         1,221.5   

Commercial mortgage-backed securities

     28.7         231.5         260.2   

Collateralized debt obligations

     4.4                 4.4   

Other asset-backed securities

     9.1                 9.1   
  

 

 

    

 

 

    

 

 

 

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

   $ 646.5       $ 2,777.1       $ 3,423.6   
  

 

 

    

 

 

    

 

 

 

Collateralized Loan Obligations.    We own variable interests in collateralized loan obligations (“CLOs”) previously managed by us. These CLOs have assets consisting primarily of senior secured loans, unsecured loans and high yield bonds. Our variable interests in the CLOs consist of debt securities and a right to a portion of the CLOs’ management and incentive fees. The carrying amount of the debt securities was $14.0 million and $14.1 million at February 29, 2012 and November 30, 2011, respectively. Management and incentives fees are accrued as the amounts become realizable. Our exposure to loss in these CLOs is limited to our investments in the debt securities.

 

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In addition, we have variable interests in Babson Loan Opportunity CLO, Ltd., a third party managed CLO. This VIE has assets consisting primarily of senior secured loans, unsecured loans and high yield bonds. Our variable interests in this VIE consists of debt securities. The fair value of our interests in this VIE consist of a direct interest and an indirect interest via Jefferies Finance, LLC. Our exposure to loss is limited to our investments in the debt securities.

Asset Management Vehicle.    We manage the Jefferies Umbrella Fund, an “umbrella structure” company that enables investors to choose between one or more investment objectives by investing in one or more sub-funds within the same structure. The assets of the Jefferies Umbrella Fund primarily consist of convertible bonds. 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 29, 2012 and November 30, 2011 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 “USA Fund”). As of February 29, 2012 and November 30, 2011, we funded approximately $25.2 million and $17.9 million, respectively, of our commitment. The carrying amount of our equity investment was $18.8 million and $17.4 million at February 29, 2012 and November 30, 2011, respectively. Our exposure to loss is limited to our equity commitment. The USA Fund has assets consisting primarily of private equity and equity related investments.

We have variable interests in Jefferies Employees Partners IV, LLC (“JEP IV”) consisting of an equity investment and a loan commitment. The carrying amount of our equity investment was $2.8 million at February 29, 2012 and November 30, 2011. During the fourth quarter of 2010, we repaid outstanding debt of JEP IV on its behalf and committed to make loans to JEP IV up to an aggregate principal amount of $54.0 million. As of February 29, 2012 and November 30, 2011, we funded approximately $45.2 million and $44.3 million, respectively, of the aggregate principal balance, which is included in Loans to and investments in related parties. Our exposure to loss is limited to our equity investment and the aggregate amount of our loan commitment. JEP IV has assets consisting primarily of private equity and equity related investments.

 

Note 10. Equity Method Investments

Investments accounted for under the equity method are included in Loans to and investments in related parties in the Consolidated Statements of Financial Condition. Equity method gains and losses are included in Other income in the Consolidated Statements of Earnings. Our significant investments accounted for under the equity method are Jefferies Finance, LLC and Jefferies LoanCore LLC.

Jefferies Finance, LLC

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, LLC (“JFIN”), a joint venture entity created for the purpose of offering senior loans to middle market and growth companies. JFIN is a commercial finance company whose primary focus is the origination and syndication of senior secured debt in the form of term and revolving loans. Loans are originated primarily through the investment banking efforts of Jefferies, with Babson Capital providing primary credit analytics and portfolio management services. JFIN can also originate other debt products such as second lien term, bridge and mezzanine loans, as well as related equity co-investments. JFIN also purchases syndicated loans in the secondary market, including loans that are performing, stressed and distressed loan obligations.

On March 1, 2011, we and MassMutual increased our equity commitments to JFIN, with an incremental $250 million committed by each partner. Including the incremental $250 million from each partner, the total committed equity

 

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capital of JFIN is $1.0 billion. As of February 29, 2012, we have funded $107.5 million of our aggregate $500.0 million commitment, leaving $392.5 million unfunded.

In addition, on March 1, 2011, we and MassMutual entered into a $1.0 billion Secured Revolving Credit Facility, to be funded equally, to support loan underwritings by JFIN. The Secured Revolving Credit Facility bears interest based on the interest rates of the related JFIN underwritten loans and is secured by the underlying loans funded by the proceeds of the facility. The facility is scheduled to mature on March 1, 2014 with automatic one year extensions subject to a 60 day termination notice by either party. At February 29, 2012, we have funded $79.9 million of our $500.0 million commitment. During the three months ended February 29, 2012, $3.0 million of interest income is included in the Consolidated Statement of Earnings related to the Secured Revolving Credit Facility.

The following is a summary of selected financial information for JFIN as of February 29, 2012 and November 30, 2011 (in millions):

 

 

     February 29,
2012
     November 30,
2011
 

Total assets

   $ 1,376.5       $ 1,457.8   

Total liabilities

     932.7         1,044.3   

Total equity

     443.8         413.5   

Our total equity balance

     221.9         206.8   

JFIN’s net earnings were $30.1 million and $26.4 million for the three months ended February 29, 2012 and February 28, 2011, respectively.

We engage in debt capital markets transactions with JFIN related to the originations of loans by JFIN. In connection with such transactions, we earned fees of $23.7 million and $18.6 million during the three months ended February 29, 2012 and February 28, 2011, respectively, recognized within Investment banking on the Consolidated Statements of Earnings. In addition, in relation to these transactions, we paid fees to JFIN of $3.8 million and $0.6 million during the three months ended February 29, 2012 and February 28, 2011, respectively, recognized within Business development expenses on the Consolidated Statements of Earnings.

During the three months ended February 28, 2011, we purchased participation certificates in loans originated by JFIN of $477.2 million, which were subsequently redeemed in full during the same period. There were no equivalent transactions during the three months ended February 29, 2012.

Under a service agreement, we charged to JFIN $10.9 million for certain administrative services for the three months ended February 29, 2012. Receivables from JFIN, included within Other assets on the Consolidated Statements of Financial Condition, were $31.0 million and $16.6 million at February 29, 2012 and November 30, 2011, respectively.

 

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(Unaudited)

 

Jefferies LoanCore LLC

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 LLC (“LoanCore”), a commercial real estate finance company. LoanCore originates commercial real estate loans 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. LoanCore is currently solely capitalized with equity and has aggregate equity commitments of $600.0 million. As of February 29, 2012 and November 30, 2011, we have funded $168.5 million and $163.3 million, respectively, of our $291.0 million equity commitment and have a 48.5% voting interest in LoanCore.

The following is a summary of selected financial information for LoanCore as of February 29, 2012 and November 30, 2011 (in millions):

 

 

     February 29,
2012
     November 30,
2011
 

Total assets

   $ 804.1       $ 761.4   

Total liabilities

     445.6         427.4   

Total equity

     358.5         334.0   

Our total equity balance

     173.9         162.0   

LoanCore’s net earnings were $13.6 million for the three months ended February 29, 2012. LoanCore did not have material earnings or losses during the three months ended February 28, 2011.

Under a service agreement, we charged LoanCore $0.2 million for administrative services for the three months ended February 29, 2012. At February 29, 2012 and November 30, 2011, $0.2 million and $0.3 million, respectively, was included in Other assets on the Consolidated Statements of Financial Condition relating to receivables from LoanCore.

LoanCore enters into derivative transactions with us to hedge its loan portfolio. As of February 29, 2012, the aggregate fair market value of derivative transactions outstanding with LoanCore was $25.6 million and included within Financial instruments owned. During the three months ended February 29, 2012, we have recognized gains within Principal transaction revenues of $7.9 million on such transactions with LoanCore.

 

Note 11. Goodwill and Other Intangible Assets

Goodwill

The following table is a summary of the changes to goodwill for the three months ended February 29, 2012 (in thousands):

 

 

     Three Months
Ended
February 29, 2012
 

Balance, at beginning of period

   $ 365,574   

Add: Translation adjustments

     (66
  

 

 

 

Balance, at end of period

   $ 365,508   
  

 

 

 

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

 

At least annually, and more frequently if warranted, we assess goodwill for impairment. We completed our annual test of goodwill as of June 1, 2011 and performed additional impairment testing as of November 30, 2011. As of June 1 and November 30, 2011 no goodwill impairment was identified. Periodically estimating the fair value of a reporting unit requires significant judgment and often involves the use of significant estimates and assumptions. These estimates and assumptions could have a significant effect on whether or not an impairment charge is recorded and the magnitude of such a charge. Further, adverse market or economic events could result in impairment charges in future periods.

All goodwill is assigned to our Capital Markets segment and is deductible for tax purposes.

Intangible Assets

The following table presents the gross carrying amount, accumulated depreciation and net carrying amount of identifiable intangible assets and weighted average amortization period as of February 29, 2012 and November 30, 2011 (in thousands):

 

 

     February 29, 2012  
     Gross cost      Accumulated
amortization
    Net carrying
amount
     Weighted
average
remaining
lives (years)
 

Exchange and clearing organization membership interests and registrations

   $ 11,219       $      $ 11,219         N/A   

Customer relationships

     10,542         (3,128     7,414         6.7   

Trade name

     1,680         (578     1,102         1.8   

Other

     100         (8     92         13.5   
  

 

 

    

 

 

   

 

 

    
   $ 23,541       $ (3,714   $ 19,827      
  

 

 

    

 

 

   

 

 

    

 

     November 30, 2011  
     Gross cost      Accumulated
amortization
    Net carrying
amount
     Weighted
average
remaining
lives (years)
 

Exchange and clearing organization membership interests and registrations

   $ 11,219       $      $ 11,219         N/A   

Customer relationships

     10,542         (2,776     7,766         6.9   

Trade name

     1,300         (361     939         1.1   

Other

     100         (8     92         13.8   
  

 

 

    

 

 

   

 

 

    
   $ 23,161       $ (3,145   $ 20,016      
  

 

 

    

 

 

   

 

 

    

The aggregate amortization expense for the three months ended February 29, 2012 and February 28, 2011 was $0.6 million and $0.2 million, respectively. Amortization expense is included in Other expenses on the Consolidated Statements of Earnings.

 

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JEFFERIES GROUP, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — CONTINUED

(Unaudited)

 

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

 

 

Fiscal year

   Estimated future
amortization
expense
 

2012 (Period from April to November)

   $ 1,690   

2013

     1,319   

2014

     929   

2015

     771   

2016

     771   

2017

     714   

Mortgage Servicing Rights

In the normal course of business we originate military housing mortgage loans and sell such loans to investors. In connection with these activities we may retain the mortgage servicing rights that entitle us to a future stream of cash flows based on contractual serving fees. Mortgage servicing rights to military housing mortgage loans are accounted for as an intangible asset and included within Other assets in the Consolidated Statements of Financial Condition. The mortgage servicing rights are amortized over the period of the estimated net servicing income, which is reported in Other income in the Consolidated Statements of Earnings. We provide no credit support in connection with the servicing of these loans and are not required to make servicing advances on the loans in the underlying portfolios. We determined that the servicing rights represent one class of servicing rights based on the availability of market inputs to measure the fair value of the asset and our treatment of the asset as one aggregate pool for risk management purposes. We earned fees related to these servicing rights of $1.1 million and $0.9 million during the three months ended February 29, 2012 and February 28, 2011, respectively.

The following presents the activity in the balance of these servicing rights for the three months ended February 29, 2012 and twelve months ended November 30, 2011 (in thousands):

 

 

     Three Months
Ended
February 29, 2012
    Twelve Months
Ended
November 30, 2011
 

Balance, beginning of period

   $ 8,202      $ 8,263   

Add: Acquisition

     162        347   

Less: Pay down

     (211       

Less: Amortization

     (97     (408
  

 

 

   

 

 

 

Balance, end of period

   $ 8,056      $ 8,202   
  

 

 

   

 

 

 

We estimate the fair value of these servicing rights was $15.5 million and $15.6 million at February 29, 2012 and November