Business context and reporting period
Institutional Financial Markets, Inc. (IFMI), which has used the Cohen & Company name, filed this Form 10-K for the fiscal year ended December 31, 2016. The company provides fixed-income capital-markets, asset-management and principal-investing services. Dollar amounts below are in millions unless stated otherwise. The filing is an annual report; fourth-quarter figures are included where noted.
Financial performance and position
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Total revenue | $55.35 | $46.16 |
| Operating income (loss) | $8.59 | ($1.66) |
| Net income (loss), consolidated | $3.43 | ($5.67) |
| Net income (loss) attributable to IFMI | $2.27 | ($4.08) |
| Basic and diluted EPS | $0.19 | ($0.28) |
| Net interest expense | $4.74 | $3.92 |
- Revenue rose 20%. Net trading revenue increased 26% to $39.11, while asset-management revenue fell 11% to $8.59 and new-issue/advisory revenue fell 44% to $2.98. Principal transactions and other income rose to $4.67 from $0.08.
- Operating expenses declined 2% to $46.76; compensation and benefits increased 11% to $31.13, partly offset by lower occupancy, clearing and professional costs. Operating margin was approximately 15.5%, versus negative 3.6% in 2015.
- Cash and cash equivalents were $15.22 at year-end, up from $14.12. Cash flow was negative $8.73 from operations, positive $7.95 from investing and positive $2.27 from financing.
- Total assets were $561.27, liabilities $514.51 and total equity $46.76. Balance-sheet debt was $29.52; the filing separately reports approximately $56.4 of recourse debt at par, comprising $8.25 of 8% convertible notes and $48.13 of net junior subordinated notes. Repurchase-agreement liabilities were $295.45, against $281.82 of resale-agreement receivables. Margin payable to clearing brokers was $85.76.
- Regulated broker-dealer net capital/liquid capital totaled $42.07, with $40.73 above stated minimum requirements. The company reported approximately $3.67 billion of AUM, down from $3.91 billion; 93.8% was in legacy CDOs.
- FY 2016 dividends were $0.08 per share. Fourth-quarter 2016 revenue was $13.16, operating income $2.46, consolidated net income $0.43, IFMI-attributable income $0.20 and EPS $0.02; fourth-quarter 2015 included a $2.64 attributable loss.
Material changes and outlook
- Trading gains were the main revenue driver: mortgage trading increased $4.12, high-yield corporate $3.33 and investment-grade corporate $1.22. CLO investment income and gains contributed to the improvement in principal-investing results; the company recorded $2.63 of CLO investment gains in 2016 versus a $1.51 loss in 2015.
- Asset-management fees continue to face structural pressure from declining CDO collateral, defaults, deferrals, ended reinvestment periods and possible auction-call liquidations. Management said it had not completed a securitization since 2008, did not expect to complete new securitizations and expected CDO-related fees to continue declining.
- The company reported no formal quantified earnings guidance. Management described results as unpredictable and sensitive to market activity, interest rates, mortgage originations, competition and personnel. Cost-control efforts continue; their sufficiency is not assured.
- In October 2016, an entity owned by board chairman Jack DiMaio and his spouse invested $6.0 in the Operating LLC, with another $1.0 invested in January 2017. The agreement provides the investor 50% of specified net revenues from JVB’s institutional corporate-trading business and includes redemption and business-sale provisions.
- On March 10, 2017, the Operating LLC issued a $15.0, five-year, 8% convertible secured note to a trust established by Daniel Cohen, a senior executive and vice chairman. It is convertible into Operating LLC units at $1.45 per unit. The related-party transaction was negotiated by a special committee of independent directors. On the same date, the proposed sale of European operations to an entity controlled by Mr. Cohen was terminated; the associated $0.6 termination fee was offset against a financing fee. An employment-agreement amendment reduced a specified potential severance benefit from $3.0 to $1.0.
- Material risks include trading and valuation volatility, illiquid and subordinated CLO investments, falling legacy CDO fees and potential management-contract terminations, reliance on Pershing for clearing and margin financing, liquidity and funding needs, regulatory capital restrictions, and competition. A Pennsylvania tax assessment of $4.68 plus interest remains under appeal; the company recorded no reserve. Routine legal and regulatory matters were also disclosed.
Important facts for investors to verify
- Whether the 2016 trading improvement is repeatable and how much relies on unrealized or model-based valuations; the filing notes that some valuations use unobservable inputs.
- The pace of CDO AUM and fee erosion, auction outcomes, and the extent to which replacement asset-management or advisory revenue can offset declines.
- Liquidity and financing exposure, including the $85.76 margin payable, repo funding, clearing-broker concentration, and the terms and cash burden of related-party financing.
- The recoverability and timing of principal-investment values, particularly CLO equity, and the company’s sensitivity to market and credit assumptions.
- The status and potential cost of the Pennsylvania tax appeal, deferred-tax assets and loss carryforwards, and the impact of any ownership change on tax attributes.
- Related-party governance and potential dilution: Mr. Cohen’s voting influence, the $15.0 convertible note, Operating LLC unit redemption rights, and outstanding equity awards.
- Management reported effective disclosure controls and internal control over financial reporting; the auditor did not provide an internal-control attestation. The financial-statement audit opinion was unmodified.