Cohen & Company Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; comparisons are with the three months ended March 31, 2017 unless otherwise noted. Financial statement amounts below are in U.S. dollars, converted to millions from the filing’s stated thousands, except per-share data.
Business context and reporting period
Cohen & Company is a financial services company focused on fixed-income markets. Its businesses are Capital Markets, Asset Management and Principal Investing. At quarter-end, assets under management (AUM) were $3.43 billion, of which 88.6% was in collateralized debt obligations (CDOs). The company said it had not completed a new securitization since 2008.
Financial and operating performance
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenue | $9.34 million | $14.49 million |
| Operating expenses | $9.70 million | $11.90 million |
| Operating income (loss) | $(0.36) million | $2.59 million |
| Net income (loss), consolidated | $(2.15) million | $0.97 million |
| Net income (loss) attributable to Cohen & Company Inc. | $(1.47) million | $0.67 million |
| Basic and diluted EPS | $(1.26) | $0.56 basic; $0.52 diluted |
| Operating cash flow | $4.66 million | $(19.89) million |
- Revenue fell 36%. Net trading revenue declined 23% to $6.19 million; asset management revenue fell 33% to $1.80 million; new issue and advisory revenue fell 37% to $0.70 million; and principal transactions and other income fell 75% to $0.65 million.
- Operating expenses decreased 19%, mainly reflecting lower compensation and professional fees. The revenue decline nevertheless drove the company from operating profit to an operating loss. Calculated operating margin was approximately negative 3.9%, versus positive 17.9% a year earlier.
- Interest expense rose 13% to $1.82 million. The filing reports no conventional gross-margin measure.
- Cash and cash equivalents were $11.76 million at March 31, down from $22.93 million at year-end. Investing activities used $15.72 million, including $16.77 million for other investments; operating activities provided $4.66 million. Financing activities used $0.19 million.
- Total assets were $2.41 billion and total liabilities were $2.37 billion. Total equity was $45.71 million, down from $48.16 million at December 31, 2017.
- Debt carrying value was $44.40 million; redeemable financial instruments added $16.73 million. The debt included $15.0 million of 8% convertible notes due March 2022, $8.25 million of 8% convertible notes due September 2018, and junior subordinated notes. The filing reports estimated fair value of debt of $55.73 million.
- Repo-related balances expanded: receivables under resale agreements were $2.07 billion and securities sold under repurchase agreements were $2.11 billion, compared with $1.68 billion and $1.69 billion, respectively, at year-end. These are collateralized financing balances, not equivalent to unsecured borrowings.
- Regulatory capital remained above minimums: JVB’s adjusted net capital was $59.10 million, $58.85 million above its minimum; CCFL’s net liquid capital was $2.22 million, $1.02 million above its minimum.
Material changes versus the prior comparable period
- Net trading revenue decreased by $1.88 million. Matched-book repo revenue increased, but mortgage, high-yield corporate, investment-grade corporate, and wholesale and other trading revenue declined.
- Asset management fees from CDOs fell as principal repayments, deferrals, defaults and reduced assets under management weighed on fees. Other asset management revenue declined mainly because of lower performance fees.
- Principal transactions and other income included no Alesco X-XVII revenue share in Q1 2018; Q1 2017 included $1.78 million from that arrangement, which expired in February 2017. This was a significant factor in the year-over-year decline.
- Compensation and benefits fell $1.99 million, partly due to lower incentive compensation and no first-quarter director restricted-stock grants; headcount nevertheless increased to 92 from 80 a year earlier.
- AUM was $3.43 billion, down from $3.54 billion at March 31, 2017 and $3.49 billion at December 31, 2017.
- Operating cash flow turned positive compared with the prior-year quarter, while cash declined in both periods. Q1 2018 cash movements reflected larger repo balances and purchases of other investments; Q1 2017 financing included issuance of the $15 million convertible note.
Outlook, commentary, risks and contingencies
- The filing provides no specific numerical earnings or revenue guidance. Management warns that results are unpredictable and may vary substantially by quarter, depending on financial-market conditions, trading volumes, interest rates, mortgage activity and transaction closings.
- Management says fixed-income brokerage margins and volumes remain under pressure from competition and lower market activity. Cost controls and business diversification are ongoing, but there is no assurance they will offset margin compression.
- Management expects asset management revenue to remain exposed to declining CDO assets and notes that new securitizations depend on origination capacity, financing availability and market demand. The company was developing Concordant Capital Group to pursue residential transition loans and was seeking capital and business partners.
- Matched-book repo funding presents concentration and liquidity risks. The filing identifies reliance on FICC for much of GCF repo funding and concentration among four gestational repo borrowers. Repo and clearing arrangements can require additional collateral; a default or loss of clearing access could disrupt business.
- On April 25, 2018, after quarter-end, JVB entered a $25 million credit facility with MB Financial Bank, bearing interest at LIBOR plus 6%, with a $250,000 commitment fee and a 0.50% fee on the undrawn commitment. The facility matures April 10, 2020, is secured and guaranteed by affiliates, and has financial covenants. The filing does not state that any amount had been drawn.
- The company declared a $0.20-per-share dividend for payment May 30, 2018. Management cautions that future dividends may be reduced or discontinued.
- A Pennsylvania tax assessment of $4.68 million plus interest relates to a subsidiary that ceased operations in 2009. The company recorded no liability, stating it believes claims are limited to that subsidiary’s assets. Management also describes routine legal and regulatory matters as not expected to have a material adverse effect, while noting related future legal costs cannot be estimated.
- Level 3 valuations and principal investments involve judgment and may differ from eventual sale values. A 100-basis-point parallel rise in yields was estimated to produce a $2.94 million loss; a 10% adverse equity-price move a $1.44 million loss; and a 100-basis-point change in three-month LIBOR a $0.48 million annual change in cash interest.
- Management reported disclosure controls and procedures were effective as of March 31, 2018, with no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether revenue and profitability stabilize after the broad year-over-year declines, particularly in trading, asset management and new issue/advisory activities.
- How much cash and usable borrowing capacity remain available after repo growth, investment purchases and the April 2018 credit facility; confirm facility drawings, fees and covenant compliance in later filings.
- The maturity and refinancing or conversion outcome of the $8.25 million 2013 Convertible Notes due September 2018, and the terms and related-party status of convertible and redeemable financing.
- Whether repo counterparties, FICC funding access, clearing arrangements and collateral requirements remain stable, given the business’s concentration and liquidity exposures.
- The valuation, performance and impairment exposure of CLOs and other fair-value investments, including the $14.25 million CLO balance measured using Level 3 inputs.
- Developments in the Pennsylvania tax assessment, routine legal matters, and the sustainability of the quarterly dividend amid losses and financing obligations.