Business context and reporting period
Institutional Financial Markets, Inc. (IFMI)—the registrant named in this filing, although the request identifies Cohen & Co Inc.—filed this unaudited Form 10-Q for the three months ended March 31, 2014. IFMI is a financial services company with Capital Markets, Asset Management, and Principal Investing segments. It reported $5.33 billion of assets under management, approximately 99% in CDOs.
In January 2014, the company merged its two U.S. broker-dealers, CCPR and JVB, under the JVB brand and reduced its workforce by approximately 20%. In February, it sold the Star Asia Group.
Key financial results
Amounts below are in millions of dollars, except per-share data and AUM.
| Metric | Q1 2014 | Q1 2013 / comparison |
|---|---|---|
| Revenue | $13.187 | $14.026; down 6% |
| Operating expenses | $14.879 | $21.098; down 29% |
| Operating loss | $(1.692) | $(7.072) |
| Net loss attributable to IFMI | $(2.098); $(0.14) per basic and diluted share | $(4.500); $(0.40) per share |
| Operating margin | Approximately (12.8%) | Approximately (50.4%) |
| Cash flow from operations | $1.444 | $(4.353) |
| Cash flow from investing | $14.088 | $0.580 |
| Cash and cash equivalents | $28.286 at March 31 | $13.161 at December 31, 2013 |
Revenue components: net trading was $6.929 million (down 47%); asset management was $4.257 million (down 11%); new issue and advisory was $0.330 million (down 67%); and principal transactions and other income was $1.671 million versus a loss of $4.790 million in Q1 2013. Interest expense increased to $1.129 million from $1.029 million. Income from equity-method affiliates fell to $0.026 million from $1.519 million.
At March 31, total assets were $287.186 million, total liabilities $228.658 million, and total equity $58.528 million. Debt carrying value was $30.008 million, compared with $29.674 million at year-end; estimated fair value of debt was $42.7 million. Repurchase-agreement liabilities were $64.930 million, and trading securities sold but not yet purchased were $50.121 million.
Broker-dealer regulatory capital exceeded minimums: JVB had $17.541 million of adjusted net capital, $17.291 million above its minimum; CCFL had $2.612 million of net liquid capital, $0.621 million above its minimum.
Material changes and unusual items
- Trading revenue declined principally because of weaker fixed-income markets, lower European volumes, and removal of overlapping product groups and personnel following the broker-dealer merger. New issue and advisory revenue also fell after JVB stopped providing SPAC investment-banking and advisory services.
- Expenses fell mainly because of lower compensation and the workforce reduction; headcount was 132 at March 31, versus 202 a year earlier. Compensation and benefits decreased 41% to $7.970 million.
- The Star Asia Group sale generated $20.043 million upfront and a recorded gain of $0.078 million. IFMI is entitled to contingent payments equal to 15% of certain revenues for at least four years; these are recognized as earned. Investing cash flow included $19.924 million of net sale proceeds.
- IFMI invested $7.109 million in equity tranches of three CLOs during the quarter and said CLO investments would become a more important part of Principal Investing.
- Operating cash flow turned positive, but the $15.125 million increase in cash was substantially supported by the Star Asia sale and trading-related balance changes.
- In March, IFMI gave notice that it intended to redeem all $3.121 million of its 10.5% New Notes for cash on May 20, 2014. The $8.248 million of 8% convertible notes mature in 2018 and are convertible at $3.00 per share, subject to adjustments.
Outlook, risks and contingencies
Management described markets as uneven and vulnerable to investor sentiment, and expected the business environment to remain challenging for the rest of 2014. It believed available cash, the trading portfolio, and related borrowing capacity would cover near-term operating needs, while cautioning that future financing may not be available or favorable. No specific earnings or revenue guidance was provided. The board declared a $0.02-per-share dividend on May 1, payable May 30, 2014, and may change or discontinue dividends.
Key risks include market and trading volatility, compressed brokerage margins, dependence on CDO-related management fees, counterparty and collateral calls, and illiquidity and valuation uncertainty in investments. IFMI estimated that a 100-basis-point rise in the yield curve would reduce fair value of net interest-rate-sensitive assets by $3.791 million; a 10% adverse change in equity prices would affect value by $0.636 million. The filing added specific caution that CLO equity is highly leveraged, subordinate, potentially illiquid, and exposed to loss if collateral or coverage tests deteriorate.
CCS and CIRA were defendants in Northern Rock litigation alleging fraud and other claims concerning a CDO investment; the company said it would defend the case, and the filing did not provide a clear estimate of potential damages. IFMI also contested a Pennsylvania tax assessment of $4.683 million, including penalties, and recorded no reserve. Routine legal and regulatory matters were also disclosed. Management reported disclosure controls were effective and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether trading activity and new-issue revenue recover after the broker-dealer consolidation, and whether cost reductions can offset continued margin pressure.
- Cash generation excluding the Star Asia sale and the sustainability of liquidity amid trading, repo, and collateral requirements.
- Completion and cash impact of the planned May 20, 2014 New Notes redemption, and any conversion or dilution from the 8% notes and exchangeable Operating LLC units.
- Realized performance, liquidity, and valuation assumptions for the new CLO equity portfolio and other Level 3 investments.
- Outcomes of the Northern Rock litigation and Pennsylvania tax appeal, neither of which had a clear ultimate financial impact in the filing.
- Whether contingent Star Asia sale payments materialize and how the asset sale affects ongoing AUM and management-fee revenue.