Valuentum Exclusive Analysis for the Discerning Investor

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Investment-bank Jefferies (JEF) has come under scrutiny in the past few trading sessions following a downgrade of its credit rating by an independent rating firm, which cited large gross exposure to European debt, the focal point of the market’s nervousness in the past few months. In response, Jefferies pretty much opened its sovereign books to the public late last week (detailing both its long and short positions and its net exposure per country), and then announced today that it had reduced its gross exposure to Europe by half. We are quite impressed with this unprecedented transparency, but that’s not why we’re encouraged by this development.

We’ve reproduced Jefferies’ press release that hit the wire this morning:

Jefferies announced today that its trading positions in the sovereign securities of the nations of Portugal, Italy, Ireland, Greece, and Spain have been reduced by an aggregate of approximately $1.1 billion long and $1.1 billion short. This represents a 49.5% reduction in Jefferies’ gross holdings of these securities since the close of business Friday and resulted in no meaningful profit or loss on today’s trading activity or our remaining positions, which continue to be substantially matched by country and maturity. Jefferies’ current net exposure to these sovereign securities is currently $59 million, or 1.7% of shareholder equity, with negligible market or credit risk.

“We undertook this reduction in our holdings solely to demonstrate the liquid nature of this market-making trading book,” said Richard Handler, Chairman and CEO, and Brian Friedman, Chairman of the Executive Committee of Jefferies, in a joint statement. “We will now resume our normal market-making activities and serve our clients around the world.”

As Jefferies outlined above, the European sovereign markets remain incredibly liquid and organized. If a firm like Jefferies can move in and out at will (despite facing capital concerns), then there is little doubt that the other larger US investment banks can do as well. As we outlined in the October edition of our Best Ideas Newsletter, we maintain that, if we encounter any problems with Europe, it will merely be transitory and the health of the US economy will continue to be strong. We've seen no information since the publication of our newsletter to disconfirm this thesis.