Jefferies puts maximum loss exposure due to involvement with FXCM at $130m

Jefferies Financial Group Inc (NYSE:JEF), formerly known as Leucadia National Corporation, has filed its 10-Q report for the quarter to end-February 2020 with the Securities and Exchange Commission (SEC). The document shows Jefferies’ estimates regarding its involvement with FXCM.

Jefferies’ investment in FXCM and associated companies consist of a senior secured term loan due February 15, 2021, ($71.6 million principal outstanding at February 29, 2020); a 50% voting interest in FXCM and rights to a majority of all distributions in respect of the equity of FXCM.

Net revenues from Jefferies’ FXCM term loan include gains of $2.5 million and $0.5 million during the first quarter of 2020 and 2019, respectively.

FXCM is considered a VIE and Jefferies’ term loan and equity ownership are variable interests. Jefferies has determined that it is not the primary beneficiary of FXCM because it does not have the power to direct the activities that most significantly impact FXCM’s performance. Therefore, Jefferies does not consolidate FXCM and Jefferies accounts for its equity interest under the equity method as an investment in an associated company.

Jefferies’ maximum exposure to loss as a result of its involvement with FXCM is limited to the carrying value of the term loan ($61.6 million) and the investment in associated company ($68.4 million), which totaled $130 million at February 29, 2020. This compares to $129.3 million at November 30, 2019.

During February 2017, Global Brokerage Holdings and FXCM’s U.S. subsidiary, Forex Capital Markets LLC (FXCM U.S.) settled complaints filed by the National Futures Association and the Commodity Futures Trading Commission (“CFTC”) against FXCM U.S. and certain of its principals relating to matters that occurred between 2010 and 2014. As part of the settlements, FXCM U.S. withdrew from business and sold FXCM U.S.’s customer accounts. Based on the above actions, Leucadia evaluated in the first quarter of 2017 whether its equity method investment was fully recoverable. The Group engaged an independent valuation firm to assist management in estimating the fair value of FXCM. The estimate of fair value was based on a discounted cash flow and comparable public company analysis. The result of the analysis indicated that the estimated fair value of Leucadia’s equity interest in FXCM was lower than the carrying value by $130.2 million.

The Group concluded based on the regulatory actions, FXCM’s restructuring plan, investor perception and declines in the trading price of Global Brokerage’s common shares and convertible debt, that the decline in fair value of its equity interest was other than temporary. As such, the Group impaired its equity investment in FXCM in the first quarter of 2017 by $130.2 million, which was recorded in Income (loss) related to associated companies.

During the fourth quarter of 2018, the Group recorded an additional impairment charge of $62.1 million related to the equity component of its investment in FXCM, which is based on updated expectations that had been impacted by the then revised regulations of the European Securities Market Authority (ESMA) and dampened operating results. Based on the updated projections, the Group evaluated in the fourth quarter of 2018 whether its equity method investment was fully recoverable. The result of the analysis indicated that the estimated fair value of the equity interest in FXCM was lower than the carrying value by $62.1 million. The Group concluded that based on the decline in projections and the adverse effects of the European regulations, that the decline in fair value of its equity interest was other than temporary. As a result, it impaired its equity investment in FXCM in the fourth quarter of 2018 by $62.1 million, which was recorded in Income (loss) related to associated companies.