Institutional Financial Markets, Inc. (formerly Cohen & Company Inc.) — Q3 2011 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2011. The company is a credit-focused financial firm with Capital Markets, Asset Management and Principal Investing segments; it reported approximately $8.5 billion of assets under management. Dollar amounts below are in millions unless noted.
Financial results and position
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Revenue | $20.9 | $23.1 | $76.6 | $100.6 |
| Operating income (loss) | $(7.8) | $(6.2) | $(14.4) | $4.8 |
| Net income (loss) | $(7.7) | $(0.1) | $(12.3) | $7.6 |
| Net income (loss) attributable to IFMI | $(4.0) | $0.0 | $(7.0) | $5.0 |
| Basic and diluted EPS | $(0.38) | $0.00 | $(0.65) | $0.48 |
- Margins: Operating margin was approximately (37%) in Q3 2011 versus (27%) in Q3 2010, and (19%) for the nine months versus 5% in the prior-year period.
- Revenue mix: Nine-month net trading revenue rose 2% to $57.5; asset management revenue fell 13% to $16.5; new issue and advisory revenue declined 8% to $1.9; and principal transactions and other income dropped to $0.7 from $23.0. The prior year included substantially larger investment fair-value gains.
- Expenses and non-operating items: Nine-month operating expenses declined 5% to $91.1, including no goodwill impairment versus a $5.6 impairment in 2010. Q3 compensation and benefits rose 41% to $19.4, partly reflecting acquisitions and severance. Nine-month net interest expense fell 32% to $4.2. Equity-method income was $0.8 in Q3, down from $6.1, while the nine-month figure was $5.4.
- Cash flow: For the nine months, operating cash flow was $0.2, investing cash flow $(10.3), and financing cash flow $(8.3). Cash and cash equivalents declined $18.3 to $25.6; restricted cash was another $0.9.
- Balance sheet and debt: Assets were $321.0 and liabilities $225.1 at September 30. Reported debt carrying value was $40.8, down from $44.7 at year-end 2010. The $2.9 bank facility balance matures in September 2012; the filing says no additional borrowing was available under that facility. Convertible notes had $19.5 principal outstanding, including $11.9 of old notes whose holders could first require repurchase in May 2012 and $7.6 of exchanged notes first puttable in May 2014. The company reported compliance with debt covenants.
- Liquidity and regulatory capital: Management said existing cash and the trading portfolio were expected to support ongoing needs, while noting uncertainty about replacing or obtaining financing. Broker-dealer regulatory capital totaled $43.4 against minimum requirements of $2.5; capital is subject to distribution restrictions.
Material changes and significant events
- Revenue fell 24% for the nine months despite contributions from the January JVB acquisition and the May PrinceRidge transaction. Management cited weak markets, lower trading volumes and margins, as well as lower investment gains compared with 2010.
- IFMI acquired JVB in January and contributed $45 million of cash, payables and its CCCM broker-dealer interests to obtain an approximately 70% interest in PrinceRidge on May 31. PrinceRidge generated $10.7 million of Q3 revenue and a $3.8 million net loss attributable to IFMI for the quarter; final FINRA approval followed on October 19. A PrinceRidge partner’s withdrawal resulted in a $3.2 million payable, redeemable over five years.
- The company exchanged $7.6 million principal of 7.625% convertible notes for 10.50% notes, extending the first holder put date for that portion from 2012 to 2014. In October, it also exchanged a further $0.5 million of old notes on similar terms.
- In March, IFMI sold advisory agreements for certain Deep Value funds and managed accounts, retaining certain incentive-fee rights and a revenue-sharing entitlement. The first Deep Value fund completed liquidation in 2011.
- IFMI repurchased and retired 647,701 shares in a private transaction for $1.5 million, or $2.25 per share. It declared a $0.05-per-share dividend payable December 6, 2011.
Outlook, risks and contingencies
- No specific earnings or revenue guidance was provided. Management expected a taxable loss for 2011 and recorded a tax benefit, subject to deferred-tax-asset limitations.
- Management described continued margin and volume pressure in corporate bond brokerage, increased competition and weak market activity. Cost reductions were implemented in Q3, but management cautioned they might not be sufficient.
- Investment and valuation risk is significant: $43.7 million, or 98%, of other investments at fair value was concentrated in Star Asia, EuroDekania and Tiptree; Star Asia alone was valued at $38.2 million. Much of the portfolio relied on Level 3 or other less-observable valuation inputs. The company cited Japan disaster-related effects on Star Asia and foreign-exchange sensitivity; it terminated all yen forward contracts after quarter-end, leaving greater unhedged exposure.
- Repurchase agreements and clearing arrangements can require additional collateral; failure to meet margin calls could result in losses or disruption. Period-end repurchase-agreement liabilities were $42.8 million, and reverse repurchase receivables were $39.2 million.
- Contingencies include Sentinel-related litigation, for which no liability was recorded, and an Alesco XIV guarantee with a recorded $1.1 million liability and maximum potential loss of $8.75 million. Cohen Legacy was dismissed without prejudice from a separate RMBS lawsuit in September. The company also disclosed an unrecognized tax benefit of $1.2 million.
- Disclosure controls were deemed effective at quarter-end; integration of JVB controls was ongoing, with completion expected by year-end.
Important facts for investors to verify
- Whether the Q3 cost reductions and acquired businesses can restore operating profitability amid continued market and brokerage-margin pressure.
- The sustainability and realizability of fair values—especially Star Asia and other Level 3 or illiquid holdings—and the effect of the now-terminated yen hedges.
- Liquidity available at the parent level, restrictions on subsidiary distributions, and the ability to meet the 2012 bank facility maturity and potential May 2012 note repurchase.
- PrinceRidge integration performance, its redeemable non-controlling interests and withdrawal obligations, and whether the transaction’s expected benefits exceed its costs.
- Developments in the Sentinel litigation and the Alesco XIV guarantee, including any change in estimated exposure or collateral requirements.