Securitization Activities and Variable Interest Entities

9 Months Ended

Aug. 31, 2011

Securitization Activities and Variable Interest Entities [Abstract]

Securitization Activities and Variable Interest Entities

Note 8. Securitization Activities and Variable Interest Entities

Securitization Activities

We engage in securitization activities related to mortgage loans and mortgage-backed and other asset-backed securities. In our securitization activities, we use special purpose entities (“SPEs”). Our securitization vehicles generally meet the criteria of variable interest entities; however we do not consolidate our securitization vehicles as we do not meet the characteristics of the primary beneficiary for these vehicles. See “Variable Interest Entities” in this footnote for further discussion on variable interest entities and our determination of the primary beneficiary.

We derecognize financial assets transferred in securitizations when we have relinquished control over such assets. If we have not relinquished control over transferred assets, the financial 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 prior to securitization, with unrealized gains and losses reflected in Principal transactions in the Consolidated Statements of Earnings. We act as placement or structuring agent in connection with the beneficial interests issued by securitization vehicles. Net revenues are recognized in connection with these activities.

Our continuing involvement in securitization vehicles to which we have transferred assets is limited to holding beneficial interests in these vehicles (i.e., securities issued by these vehicles), which are included within Financial instruments owned on the Consolidated Statements of Financial Condition, and servicing rights over certain transferred assets (i.e., project loans), which are included within Other assets on the Consolidated Statements of Financial Condition. We apply fair value accounting to the securities and the servicing rights are amortized over the period of the estimated net servicing income. We have not provided financial or other support to these securitization vehicles during the nine months ended August 31, 2011 and eight months ended August 31, 2010. 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 August 31, 2011 and November 30, 2010. Although not obligated, we may make a market in the securities issued by these securitization vehicles. In these market-making transactions, we buy these securities from and sell these securities to investors. Securities purchased through these market-making activities are not considered to be continuing involvement in these vehicles, although the securities are included in Financial instruments owned — Mortgage- and asset-backed securities.

During the three and nine months ended August 31, 2011, we transferred assets of $2,337.7 million and $8,988.2 million, respectively, as part of our securitization activities in which we had continuing involvement, received cash proceeds of $1,922.7 million and $7,421.1 million, respectively, beneficial interests of $434.6 million and $1,624.3 million, respectively, servicing rights of $0.3 million and $0.3 million, respectively, and recognized Net revenues of $17.0 million and $45.2 million, respectively. During the three and eight months ended August 31, 2010, we transferred assets of $3,236.8 million and $8,493.9 million, respectively, as part of our securitization activities in which we had continuing involvement, received cash proceeds of $2,710.7 million and $6,982.0 million, respectively, beneficial interests of $543.0 million and $1,579.9 million, respectively, servicing rights of $-0- and $0.1 million, respectively, and recognized Net revenues of $12.3 million and $63.8 million, respectively. These transfers were accounted for as sales of assets. Assets received in the form of securities issued in these transfers were 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.

The following tables present the total information regarding securitization vehicles to which we, acting as transferor, have transferred assets and for which we received sale accounting treatment at August 31, 2011 and November 30, 2010 (in millions):


	Assets obtained			As of August 31, 2011
Securitization Type	as proceeds			Total Assets (4)		Assets Retained
Residential mortgage-backed securities	$	1,490.1	(3)	$	7,097.2	$	679.8	(1)(2)
Commercial mortgage-backed securities		134.2	(3)		3,076.4		73.0	(1)(2)
Project loans		0.3	(5)		90.0		0.3	(6)


(1)		At August 31, 2011, the securities issued in these securitizations are comprised of government agency-backed securities.

(2)		A significant portion of these securities have been subsequently sold in secondary-market transactions to third parties. As of September 30, 2011, we continue to hold approximately $403.9 million and $53.4 million of these Residential mortgage-backed securities and Commercial mortgage-backed securities, respectively, in inventory.

(3)		Initial fair value of securities received on date of asset transfer that were issued by securitization vehicles.

(4)		Represents unpaid principal amount of assets in the securitization vehicles.

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

(6)		Represents amortized servicing rights on transferred project loans.


	Assets obtained			As of November 30, 2010
Securitization Type	as proceeds			Total Assets (6)		Assets Retained
Residential mortgage-backed securities	$	2,203.1	(3)	$	6,549.5	$	684.7	(1)(2)
Commercial mortgage-backed securities		105.7	(3)		2,005.4		40.4	(1)(2)
Project loans		0.1	(4)		107.8		0.1	(5)


(1)		At November 30, 2010, the securities issued in these securitizations are comprised of government agency-backed securities.

(2)		A significant portion of these securities have been subsequently sold in secondary-market transactions to third parties. As of September 30, 2011, we continue to hold approximately $60.9 million and $28.6 million of these Residential mortgage- backed securities and Commercial mortgage-backed securities, respectively, in inventory.

(3)		Initial fair value of securities received on date of asset transfer that were issued by securitization vehicles.

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

(5)		Represents amortized servicing rights on transferred project loans.


(6)		Represents unpaid principal amount of assets in the securitization vehicles.

The following table presents cash flows received during the three and nine months ended August 31, 2011 and three and eight months ended August 31, 2010 related to securitization vehicles to which we have transferred assets and received sale accounting (in millions):


					Nine Months		Eight Months
	Three Months Ended (1)				Ended		Ended
	August 31,		August 31,		August 31,		August 31,
	2011		2010		2011 (1)		2010 (1)
Residential mortgage-backed securities	$	24.8	$	11.5	$	55.3	$	26.3
Commercial mortgage-backed securities		2.0		0.7		4.0		0.9


(1)		There were no beneficial interests held on project loans for the three and nine months ended August 31, 2011. Cash flows received on beneficial interests in securitization vehicles of project loans were de minimis for the three and eight months ended August 31, 2010.

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

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.

VIEs Where We Are The Primary Beneficiary

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 August 31, 2011 and November 30, 2010 (in millions). 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.


	August 31, 2011						November 30, 2010
			Mortgage- and						Mortgage- and
			Asset-backed						Asset-backed
	High Yield		Securitizations		Other		High Yield		Securitizations		Other
Cash	$	283.7	$	—	$	0.3	$	202.6	$	—	$	—
Financial instruments owned		779.2		11.6		7.3		889.8		101.4		21.0
Securities borrowed		238.9		—		—		455.8		—		—
Receivable from brokers and dealers		177.8		—		—		195.5		—		—
Other		24.7		—		—		11.6		0.1		—

	$	1,504.3	$	11.6	$	7.6	$	1,755.3	$	101.5	$	21.0

Financial instruments sold, not yet purchased	$	383.6	$	—	$	—	$	602.6	$	—	$	—
Payable to brokers and dealers		134.5		—		—		157.1		—		—
Mandatorily redeemable interests (1)		1,047.9		—		—		1,047.9		—		—
Promissory note (2)		—		—		4.1		—		—		4.4
Secured financing (3)		—		11.6		—		—		101.4		—
Other		36.9		—		0.3		36.3		0.1		—

	$	1,602.9	$	11.6	$	4.4	$	1,843.9	$	101.5	$	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 in the Consolidated Statements of Financial Condition was approximately $313.1 million and $315.9 million at August 31, 2011 and November 30, 2010, respectively.

(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 in the Consolidated Statements of Financial Condition. Approximately $8.9 million and $15.7 million of the secured financing represents an amount held by us in inventory and is eliminated in consolidation at August 31, 2011 and November 30, 2010, 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 securities 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. As a result of agreements entered into with Leucadia in April 2008, any request to Leucadia for additional capital investment in JHYH requires the unanimous consent of our Board of Directors, including the consent of any Leucadia designees to our board. 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 August 31, 2011 and November 30, 2010, the carrying amount of our variable interests was $324.9 million and $328.2 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, 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 beneficial interests (i.e., securities) issued by the securitization vehicle. Our variable interests in this vehicle consist of beneficial interests 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.

During the quarter, we sold beneficial interests in a mortgage-backed securitization vehicle for which we were previously the primary beneficiary. Upon the sale of our beneficial interests in this vehicle, we determined that we are no longer the primary beneficiary of this vehicle as we do not have an obligation to absorb losses or a right to receive benefits that could potentially be significant to this vehicle. As such, we deconsolidated this mortgage-backed securitization vehicle during the third quarter.

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.

VIEs Where We Have a Variable Interest

We also hold variable interests in VIEs in which we are not the primary beneficiary and accordingly do not consolidate. We do not consolidate these VIEs as we do not have the power to direct the activities that most significantly impact their economic performance. Other than Jefferies Employees Partners IV, LLC, as discussed below, we have not provided financial or other support to these VIEs during the nine months ended August 31, 2011 or eleven months ended November 30, 2010 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 August 31, 2011 and November 30, 2010.

We have aggregated certain nonconsolidated VIEs based upon principal business activity. The following tables present the total assets of nonconsolidated VIEs in which we hold variable interests, our maximum exposure to loss from these nonconsolidated VIEs, and the carrying amount of our interests in these nonconsolidated VIEs at August 31, 2011and November 30, 2010 (in millions):


	August 31, 2011
			Maximum exposure
			to loss in non-
	VIE Assets		consolidated VIEs			Carrying Amount
Collateralized loan obligations	$	1,794.1	$	45.5	⁽²⁾	$	45.5
Mortgage- and asset-backed vehicles — Non-agency (1)		92,722.8		847.6	⁽²⁾		847.6
Mortgage- and asset-backed vehicles — Agency (1)		7,296.5		2,090.7	⁽²⁾		2,090.7
Asset management vehicle		1,167.1		3.0	⁽²⁾		3.0
Private equity vehicles		96.3		131.5			64.0

Total	$	103,076.8	$	3,118.3		$	3,050.8


(1)		VIE assets represent the unpaid principal balance of the assets in these vehicles at August 31, 2011.

(2)		Our maximum exposure to loss in these non-consolidated VIEs is limited to our investment.


	November 30, 2010
			Maximum exposure
			to loss in non-
	VIE Assets		consolidated VIEs			Carrying Amount
Collateralized loan obligations	$	1,937.8	$	35.3	⁽²⁾	$	35.3
Mortgage- and asset-backed vehicles — Non-agency (1)		91,285.1		852.1	⁽²⁾		852.1
Mortgage- and asset-backed vehicles — Agency (1)		7,464.8		1,840.9	⁽²⁾		1,840.9
Asset management vehicle		760.4		18.1	⁽²⁾		18.1
Private equity vehicles		63.9		131.0			49.7

Total	$	101,512.0	$	2,877.4		$	2,796.1


(1)		VIE assets represent the unpaid principal balance of the assets in these vehicles at November 30, 2010.

(2)		Our maximum exposure to loss in these non-consolidated VIEs is limited to our investment.

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. No gain or loss was recognized upon the initial consolidation of these CLOs. Subsequently, we sold and assigned our management agreements for the CLOs to a third party; thus, we no longer have the power to direct the most significant activities of the CLOs. Upon the assignment of the management agreements in the first quarter of 2010, we deconsolidated the CLOs. Our remaining variable interests in the CLOs subsequent to the assignment of our management agreement consist of debt securities and a right to a portion of the CLOs’ management and incentive fees. The debt securities are accounted for at fair value and are included in Financial instruments owned at August 31, 2011 and November 30, 2010 on our Consolidated Statements of Financial Condition. The carrying amount of the debt securities was $12.4 million and $8.8 million at August 31, 2011 and November 30, 2010, respectively. The 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.

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. The direct investment is accounted for at fair value and included in Financial instruments owned in our Consolidated Statements of Financial Condition. Our exposure to loss is limited to our investments in the debt securities.

Mortgage- and Asset-Backed Vehicles. We purchase and sell variable interests in VIEs, which primarily issue mortgage-backed and other asset-backed securities, in connection with our trading and market-making activities. Our variable interests in these VIEs consist of mortgage and asset-backed securities and are accounted for at fair value and included in Financial instruments owned on our Consolidated Statements of Financial Condition. We include our variable interests in agency mortgage and asset-backed vehicles in the disclosure of our variable interests in VIEs.

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 August 31, 2011 and November 30, 2010 under the risk and reward model. Our variable interests in the Jefferies Umbrella Fund consist of equity interests, management fees and performance fees. The equity interests are accounted for on the equity method and included in Investments in managed funds on our Consolidated Statements of Financial Condition.

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 August 31, 2011 and November 30, 2010, we funded approximately $17.9 million and $9.3 million, respectively, of our commitment. The USA Fund has assets consisting primarily of private equity and equity related investments. Our investment in the USA Fund is accounted for on the equity method and included in Investments in managed funds in our Consolidated Statements of Financial Condition. The carrying amount of our equity investment was $17.6 million and $9.1 million at August 31, 2011 and November 30, 2010, respectively. Our exposure to loss is limited to our equity commitment.

We have variable interests in Jefferies Employees Partners IV, LLC (“JEP IV”). JEP IV has assets consisting primarily of private equity and equity related investments. Our variable interests in JEP IV consist of an equity investment and a loan commitment. Our equity investment in JEP IV is accounted for on the equity method and included in Investments in managed funds in our Consolidated Statements of Financial Condition. The carrying amount of our equity investment was $2.8 million and $1.8 million at August 31, 2011 and November 30, 2010, respectively. During the fourth quarter of 2010, we repaid outstanding debt of JEP IV on its behalf and committed to make loans to JEP IV in an aggregate principal amount of up to $54.0 million. As of August 31, 2011 and November 30, 2010, we funded approximately $43.6 million and $38.8 million, respectively, of the aggregate principal balance, which is included in Other investments in our Consolidated Statements of Financial Condition. Our exposure to loss is limited to our equity investment and the aggregate amount of our loan commitment.