Cohen & Co Inc. quarterly report, Q2 FY2013

Business context and reporting period

Institutional Financial Markets, Inc. (IFMI; the filing describes Cohen & Co. entities within its operations) filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2013. The financial statements are in thousands of dollars, except per-share data. IFMI is a financial-services company focused on credit-related fixed-income markets, with Capital Markets, Asset Management and Principal Investing segments. Assets under management were $6.19 billion, 95% of which was in CDOs.

Financial performance and position

• Q2 revenue fell 45% year over year; six-month revenue fell 37%. Net trading revenue declined 42% in Q2 and 34% for the half-year. Asset-management revenue also declined, while new-issue and advisory revenue increased from a low base.
• Principal transactions and other income were losses of $2.623 million in Q2 and $7.413 million for the half-year. Fair-value losses on other investments were $4.594 million in Q2 and $9.993 million for the half-year.
• Operating expenses fell 19% in Q2 and 15% for the half-year, mainly reflecting lower compensation and benefits. Cost reductions did not offset weaker revenue and investment marks.
• Six-month operating cash flow was negative $5.281 million, versus positive $1.079 million in 2012. Investing activities provided $2.646 million and financing activities used $1.774 million. Cash declined $4.584 million to $9.916 million.
• At June 30, total assets were $357.121 million, total liabilities $293.858 million, and permanent equity $62.745 million. Debt carried at $26.400 million, up from $25.847 million at year-end; estimated debt fair value was $36.5 million. Repurchase-agreement liabilities were $103.443 million.
• Trading inventory was $176.875 million; other investments at fair value were $28.686 million. Star Asia represented $20.935 million of the latter and was valued using a Level 3 internal model. IFMI reported a Star Asia fair-value decline of $9.234 million for the half-year, including a $5.697 million foreign-exchange loss.
• Broker-dealer subsidiaries reported regulatory capital above minimum requirements. IFMI stated that available cash, trading assets and related borrowing capacity were expected to meet near-term operating needs.

Changes, outlook, risks and unusual items

• Management attributed weaker trading results to lower volumes and margins, rising interest rates and mark-to-market losses; it noted a further broad-based volume reduction beginning in June. Management characterized the business environment as challenging for the remainder of 2013 and warned that market uncertainty could continue to constrain trading.
• Asset-management fees from U.S. Alesco X–XVII services declined after the service agreement expired in February 2013. IFMI may still receive contingent incentive payments through February 2017. AUM was down from $6.241 billion at June 2012; company-sponsored CDO AUM declined to $5.894 billion from $6.048 billion.
• In March, IFMI gained control of Star Asia Manager and began consolidating it. The acquisition contributed $1.055 million in revenue and $0.661 million in net income from March 1 through June 30; purchase accounting remained provisional.
• A proposed $13.746 million investment by Mead Park Capital and CBF comprised $5.498 million of common stock and $8.248 million of convertible notes bearing 8% interest and maturing in five years. Closing required shareholder approval and other conditions. The company warned of potential dilution and risks if the transaction did not close. The filing described planned board and executive changes, including a CEO succession search; Lester Brafman was appointed President in June.
• An Alesco XIV guarantee liability of $1.084 million was extinguished when the underlying loan was repaid in May; IFMI recognized the amount as income. Conversely, the court denied IFMI’s motion to dismiss a U.S. Bank fee-related lawsuit in July; IFMI intended to defend the case and said the ultimate loss was uncertain.
• Management highlighted exposure to interest rates, market liquidity and trading volumes, counterparty and margin-call risks, foreign exchange (especially Japanese yen), and illiquid or model-valued investments. A 100-basis-point yield-curve rise was estimated to produce a $5.173 million loss; a 10% adverse equity-price move, a $2.796 million loss; and a 10% adverse foreign-exchange move, a $2.423 million loss.
• On August 6, after quarter-end, the board declared a $0.02-per-share dividend. The filing cautioned that future dividends could be reduced or discontinued. The $8.121 million contingent convertible notes had an earliest holder put date of May 2014, creating a near-term refinancing or repayment consideration.

Important facts for investors to verify

• Whether the Mead Park/CBF financing closed, the resulting dilution and note terms, and the status of the CEO and board transition.
• Subsequent trading volumes, revenue trends and expense reductions, especially after the June activity slowdown and interest-rate-driven inventory losses.
• Liquidity available to meet repo margin calls and the May 2014 note put; also verify financing access and subsidiary regulatory-capital restrictions.
• Valuation assumptions and further performance or currency movements for Star Asia and other investments, including Level 3 marks.
• Developments and any additional accruals in the U.S. Bank litigation, as well as continuation of the quarterly dividend.