Cohen & Company Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018; comparative periods are the corresponding 2017 periods. Dollar amounts below are in millions unless noted. Cohen & Company is a fixed-income financial services company with Capital Markets, Asset Management, and Principal Investing segments. At quarter-end, AUM was $3.18 billion, including $2.81 billion, or 88.2%, in CDOs.
Financial results and position
| Metric | Q2 2018 | Q2 2017 | Six months 2018 | Six months 2017 |
|---|---|---|---|---|
| Revenue | $12.19 | $11.37 | $21.53 | $25.87 |
| Operating income | $1.38 | $1.73 | $1.02 | $4.31 |
| Operating margin | 11.3% | 15.2% | 4.7% | 16.7% |
| Income (loss) before taxes | $(0.83) | $0.61 | $(3.01) | $1.59 |
| Consolidated net income (loss) | $(0.19) | $0.61 | $(2.34) | $1.58 |
| Net income (loss) attributable to Cohen & Company Inc. | $0.08 | $0.43 | $(1.39) | $1.10 |
Q2 basic and diluted EPS were both $0.07, versus $0.35 a year earlier. Six-month basic and diluted loss per share was $1.19, versus earnings per share of $0.91 basic and $0.84 diluted in 2017.
- Revenue mix and drivers: Q2 net trading revenue rose 18% to $7.19 million and asset-management revenue rose 85% to $3.21 million. New-issue/advisory revenue fell 80% to $0.18 million; principal transactions and other income fell 39% to $1.62 million. For the six months, revenue declined 17%, with lower new-issue/advisory and principal/other income partly offset by higher asset-management fees.
- Expenses and interest: Q2 operating expenses increased 12% to $10.82 million, including compensation growth and higher clearing/execution costs. Six-month operating expenses decreased 5% to $20.51 million, but net interest expense rose 48% to $4.02 million. Q2 net interest expense was $2.20 million, nearly double the prior-year quarter.
- Cash flow: Six-month operating cash flow was positive $12.31 million, versus negative $21.82 million in 2017; investing cash flow was negative $16.86 million versus positive $2.75 million; financing cash flow was negative $1.64 million versus positive $14.35 million. Cash declined by $6.31 million to $16.62 million.
- Balance sheet and funding: At June 30, total assets were $2.755 billion, total liabilities $2.710 billion, and total equity $44.94 million. Resale-agreement receivables were $2.415 billion and repurchase-agreement liabilities $2.456 billion. Recorded debt was $44.62 million, and redeemable financial instruments totaled $16.73 million. The $25 million MB Financial credit facility was undrawn; it matures in April 2020 and bears interest at LIBOR plus 6% when drawn.
- Dividends and capital: The company declared dividends of $0.20 per common share each quarter through Q2 2018. On August 1, 2018, the board declared another $0.20 dividend, payable August 31. JVB and CCFL reported regulatory capital above their respective minimums.
Changes, outlook, and material risks
- Q2 revenue increased modestly, but operating income and parent-attributable income declined; the company reported a consolidated quarterly loss. For the six-month period, revenue and operating income fell substantially and results shifted from profit to loss.
- Management attributed asset-management growth partly to higher managed-account AUM and performance fees. CDO management fees remain exposed to declining collateral balances; the company has not completed a new securitization since 2008. New-issue and advisory revenue is volatile because it depends on a limited number of engagements and transaction closings.
- Lower six-month principal/other income reflected, among other items, the expiration of the Alesco revenue share and the termination of the Star Asia revenue-share arrangement. Q2 comparisons were also affected by a large Star Asia incentive fee in the 2017 quarter.
- Management provided no numerical earnings or revenue guidance. It described results as unpredictable, cited ongoing competition and fixed-income margin pressure, and said available cash, trading investments, and related borrowing capacity should meet near-term operating needs. It cautioned that financing may not be available on favorable terms and that dividends may be reduced or discontinued.
- Funding and market exposures: The matched-book repo business expanded significantly. The company relies on FICC for nearly all GCF repo funding, creating funding concentration; its gestational repo business has reverse-repo exposure to four counterparties. Margin calls, counterparty defaults, loss of clearing access, or tighter funding terms could disrupt operations. A parallel 100-basis-point yield-curve increase was estimated to reduce value by $4.86 million; a 100-basis-point LIBOR change would alter annual cash interest by $0.481 million.
- Other risks and contingencies: Trading and investment values may be volatile, including Level 3 valuations based on significant unobservable inputs. The company disclosed a Pennsylvania tax assessment of $4.683 million plus interest relating to an inactive subsidiary; it recorded no liability and believes its exposure is limited to that subsidiary’s assets. Routine legal and regulatory matters were not expected by management to have a material effect. Disclosure controls were reported effective, with no material internal-control changes during the quarter.
Important facts for investors to verify
- Whether the company can sustain earnings as revenue-share arrangements expire, CDO assets amortize, and trading and advisory revenues fluctuate.
- The economics, concentration, collateral terms, and rollover/funding risks of the rapidly expanded matched-book repo business and its dependence on FICC.
- Liquidity and refinancing plans for the $8.248 million 2013 convertible notes due September 2018, alongside the 8% related-party convertible note and redeemable instruments.
- The assumptions and sensitivity behind CLO and other fair-value estimates, including Level 3 valuations and investment impairment risk.
- The status and potential consequences of the Pennsylvania tax assessment, and the sustainability of dividends given losses, cash balances, and regulatory capital constraints.