Wall Street can take some comfort from the 60 per cent bump in first-quarter profits by one of its kind, $4-billion (U.S.) minnow Jefferies . Business improved across the board for the New York-based securities firm, with fixed-income trading powering most of the surge – revenue jumped a whopping 140 per cent from the previous quarter. That sets the stage for larger rivals like JPMorgan and Goldman Sachs to follow suit when they report earnings next month. But Jefferies' results herald no more than a return to mediocrity.
Much of the juice in trading across the industry so far this year flows from two bailouts in Europe: the deal to restructure Greek debt and the European Central Bank's rescue fund for financial institutions. These calmed nerves enough for investors to return to the table as well as giving a boost to asset prices. Jefferies isn't as fully in the flow of that as its bigger peers – more than 80 per cent of its revenue comes from North America. But as CEO Richard Handler points out, the improving European situation boosted client activity at "reasonable" spreads.
That won't be easy to sustain. Trading volume may well not slip back to the soporific levels of last year, but the value of financial assets can only improve so much. And spreads are likely to narrow more, driving down revenue. It would require a significant uptick in business or an increase in leverage – or both – to offset that. Yet brokerages aren't too keen to bump up the latter; Jefferies seems very comfortable sticking with a balance sheet geared up to a quarterly average of around 11.5 times shareholders' equity.
Stakeholders and regulators will be pleased that Wall Street doesn't seem to be cranking up the risk-taking, at least by this metric. But absent roaring markets, it keeps other important measures of success pretty low. Even after bouncing back from the year-end doldrums, Jefferies only managed to eke out a return on equity of some 9.5 per cent.
That's roughly what's needed to earn or surpass its cost of capital. With the firm now trading at 1.2 times book value, shareholders seem confident both in the firm's ability to maintain that, and in its balance sheet. That's all welcome. But unless business builds substantially on recent improvements, it's likely to be another so-so year in finance.