Cohen & Co Inc. quarterly report, Q2 FY2017

Business context and reporting period

Institutional Financial Markets, Inc. (IFMI) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2017. The filing identifies the registrant as IFMI, not Cohen & Co Inc.; confirm the intended issuer. IFMI is a fixed-income financial services company with Capital Markets, Asset Management, and Principal Investing segments. It reported $3.61 billion of assets under management (AUM), 91.7% in CDOs.

Unless otherwise stated, financial figures below are in thousands of dollars. Quarterly and six-month comparisons are against the corresponding 2016 periods.

Financial performance and position

• Revenue fell 21% in Q2 and 8% in the first half. Q2 net trading revenue declined 46% to $6,095; first-half net trading revenue declined 34% to $14,170.
• First-half asset management revenue increased 14% to $4,423 and new issue/advisory revenue increased 45% to $1,980. Principal transactions and other income rose to $5,293 from $1,367, including higher revenue-share income.
• Operating expenses declined 21% in Q2 and 12% in the first half, primarily due to lower compensation and benefits. First-half compensation fell 25% to $12,734; professional fees and other operating expense rose 26% to $4,028.
• First-half operating margin was approximately 16.7%, versus 12.4% in 2016; Q2 was approximately 15.2%, versus 15.4%.
• At June 30, cash was $10,716, total assets $699,409, total liabilities $651,180, and total equity $48,229. Cash was $15,216 at year-end 2016.
• First-half operating cash flow was negative $21,816, compared with negative $8,378 in 2016; investing cash flow was positive $2,752 and financing cash flow positive $14,349. The operating outflow primarily reflected activity in resale agreements, broker/clearing balances, and securities financing. Cash ended the period down $4,500.
• Reported debt was $43,647, up from $29,523 at year-end, including a new $15,000 convertible note. Separately, repurchase-agreement financing was $421,166 and resale-agreement receivables were $410,309; these short-term secured balances are material to liquidity and trading operations.
• JVB’s regulatory net capital exceeded its minimum by $54,850; CCFL’s net liquid capital exceeded its minimum by $1,231. The filing states total broker-dealer regulatory capital was $57,443.

Material changes and management commentary

• The $15 million, 8% convertible senior secured note was issued in March 2017 to DGC Family Fintech Trust, established by a senior executive and board vice chairman. It matures in March 2022, is convertible at $1.45 per Operating LLC unit, and is secured by equity interests in the Operating LLC’s subsidiaries. The related-party transaction includes a $600 fee offset against a termination fee tied to the canceled European sale.
• The proposed sale of European operations for approximately $8.7 million was terminated on March 10, 2017. A related employment-agreement change reduced a potential termination payment to Daniel Cohen from $3 million to $1 million.
• Management expects CDO management revenue to decline over time: IFMI has not completed a securitization since 2008 and does not expect to complete future securitizations. The Alesco revenue-share arrangement ended in February 2017; Star Asia revenue-share income could decline significantly and end in the first half of 2018.
• IFMI is pursuing FICC membership to expand matched-book repo financing, but approval is uncertain; it incurred $316 of related expenses in the first half. It also formed Concordant to develop a residential transition-loan business and is seeking capital and counterparties.
• Management believes available cash, trading-portfolio assets, and borrowing capacity should meet near-term operating needs, but cautions that replacement or additional financing may not be available on favorable terms. It identifies volatile markets, trading volumes, competition and margin pressure, key-personnel dependence, counterparty/concentration risk, and liquidity and collateral demands as significant risks.
• A Pennsylvania tax assessment of $4,683 plus interest, relating to a 2009 subsidiary tax credit, remains under appeal; IFMI recorded no reserve. Routine legal and regulatory matters are also disclosed.
• The board declared a $0.02-per-share dividend payable August 31, 2017. The filing gives no quantified earnings guidance. Management reported disclosure controls effective as of June 30, 2017.

Important facts for investors to verify

• Confirm issuer identity: this filing is for Institutional Financial Markets, Inc. (IFMI), despite the request metadata naming Cohen & Co Inc.
• Assess the sustainability and quality of earnings: trading revenue fell sharply, while 2017 results benefited from revenue-share income, including a $1,579 contingent amount from the expired Alesco arrangement and a large Star Asia incentive payment.
• Review liquidity and funding exposure, including negative operating cash flow, reliance on repo and margin financing, counterparty concentration, collateral requirements, and the new convertible note’s maturity, security, and conversion terms.
• Evaluate fair-value uncertainty and impairment risk: $4,855 of other investments were Level 3 assets, principally CLOs, valued using unobservable assumptions; the filing reports impairment charges on CLO investments.
• Track expected CDO fee runoff, Star Asia revenue-share expiry, FICC membership progress and costs, Concordant’s funding needs, and the unresolved Pennsylvania tax assessment.