Cohen & Company Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. Unless otherwise noted, financial amounts below are in millions of dollars; the filing presents them in thousands. Cohen & Co. is a financial services company focused on fixed-income capital markets, asset management and principal investing.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $12.237 | $10.001 | $33.765 | $35.867 |
| Operating income | $0.356 | $0.989 | $1.371 | $5.303 |
| Operating margin | 2.9% | 9.9% | 4.1% | 14.8% |
| Interest expense | $2.185 | $1.606 | $6.205 | $4.330 |
| Net income (loss) | $(1.234) | $(0.758) | $(3.575) | $0.825 |
| Net income (loss) attributable to Cohen & Company Inc. | $(0.651) | $(0.547) | $(2.045) | $0.551 |
| Basic loss per share | $(0.57) | $(0.45) | $(1.76) | $0.46 income |
Q3 revenue rose 22%, but operating expenses rose 32%; higher compensation and clearing costs, together with $0.579 million more interest expense, contributed to a larger net loss. Q3 revenue benefited from principal transactions and other income, including gains on publicly traded equity and CLO investments; new issue and advisory revenue was zero versus $2.012 million a year earlier.
For the nine months, revenue declined 6% and operating income fell 74%. Net trading revenue was nearly flat at $20.193 million. Asset management revenue increased 26% to $7.827 million, while new issue and advisory revenue fell 78% to $0.873 million and principal transactions and other income declined 12% to $4.872 million. Operating expenses increased 6%, and interest expense increased 43%.
At September 30, 2018, assets under management were $3.124 billion, down from $3.554 billion a year earlier; 86% was in company-sponsored CDOs. Cash and cash equivalents were $5.166 million, compared with $22.933 million at December 31, 2017. Nine-month cash flow was $(0.599) million from operations, $(13.289) million from investing and $(3.723) million from financing; cash declined by $17.767 million overall.
Total assets were $4.820 billion and total liabilities were $4.777 billion, largely reflecting matched-book repo activity. Receivables under resale agreements were $4.464 billion and repurchase liabilities were $4.507 billion. Debt was $43.372 million, versus $44.177 million at year-end 2017; redeemable financial instruments totaled $16.732 million. A $25 million MB Financial credit facility was available but undrawn. Stockholders’ equity was $36.570 million and total equity, including non-controlling interest, was $43.224 million.
Material changes and business developments
- Matched-book repo balances expanded substantially: resale receivables and repurchase liabilities each rose from about $1.7 billion at year-end 2017 to more than $4.4 billion at September 30, 2018. Nine-month matched-book repo net revenue increased to $3.450 million from $2.633 million.
- Management attributed the nine-month asset-management increase to growth in other managed accounts and performance fees, partly offset by lower CDO fees as assets declined. The company had not completed a new securitization since 2008.
- In May 2018, the company committed to invest up to $3 million in a U.S. Insurance JV; its investment was $1.006 million at quarter-end. In August, it invested $0.600 million in and became general partner of a SPAC fund; its recorded investment was $0.602 million.
- In October 2018, after quarter-end, a U.S. securitization auction generated payment of deferred subordinated management fees. The company expected to record $3.044 million of revenue and $1.015 million of related expense in October, but will earn no further revenue from that securitization.
- One holder of the 2013 convertible notes was repaid $1.461 million at maturity in September. The remaining notes were extended to September 2019 and their conversion price was reduced from $30 to $12 per share. The notes are held by related parties.
Outlook, risks and contingencies
The filing provides no numerical earnings or revenue guidance. Management says results are unpredictable and depend on financial-market conditions, trading volumes, interest rates, mortgage activity, transaction closings and investment performance. It expects fixed-income brokerage competition and margin pressure to continue, and notes that CDO-related fees may erode as managed assets repay, mature or liquidate. The company was developing a residential transition-loan business and seeking capital and counterparties.
Liquidity risks include low cash balances, collateral and margin calls, and dependence on continued securities-financing access. The company identifies GCF repo funding as concentrated on the FICC supply side and gestational repo as concentrated among a limited number of reverse-repo counterparties. A disruption to clearing or financing could materially impair operations. Management stated that cash, the trading portfolio and borrowing capacity should meet near-term needs, while cautioning that replacement or additional financing may not be available on favorable terms.
Market-risk sensitivities at quarter-end included an estimated $5.530 million loss for a 100-basis-point rise in the yield curve (and a corresponding gain for a 100-basis-point decline), $1.206 million for a 10% adverse equity-price change, and $0.045 million for a 10% adverse foreign-exchange change. A 100-basis-point change in three-month LIBOR was estimated to change annual cash interest by $0.481 million.
Management recorded a $0.050 million net expense in Q3 for a FINRA matter concerning historical controls; the proposed resolution awaited final FINRA approval. A Pennsylvania tax assessment of $4.683 million plus interest remained disputed; the company recorded no liability, stating the assessed subsidiary had no assets or operations and the company believed its exposure was limited. Routine legal and regulatory matters were also disclosed. The board declared a $0.20-per-share dividend on October 31, payable November 30, 2018; future dividends are not assured. The company said disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether cash and available credit are sufficient under stress, especially given the rapid growth in repo financing and dependence on FICC funding.
- How sustainable earnings are after excluding volatile investment gains, performance fees and the one-time October securitization fee; also monitor rising compensation, clearing and interest costs.
- The maturity, conversion and related-party terms of the 2013 and 2017 convertible notes, redeemable instruments, and the company’s ability to meet upcoming obligations.
- The valuation and liquidity of principal investments, including CLOs and fund interests, and the assumptions used for fair-value estimates.
- The outcome of the FINRA matter and Pennsylvania tax assessment, and whether the declared dividend and share repurchases remain consistent with liquidity and regulatory-capital needs.