This Is How You Run a Bank

• Email
• Share
• Print

We spend plenty of time blabbing about the big boys of banking -- you know, Morgan Stanley (NYSE: MS). Citigroup (NYSE: C). Bank of America (NYSE: BAC). But there's a whole separate world of smaller, niche investment banks that rarely get mentioned.

Jefferies (NYSE: JEF) is one of them, and it's putting up some impressive numbers these days. Net income for the third quarter came in at $86 million, or $0.42 per share, on record revenue of $700 million. That compares with a loss of $0.18 per share in the same period last year.

In what looks like a fairly common rundown of revenue sources, trading segments stole the show:

Segment	Q3 2009 Revenue	Q3 2008 Revenue
Commissions	$94 million	$113 million
Principal Transactions	$372 million	($3 million)
Investment Banking	$123 million	$130 million
Asset Management	$21 million	($3 million)
Net Interest Income	$84 million	$31 million

Digging a little deeper into Jefferies' trading-based revenue:

Segment	Q3 2009 Revenue
Equities	$149 million
Fixed Income and Commodities	$313 million
High Yield	$95 million

Obviously, fixed income is where it's at. This is the same setup Goldman Sachs (NYSE: GS) and JPMorgan Chase (NYSE: JPM) are enjoying: The fixed income market has been kind this year for banks that are still around to enjoy it.

So what sets Jefferies apart? Unlike some of its larger investment-banking rivals, its balance sheet leverage is fairly subdued:

Bank	Common Equity Leverage Ratio, Q2 2009*
Goldman Sachs	15.9
Morgan Stanley	18.3
Jefferies	12.3

*Most recent comparative data available

In short, it's sort of a scaled-down, under-the-radar, safer version of the big boys. Even better, Jefferies' risk-adjusted leverage ratio was just 8.4 in the most recent quarter. That isn't the kind of leverage you'd associate with a blatantly dangerous business model. It's what an investment bank used to look like. (Before the industry exploded.)

Most likely, that relative prudence stems from management knowing that it isn't too big to fail. That's what I like about Jefferies: It's essentially a mellowed-out, mini Goldman Sachs, stripped of bad publicity, conspiracy theories, Rolling Stone articles, and even regulatory burdens. Unlike Goldman and Morgan Stanley, Jefferies isn't a bank holding company (and never needed to be), so it won't fall under many of the same regulatory restrictions its competitors will.

The industry as whole still makes me squirm, but I'll admit: If you're going to run a bank, that's how you do it.

For related Foolishness:

• White House Report: Too Big to Fail, and Getting Bigger
• Roundtable: Buy This Bank
• More Mergers Means Bouncing Boutique Banks