Cohen & Company Inc. — Q3 2017 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2017. Financial figures below are in thousands of dollars unless stated otherwise. The company changed its name from Institutional Financial Markets, Inc. and completed a 1-for-10 reverse stock split on September 1, 2017; share and per-share data were retrospectively adjusted.
Business context
Cohen & Company is a fixed-income financial services firm with Capital Markets, Asset Management and Principal Investing segments. At quarter-end, assets under management were $3.55 billion, of which 90.5% was in CDOs. Management said it had not completed a securitization since 2008 and did not expect to complete future securitizations, leaving CDO-related fees exposed to declining assets.
Financial results and liquidity
| Metric | Q3 2017 | Q3 2016 | Nine months 2017 | Nine months 2016 |
|---|---|---|---|---|
| Total revenue | $10.0 million | $14.1 million | $35.9 million | $42.2 million |
| Operating income | $989 | $2,651 | $5,303 | $6,125 |
| Net income (loss) attributable to Cohen & Company | ($547) | $1,041 | $551 | $2,070 |
| Basic earnings (loss) per share | ($0.45) | $0.88 | $0.46 | $1.68 |
| Net cash from (used in) operating activities | — | ($20,331) | ($7,909) |
- Q3 operating margin was approximately 9.9%, versus 18.8% a year earlier; nine-month operating margin was approximately 14.8%, versus 14.5%.
- Q3 revenue fell 29%, primarily as net trading revenue declined 43% to $6.0 million. For the nine months, net trading revenue fell 37% to $20.2 million. New issue and advisory revenue grew, but did not offset weaker trading revenue.
- Nine-month asset management revenue rose 10% to $6.2 million, as higher managed-account revenue more than offset lower CDO fees. New issue and advisory revenue rose 83% to $4.0 million for the nine months.
- Nine-month principal transactions and other income increased to $5.5 million from $2.4 million. This included $1.579 million from the Alesco X-XVII revenue-share arrangement, which expired in February 2017, and $2.873 million from the Star Asia revenue share. Management expected Star Asia revenue to decline significantly and end in the first half of 2018.
- Operating expenses fell 15% for the nine months to $30.6 million, chiefly due to lower compensation and benefits. Interest expense increased 46% to $4.3 million, including costs from the new convertible note and redeemable financing.
- Cash and cash equivalents were $22.1 million, up from $15.2 million at December 31, 2016. Operating cash use was funded primarily by $23.9 million of financing cash flow, including $15.0 million of convertible debt proceeds and $11.0 million of redeemable-instrument proceeds.
- Total assets were $690.3 million and total equity was $47.2 million. Reported debt was $43.9 million, compared with $29.5 million at year-end 2016. Separately, repurchase-agreement liabilities were $448.1 million, against $436.5 million of resale-agreement receivables; these short-term secured financing balances are distinct from reported debt.
- Broker-dealer regulatory capital was reported at $63.7 million in total, against minimum requirements of $1.4 million. The filing cautions that regulatory restrictions can limit withdrawals or distributions from these subsidiaries.
Material changes, outlook and risks
- Trading revenue weakness was broad-based, particularly in high-yield and investment-grade corporate products. Management described earnings as unpredictable and sensitive to market activity, volatility, interest rates, mortgage volumes and competition.
- Management continued to expect CDO management fees to decline over time as underlying assets mature, repay or default. New issue and advisory revenue is also volatile because it depends on a limited number of engagements and transaction closings.
- On October 18, 2017, the company was approved as a full netting member of FICC and expected to begin using its GCF repo service in Q4 2017. It agreed to establish a committed credit line of at least $25 million within six months after account activation; FICC may terminate membership if this condition is not met. Management said access could improve financing flexibility and liquidity, while expansion of matched-book repo would be limited without access.
- On September 29, the operating subsidiary received $10 million under investment agreements with entities related to company insiders. Returns vary with matched-book repo revenue; the arrangements include redemption and termination provisions and are related-party financing.
- A separate $15 million, 8% secured convertible note was issued in March to the DGC Family Fintech Trust, established by Vice Chairman Daniel G. Cohen. It matures in March 2022, is convertible at an effective $14.50 per common share subject to terms, and is secured by equity interests in operating-company subsidiaries.
- The board declared a $0.20-per-share dividend on November 1, payable December 1, 2017. Dividends are discretionary and may be reduced or discontinued. The company also stated it could not be certain it would replace existing financing or obtain additional financing on favorable terms.
- Market risks include interest-rate exposure, counterparty and settlement failures, repo concentration, liquidity and collateral demands, and estimated fair values for less-liquid investments. A 100-basis-point yield-curve rise was estimated to produce a $4.912 million loss on net interest-rate-sensitive assets. The company also identified risks from new business initiatives and key-personnel retention.
- The company reported a Pennsylvania tax assessment of $4.683 million plus interest relating to a 2009 tax-year credit; its appeal was pending in Commonwealth Court, and no reserve was recorded. Management said routine legal and regulatory matters were not expected to materially affect results.
- Management reported effective disclosure controls as of September 30, 2017, with no material quarterly change in internal control over financial reporting. No specific earnings or revenue guidance was provided.
Important facts for investors to verify
- Whether lower trading revenue persists and whether the reported increase in other income is repeatable, particularly after the Alesco arrangement ended and Star Asia revenue declines.
- FICC account activation, compliance with the $25 million committed-line condition, and the economics and liquidity effects of expanding matched-book repo financing.
- Cash needs and repayment or conversion terms for the $15 million convertible note and insider-related redeemable financing, including variable return and redemption provisions.
- CDO AUM and fee trajectory, managed-account performance-fee sustainability, and valuation assumptions for Level 3 CLO investments.
- Resolution and potential exposure from the Pennsylvania tax appeal, and the company’s ability to meet collateral calls, regulatory capital requirements, debt obligations and dividend commitments.