Institutional Financial Markets, Inc. (IFMI) — Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2013. The filing identifies the registrant as Institutional Financial Markets, Inc., a financial services company specializing in credit-related fixed-income markets. It operated through Capital Markets, Asset Management, and Principal Investing segments and reported $5.7 billion of assets under management (AUM), 94% in CDOs. Dollar amounts below are in millions unless stated otherwise.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Revenue | $18.1 | $28.1 | $45.8 | $71.9 |
| Operating income (loss) | $(1.2) | $3.2 | $(14.1) | $(1.2) |
| Net income (loss) | $(0.3) | $3.0 | $(13.8) | $(6.1) |
| Net income (loss) attributable to IFMI | $(0.1) | $2.0 | $(9.3) | $(3.9) |
| Basic loss per share | $(0.01) | $0.19 income | $(0.80) | $(0.37) |
- Revenue mix and changes: Q3 trading revenue fell 43% to $7.8 million and asset-management revenue fell 45% to $4.6 million; new-issue and advisory revenue rose 110% to $3.7 million. For the nine months, trading revenue declined 37% to $32.5 million, asset-management revenue declined 25% to $13.6 million, new-issue and advisory revenue increased 74% to $5.3 million, and principal transactions and other income was a loss of $5.5 million.
- Drivers of losses: The nine-month principal-investment result included $8.7 million of losses from changes in fair value of other investments, including a $9.1 million decline in Star Asia. The Star Asia decline included $5.4 million from foreign exchange and $3.7 million from underlying investment values. Q3 principal transactions and other income was positive $1.9 million.
- Expenses: Nine-month operating expenses fell 18% to $60.0 million, including compensation and benefits down 25% to $37.5 million. Lower compensation reflected reduced incentive pay and headcount declining from 204 to 189; cost reductions did not offset the revenue decline.
- Cash flow and liquidity: Cash and equivalents were $22.3 million at September 30, up from $14.5 million at year-end. Nine-month operating cash flow was negative $5.8 million, investing cash flow positive $3.4 million, and financing cash flow positive $10.3 million. Management said available cash, trading assets, and related borrowing capacity were expected to support near-term operating needs.
- Balance sheet and debt: Total assets were $273.9 million and total liabilities $205.8 million. Carrying-value debt was $34.6 million, versus $25.8 million at year-end; estimated fair value of debt was $45.1 million. Securities sold under repurchase agreements were $94.9 million, approximately matched by $94.9 million of receivables under resale agreements. Stockholders’ equity was $55.7 million.
- Regulatory capital: U.S. broker-dealers and the U.K. subsidiary held total regulatory net capital of $30.2 million, against stated minimum requirements totaling $2.3 million. Capital held in regulated subsidiaries may not be freely available to the parent.
- Margins: The filing does not present a defined gross-margin measure. Operating results and revenues are reported above.
Material changes and significant events
- Net trading and asset-management revenues contracted substantially year over year. Management cited lower market volumes and margins, competitive pressure, and weaker activity in agency securities, Treasuries, municipal bonds, and structured products. The prior-year comparison also included equity-derivatives business sold in December 2012.
- AUM declined to $5.7 billion from $6.3 billion at December 31, 2012, mainly reflecting lower CDO AUM. Management stated that it had not completed a new securitization since 2008.
- In September, the company raised approximately $5.5 million through common-stock sales and issued $8.25 million of 8% convertible notes due 2018, convertible at $3 per share. The transactions were part of an aggregate $13.75 million investment commitment. The notes and related equity issuances may dilute existing shareholders.
- In March, IFMI obtained full control of Star Asia Manager, previously an equity-method investment. The acquired manager contributed $1.8 million in revenue and $1.0 million in net income from acquisition through September.
- After quarter-end, the company repurchased $5.0 million principal amount of its 10.5% notes for $5.238 million, including accrued interest. This reduced their principal balance from $8.121 million to $3.121 million. Holders had a May 2014 put date for the remaining notes.
Outlook, risks, contingencies, and unusual items
- Management described the markets as uneven and vulnerable to investor sentiment and expected the general business environment to remain challenging for the rest of 2013. It warned that Federal Reserve policy uncertainty could further depress trading volumes. No numerical earnings or revenue guidance was provided.
- IFMI planned to consolidate broker-dealers CCPR and JVB and reduced its workforce by approximately 20% in connection with the plan. It expected fourth-quarter 2013 pretax employee-separation and vendor-termination charges of $2.0–$2.5 million. Regulatory approval, execution, and anticipated cost savings were uncertain.
- Principal-investment valuations involve judgment. Star Asia was valued using an internal model that adjusted reported NAV for estimated debt fair value; the filing states that using unadjusted NAV would have produced a materially higher valuation. The investment is exposed to Japanese real-estate performance and currency movements. At quarter-end, reported long yen exposure was ¥3.4 billion, hedged by ¥1.25 billion.
- Legal matters included a U.S. Bank fee-related contract action, in which the court denied IFMI’s motion to dismiss, and a Northern Rock action for which a summons had been served but no complaint had yet been filed. The company said the ultimate U.S. Bank loss was uncertain.
- In October, the company received a $4.683 million Pennsylvania tax assessment relating to a subsidiary’s 2009 tax credit. It planned an administrative appeal and recorded no reserve.
- A $1.084 million guarantee liability was released after the underlying loan was repaid in May, producing other income. The quarter also included a $1.402 million benefit from recognition of a previously unrecognized tax benefit.
- Repurchase financing and trading involve collateral, counterparty, settlement, and liquidity risks. Management reported that it had met margin calls to date but could not assure it would meet future collateral demands. The filing reported no material off-balance-sheet arrangements.
- IFMI declared a $0.02-per-share dividend for Q3 and, on October 31, declared another $0.02 dividend payable in November. Management cautioned that future dividends could be reduced or discontinued.
Most important facts for investors to verify
- Whether trading volumes, fee revenue, and AUM stabilize after the sharp year-over-year declines, and whether operating costs can be reduced enough to restore profitability.
- The assumptions and sensitivity behind the $21.1 million Star Asia valuation, its yen exposure, and any future hedging or liquidity needs.
- Liquidity available at the parent level, regulated-subsidiary capital restrictions, and the company’s capacity to meet debt obligations, particularly the remaining 10.5% notes’ May 2014 put date.
- The dilution potential and terms of the 8% convertible notes, including possible interest deferral and conversion into common shares.
- Progress, costs, regulatory approvals, and operational effects of the CCPR/JVB consolidation and workforce reduction.
- Developments in the U.S. Bank and Northern Rock litigation and the Pennsylvania tax appeal, including any changes to recorded reserves or exposure.