Business context and reporting period
Institutional Financial Markets, Inc. (IFMI), a fixed-income-focused financial services company, filed this unaudited Form 10-Q for the quarter ended March 31, 2017. The filing reports results for the three months ended March 31, 2017, compared with the same period in 2016. Amounts below are in U.S. dollars; financial-statement figures are in thousands unless stated otherwise.
IFMI operates Capital Markets, Asset Management, and Principal Investing businesses. It reported $3.54 billion of assets under management (AUM), of which 93.5% was in CDOs.
Financial and operating metrics
| Metric | Q1 2017 | Q1 2016 |
|---|---|---|
| Total revenue | $14,492 | $13,735 |
| Operating expenses | $11,904 | $12,471 |
| Operating income | $2,588 | $1,264 |
| Interest expense | $1,612 | $990 |
| Net income | $971 | $264 |
| Net income attributable to IFMI | $672 | $199 |
| Basic / diluted earnings per share | $0.06 / $0.05 | $0.01 / $0.01 |
| Operating cash flow | $(19,892) | $(7,130) |
| Cash and cash equivalents, quarter-end | $11,178 | $5,615 |
Operating margin was approximately 17.9% versus 9.2% in Q1 2016; net income attributable to IFMI was approximately 4.6% of revenue versus 1.4%. These are calculations from reported figures.
At March 31, 2017, total assets were $572,883 and total liabilities were $525,113; total equity was $47,770. Reported debt was $43,477, compared with $29,523 at December 31, 2016. In addition, securities sold under repurchase agreements totaled $314,008, largely matched by $314,022 of receivables under resale agreements. The filing describes most repo activity as matched-book financing.
Cash fell by $4,038 during the quarter. Financing activities provided $15,196, principally from a $15,000 convertible note and a $1,000 investment in a redeemable financing instrument; operating activities used $19,892. Management stated that cash, the trading portfolio, and related borrowing capacity should provide sufficient near-term liquidity. Broker-dealer regulatory capital was reported as $54,359 against minimum requirements totaling $1,383.
Material changes versus the prior comparable period
- Revenue rose 6% to $14,492. Net trading revenue fell 21% to $8,075, including a $2,674 decline in investment-grade corporate trading, partly offset by stronger mortgage and high-yield corporate trading.
- Asset management revenue increased 16% to $2,692, as managed-account fees and performance fees more than offset a $390 decline in CDO fees. AUM was $3.54 billion, down from $3.89 billion a year earlier.
- New issue and advisory revenue increased to $1,112 from $381, while principal transactions and other income rose to $2,613 from $840. The latter included $1,776 from the Alesco X-XVII revenue-share arrangement, which expired in February 2017; the company said no further revenue would be earned from it.
- Operating expenses declined 5%, primarily reflecting lower compensation and benefits. Professional fees rose by $691, mainly for consulting related to European new-issue and advisory revenue.
- Interest expense increased 63% to $1,612, including expense on the new convertible note and redeemable financing instrument.
Outlook, commentary, risks and unusual items
- Management said it does not expect to complete future securitizations and expects CDO-related asset-management revenue to continue declining as managed collateral amortizes, repays, or defaults. The filing provides no quantitative earnings or revenue guidance.
- On March 10, 2017, the operating subsidiary issued a $15,000, five-year, 8% convertible senior secured note to DGC Family Fintech Trust, established by a senior company executive and director. The note is convertible into operating-company units at $1.45 per unit and is secured by the operating subsidiary’s equity interests in its subsidiaries.
- The proposed sale of European operations for approximately $8.7 million was terminated on March 10, 2017. A $600 termination fee owed by the executive was offset against a $600 transaction fee payable to the note investor. The employment-agreement amendment reducing a potential termination payment from $3 million to $1 million became effective.
- Management described trading and new-issue revenue as volatile and sensitive to market activity, interest rates, mortgage volumes, competition, and staffing. It also cited liquidity and financing availability, counterparty credit, regulatory capital, and potential litigation as risks. A 100-basis-point yield-curve rise was estimated to cause a $1,214 loss on net interest-rate-sensitive positions; a 100-basis-point decline was estimated to produce a $1,357 gain.
- The company is appealing a Pennsylvania tax assessment of $4,683, including penalties, related to a 2009 tax year; it recorded no reserve. Management said routine legal and regulatory matters were not expected to have a material adverse effect, while noting that future legal costs cannot be estimated.
- The board declared a $0.02-per-share dividend on May 3, 2017, payable June 1, 2017. Management cautioned dividends may be reduced or discontinued.
Important facts for investors to verify
- Whether the operating cash outflow and dependence on repo, clearing-agency financing, and margin arrangements remain manageable; much of repo funding is short-term.
- The terms, related-party nature, collateral, conversion and dilution implications, and future interest burden of the $15 million note, alongside the redeemable financing instrument.
- The sustainability of earnings: trading revenue declined, CDO fees are expected to continue falling, and Q1 income included substantial revenue from an expired revenue-share arrangement.
- The valuation assumptions and realizability of investments, especially Level 3 CLO holdings and the EuroDekania investment; fair-value estimates rely in part on management assumptions.
- The outcome of the Pennsylvania tax appeal and any material developments in other litigation or regulatory matters.
- The filing stated disclosure controls were effective as of March 31, 2017, with no material changes in internal control over financial reporting during the quarter.