Cohen & Co. / Institutional Financial Markets, Inc. — Q3 2016 Form 10-Q
Reporting period: Three and nine months ended September 30, 2016. The filing’s registrant is Institutional Financial Markets, Inc. (IFMI), a fixed-income financial services company with Capital Markets, Principal Investing, and Asset Management segments. Unless otherwise noted, financial figures below are in thousands of dollars.
Financial results and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $14,090 | $12,927 | $42,190 | $36,772 |
| Operating income | $2,651 | $558 | $6,125 | $1,350 |
| Net income (loss), consolidated | $1,530 | $(647) | $2,995 | $(1,868) |
| Net income (loss) attributable to IFMI | $1,041 | $(533) | $2,070 | $(1,436) |
| Basic and diluted earnings (loss) per share | $0.09 | $(0.03) | $0.17 | $(0.09) |
| Operating margin (approx.) | 18.8% | 4.3% | 14.5% | 3.7% |
- Revenue mix: Q3 net trading revenue rose 26% to $10.486 million; asset management fell 24% to $1.781 million; new issue and advisory revenue fell 62% to $811,000; principal transactions and other income increased to $1.012 million. For the first nine months, net trading increased 43% to $31.973 million, while asset management declined 18% to $5.662 million and new issue/advisory declined 49% to $2.176 million.
- Expenses and interest: Q3 operating expenses declined 8% to $11.439 million, mainly from lower professional and other operating expenses. Nine-month expenses increased 2% to $36.065 million, including compensation and benefits up 17% to $24.392 million. Interest expense was $991,000 for Q3 and $2.973 million year to date.
- Cash flow: Operating cash flow was negative $7.909 million for the nine months, versus negative $7.980 million in 2015. Investing activities provided $7.477 million; financing activities used $3.384 million. Cash declined $4.030 million to $10.085 million.
- Balance sheet at September 30: Assets were $521.375 million, liabilities $474.742 million, and total equity $46.633 million. Cash was $10.085 million. Receivables under resale agreements were $288.286 million; repurchase-agreement liabilities were $302.800 million. Trading investments were $131.006 million.
- Debt and liquidity: Reported debt was $29.290 million, including $8.248 million of 8% convertible notes due September 2018 and junior subordinated notes. The notes’ estimated fair value was $34.684 million. JVB and CCFL reported regulatory capital above their respective minimums; combined broker-dealer net capital was $39.021 million. Management said cash, the trading portfolio, and related borrowing capacity should meet near-term operating needs, while noting uncertainty around future financing availability.
- Assets under management: $3.798 billion at quarter-end, of which 95% was in CDOs. Company-sponsored CDO AUM was $3.607 billion.
Material changes versus comparable periods
- IFMI returned to profitability in Q3 and the first nine months, from losses in the prior-year periods. Higher net trading revenue was the main contributor; nine-month operating income increased to $6.125 million from $1.350 million.
- Trading activity and matched-book repo revenue strengthened, while new issue/advisory revenue and asset management fees weakened. Management attributed lower CDO fees to shrinking collateral balances, repayments, and, for one European CLO, deteriorating portfolio performance and triggered cash-flow diversion features.
- Balance-sheet scale increased: total assets rose from $308.415 million at December 31, 2015 to $521.375 million, alongside higher resale receivables, trading assets, and repo financing. Cash fell over the same period.
- Common shares outstanding declined, reflecting repurchases and retirement of shares. The company repurchased shares for $2.319 million in the first nine months, including privately negotiated purchases.
Outlook, risks, contingencies, and unusual items
- Outlook: Management expects asset-management revenue to continue declining over time: the company has not completed a securitization since 2008 and does not expect to complete future securitizations. New issue/advisory revenue is described as volatile because it depends on a limited number of transactions and their closing dates. No numeric earnings or revenue guidance was provided.
- Market and funding risks: Results are exposed to trading volumes, market volatility, interest rates, credit performance, liquidity, counterparties, and clearing-agency financing. A 100-basis-point parallel yield-curve increase was estimated to reduce net interest-sensitive asset value by $5.584 million; a 100-basis-point decrease was estimated to increase it by $5.583 million. Repurchase and clearing obligations are recourse obligations and may require additional collateral.
- Valuation risk: Some principal investments, including CLO holdings, use Level 3 valuations and management assumptions. Level 3 CLO holdings were $6.229 million; reported sensitivity is adverse to higher assumed yields, duration, or defaults. EuroDekania, valued at $1.241 million, does not offer redemptions.
- Legal contingency: The company is appealing a Pennsylvania tax assessment of $4.683 million plus interest related to a 2009 subsidiary tax year. It recorded no reserve. Management said routine legal and regulatory matters were not expected to have a material adverse effect, but could not estimate associated future legal fees.
- European operations: A proposed sale remained unresolved; management said the likelihood of closing was very low but had not exercised its termination right.
- Related-party investment after quarter-end: On October 3, 2016, an entity owned by the board chairman and spouse invested $6 million in IFMI, LLC, with an agreement for up to $12 million. In return, it is entitled to 50% of specified quarterly Institutional Corporate Trading business revenue less certain expenses. The agreement also includes termination, redemption, and potential sale-payment provisions.
- Other capital actions: The board adopted a Section 382 rights agreement intended to protect tax-loss carryforwards. A $0.02-per-share dividend was declared November 1, 2016, payable November 30 to holders of record November 16; future dividends are not assured.
- Controls: Management concluded disclosure controls and procedures were effective as of September 30, 2016, with no material quarterly change in internal control over financial reporting.
Most important facts for investors to verify
- Whether the higher trading revenue and profitability are repeatable, given market sensitivity and the inclusion of unrealized trading gains.
- The trajectory of CDO AUM and fees, including the European CLO’s performance and cash-flow diversion provisions.
- Liquidity and collateral capacity as repo balances and trading activity grow, and the availability and terms of clearing-agency and other financing.
- The status and potential financial impact of the Pennsylvania tax appeal and the proposed European operations sale.
- The full economics, governance, and potential obligations of the chairman-affiliated investment agreement, including its revenue share and termination or redemption terms.
- Future cash needs and refinancing plans for the 8% convertible notes due in 2018 and variable-rate subordinated notes.