Cohen & Co Inc. annual report, FY2017

Business context and reporting period

Cohen & Company Inc. is a fixed-income financial services firm operating in Capital Markets, Asset Management and Principal Investing. This Form 10-K covers the fiscal year ended December 31, 2017; dollar amounts below are in millions unless stated otherwise. The quarterly figures are unaudited. The company changed its name and completed a 1-for-10 reverse stock split on September 1, 2017; historical per-share data reflects the split.

Financial performance and liquidity

Net cash from investing activities was $(3.9) million and financing activities provided $23.1 million in 2017, including $15.0 million from a convertible note and $11.0 million from redeemable instruments, partly offset by dividends, repurchases and other financing costs. The company said cash, its trading portfolio and related borrowing capacity should meet near-term operating needs. Its broker-dealer subsidiaries reported $71.9 million of regulatory net/liquid capital against $1.4 million of minimum requirements. Cash dividends were $0.80 per share for the year.

Material changes versus the prior comparable period

• Revenue fell 14%. Net trading revenue declined 31% to $26.9 million, including lower high-yield and investment-grade corporate trading; matched-book repo revenue increased.
• Asset-management revenue decreased 8% to $7.9 million. Assets under management fell 4.8% to $3.49 billion, including CDO AUM of $3.12 billion; 89.3% of AUM was in CDOs.
• New-issue and advisory revenue rose 113% to $6.3 million. Principal transactions and other income increased 37% to $6.4 million, supported in part by revenue shares.
• Operating expenses decreased 14% to $40.1 million, mainly due to lower compensation. Net interest expense increased 30% to $6.2 million, reflecting new and existing financing.
• Year-end assets increased sharply largely as matched-book repo activity expanded: resale-agreement receivables were $1,680.9 million and repurchase-agreement liabilities were $1,692.3 million, versus $281.8 million and $295.4 million, respectively, in 2016.
• For Q4 2017, revenue was $11.7 million versus $13.2 million in Q4 2016; operating income was $2.1 million versus $2.5 million, and net income attributable to the company was $1.5 million versus $0.2 million. Q4 2017 included a $1.36 million income-tax benefit.

Outlook, commentary, risks and unusual items

• Management provided no quantified forward guidance. It described results as unpredictable and subject to market activity, volatility, interest rates, mortgage originations, competition and personnel changes.
• The company began GCF repo transactions in November 2017 after becoming a FICC netting member. It must maintain a committed credit line of at least $25 million by April 30, 2018; failure could jeopardize membership and limit repo-business expansion. The filing also identifies funding concentration on the FICC side of this business.
• All managed CDOs had reached auction-call redemption features, exposing management contracts and fees to termination through successful auctions. The company had not completed a new securitization since 2008, and CDO AUM and fees continued to decline.
• Related-party financing includes a $15 million, 8% five-year convertible senior secured note issued to a trust established by the chairman, and $10 million of redeemable financing from entities associated with the chairman. The 2017 note is convertible at an effective $14.50 per common share, subject to terms and restrictions. Another redeemable instrument is associated with the vice chairman and has returns linked to a trading business.
• The Tax Cuts and Jobs Act produced a one-time $1.3 million tax benefit in Q4 from remeasurement of deferred taxes. The company reported substantial NOL and net capital loss carryforwards, but a significant valuation allowance; their future realization is uncertain.
• A Pennsylvania tax assessment of $4.683 million plus interest remains under appeal; the company recorded no reserve. Management said routine legal and regulatory matters were not expected to materially affect results, while noting legal costs could not be estimated.
• Other key risks include repo margin and counterparty exposure, dependence on Pershing for clearing and margin financing, variable-rate debt, illiquid investments, regulatory capital requirements, Brexit-related operating changes and potential loss of key staff. Management concluded disclosure controls and internal control over financial reporting were effective; auditor attestation on internal controls was not provided.

Important facts for investors to verify

• Whether the new GCF repo business earns adequate returns after financing, operating and related-party investment-return costs, and whether the required FICC credit line was established by the deadline.
• The quality and liquidity of trading and principal-investment valuations, including Level 3 assets, and the sensitivity of results to market movements.
• The pace of CDO liquidations, AUM decline and fee diversion, and the sustainability of replacement asset-management revenue.
• Liquidity and refinancing capacity, including the 2013 convertible notes due September 2018, variable-rate junior subordinated notes, repo funding and redeemable instruments.
• The terms, potential dilution and governance implications of related-party financing and the chairman’s voting influence.
• The outcome of the Pennsylvania tax appeal, use and expiration of tax-loss carryforwards, and whether dividends remain sustainable.

The financial statements received an unqualified audit opinion. Segment operating results exclude unallocated overhead and interest expense, so segment profit figures should not be read as consolidated earnings.