Business context and reporting period
Institutional Financial Markets, Inc. (IFMI; the filing identifies the issuer under this name) filed this unaudited Form 10-Q for the quarter ended March 31, 2012. The company specializes in credit-related fixed-income markets and reports Capital Markets, Asset Management, and Principal Investing segments. It reported $7.8 billion of assets under management (AUM), 98% of which was in collateralized debt obligations (CDOs). Amounts below are in millions of dollars unless stated otherwise.
Financial performance and condition
| Metric | Q1 2012 | Q1 2011 or prior date |
|---|---|---|
| Total revenue | $18.8 | $32.3 |
| Operating income (loss) | ($5.2) | $1.6 |
| Net income (loss) | ($5.9) | $0.4 |
| Net income (loss) attributable to IFMI | ($3.9) | $0.4 |
| Basic and diluted loss per share | ($0.37) | Income per share of $0.03 |
| Operating cash flow | ($4.6) | $22.6 |
| Cash and cash equivalents at period end | $14.1 | $18.2 at Dec. 31, 2011 |
| Total assets | $490.1 | $420.6 at Dec. 31, 2011 |
| Total liabilities | $410.0 | $329.2 at Dec. 31, 2011 |
| Debt carrying value | $36.9 | $37.2 at Dec. 31, 2011 |
Revenue fell 42%. Net trading revenue declined 35% to $17.7 million; asset-management revenue fell 17% to $4.9 million; and principal transactions and other income worsened to a $4.9 million loss. New-issue and advisory revenue rose to $1.1 million from $0.1 million. Total operating expenses fell 22% to $24.0 million, including compensation and benefits down 26% to $16.3 million. The resulting operating margin was approximately negative 27.7%, compared with positive 4.9% a year earlier.
The $5.2 million loss on changes in fair value of other investments was the principal-investing revenue drag, including a $5.2 million decrease in the Star Asia investment. The company reported $0.5 million of income from equity-method affiliates and $1.2 million of net interest expense. It declared a $0.02-per-share dividend for Q1 2012, versus $0.05 a year earlier.
Operating cash use of $4.6 million and financing cash use of $0.5 million contributed to a $4.2 million net cash decrease; investing activities provided $0.8 million. Securities financing balances increased: resale-agreement receivables were $216.0 million and repurchase-agreement liabilities were $220.3 million at quarter-end. Debt included $18.2 million of convertible notes, $17.2 million of junior subordinated notes, and $1.5 million of subordinated notes payable. The company said it was in compliance with debt covenants. A conventional liquidity ratio is not clearly provided.
Material changes versus the prior comparable period
- Trading revenue weakened, especially in PrinceRidge and other capital-markets operations and EDML; JVB trading revenue increased.
- Principal-investing losses deepened, mainly from the Star Asia fair-value decline. $37.1 million, or 99%, of the other-investments portfolio was concentrated in Star Asia, EuroDekania, and Tiptree; Star Asia alone was valued at $32.1 million.
- AUM fell to $7.8 billion from $9.6 billion year over year, largely reflecting lower company-sponsored CDO balances. CDO asset-management fees also faced defaults, deferrals, prepayments, and declining collateral balances.
- Cost reductions, including lower compensation and professional fees, partly offset reduced revenue. Headcount nevertheless increased to 219 from 191 year over year.
- Compared with year-end 2011, assets and liabilities rose, while cash and permanent equity declined. Repurchase-agreement liabilities increased by $85.4 million during the quarter.
Outlook, risks, contingencies, and unusual items
Management described the market environment as challenging and expected it to remain so through the rest of 2012 and the near term. It cited reduced market activity, competition and margin pressure in corporate-bond brokerage, and continuing weakness in securitization markets; the company had not completed a new securitization since 2008. Management believed cash and the trading portfolio would support near-term operating needs, but cautioned that future replacement or additional financing might not be available on favorable terms. No specific earnings or revenue guidance was provided.
Liquidity and financing risks include potential margin calls and repurchase-agreement defaults, restrictions on distributions from subsidiaries, and the Old Notes holders’ option to require repayment of $10.2 million in May 2012. The company said it expected to use cash on hand, including borrowing from PrinceRidge, if holders exercised that option. Market-risk sensitivities at March 31 included a $3.6 million loss for a 100-basis-point rise across the yield curve, and $3.7 million equity-price and $4.3 million foreign-exchange sensitivities under the filing’s stated 10% adverse-change assumptions.
Subsequent events: in May 2012, the Operating LLC borrowed $8 million from PrinceRidge at 10% interest, due in one year. The board authorized negotiation of changes that would defer Daniel Cohen’s unit redemption right and the Series B preferred-stock redemption date by one year, to December 31, 2013; the filing describes authorization to negotiate and execute the amendments, not confirmation that they were completed.
Contingencies include two Sentinel-related lawsuits against a broker-dealer subsidiary, which the company said it was vigorously defending and for which it recorded no liability. An Alesco XIV guarantee had a recorded fair-value liability of $1.1 million and maximum potential loss of $8.75 million. Separately, the company agreed to contribute $2.25 million toward an Alesco X settlement and paid it in April 2012; the expense was recorded in Q4 2011. A possible additional NPPF I interest obligation was estimated at approximately $0.1 million if the relevant advance remained outstanding through December 2014.
Valuation is a notable uncertainty: $37.3 million of the $37.6 million other-investments portfolio was classified as Level 3, relying on significant unobservable inputs. The company also used an internal model for Star Asia; its own fair value was $32.1 million, compared with $41.3 million using Star Asia’s unadjusted reported NAV.
Important facts for investors to verify
- Whether holders exercised the Old Notes put option in May 2012, and how the $10.2 million repayment was funded.
- Whether the reported $8 million PrinceRidge loan was drawn, its repayment status, and any resulting liquidity or governance implications.
- Whether the authorized redemption-date amendments were executed and how the delayed obligations affect future liquidity.
- Subsequent performance and valuation support for Star Asia and other Level 3 assets, including the impact of yen movements and concentration risk.
- Developments in the Sentinel litigation, the Alesco XIV guarantee exposure, and other legal or regulatory contingencies.
- Whether trading, CDO management fees, and new-issue activity recovered, and whether cost reductions were sufficient to restore operating profitability.