Business context and reporting period
Institutional Financial Markets, Inc. (IFMI), which was previously named Cohen & Company Inc., filed this unaudited Form 10-Q for the quarter and six months ended June 30, 2012. The filing describes a credit-focused financial firm with Capital Markets, Asset Management, and Principal Investing segments. It reported approximately $6.24 billion of assets under management (AUM), 97% in company-sponsored CDOs. Dollar amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Revenue | $25.04 | $23.46 | $43.80 | $55.77 |
| Operating income (loss) | $0.83 | ($8.18) | ($4.37) | ($6.59) |
| Net income (loss) | ($3.17) | ($5.06) | ($9.06) | ($4.64) |
| Net income (loss) attributable to IFMI | ($2.08) | ($3.37) | ($5.94) | ($3.00) |
| Basic and diluted loss per share | ($0.19) | ($0.31) | ($0.56) | ($0.28) |
- Q2 revenue rose 7%, led by a 23% increase in net trading to $19.95 million. Cost reductions helped return the quarter to operating income, but IFMI still recorded a net loss.
- First-half revenue fell 21%; net trading declined 13% to $37.64 million, asset management fees declined 15% to $9.55 million, and principal transactions and other income were a $4.66 million loss. The latter included a $5.21 million loss on fair-value changes in other investments.
- First-half operating expenses decreased 23% to $48.17 million, including lower compensation and professional fees. Net loss attributable to IFMI nevertheless widened, principally amid weaker investment valuations and lower income from equity-method affiliates; the 2011 period included a $4.36 million share of a Deep Value incentive fee.
- AUM was $6.24 billion at June 30, down from $8.06 billion at December 31, 2011 and $9.34 billion at June 30, 2011. Management attributed lower fees in part to CDO collateral defaults, deferrals, prepayments, liquidations, and foreign-exchange movements.
Cash, liquidity, and debt
- Cash and cash equivalents were $12.94 million at June 30, versus $18.22 million at year-end. First-half operating cash flow was $1.08 million, investing cash flow was $5.40 million, and financing cash flow was negative $11.71 million; cash decreased $5.28 million overall. Operating cash flow was affected materially by trading and collateral-financing balance changes.
- Total assets were $503.04 million and total liabilities $425.56 million. Debt carrying value was $26.73 million, down from $37.17 million; estimated debt fair value was $32.7 million. IFMI repurchased or redeemed $10.26 million of debt in the first half, including $10.11 million of Old Notes. The remaining $0.1 million of Old Notes was redeemed July 5, 2012.
- Repurchase-agreement liabilities were $244.06 million, compared with $247.29 million of receivables under resale agreements. The company says substantially all reverse-repurchase collateral was re-pledged. It reported meeting margin calls to date but warned it may not be able to meet future collateral demands.
- PrinceRidge partnership withdrawals were reflected in $8.30 million of mandatorily redeemable equity interests at quarter-end. IFMI also borrowed $8.0 million from PrinceRidge in May at 10%, secured by its PrinceRidge interests, with maturity in May 2013.
- Dividends declared were $0.02 per common share for Q2, compared with $0.05 in Q2 2011. The company cautioned that dividends may be reduced or discontinued.
Material changes, outlook, risks, and unusual items
- Management described the market environment as challenging and said it expected conditions to remain challenging through the remainder of 2012 and near term. It noted persistent competition and margin pressure in corporate bond brokerage, and that it had not completed a new securitization since 2008. No quantified earnings or revenue guidance was provided.
- Q2 trading gains included gains from a small number of riskless trades at PrinceRidge and EDML; management cautioned that trading results may not indicate future performance. Fair-value estimates for some holdings use Level 3 inputs and may differ from realizable sale prices.
- The $32.30 million Star Asia investment represented 86% of other investments at fair value. The company recorded a $5.06 million first-half loss on it and used an internal adjusted-NAV model; the filing states its value would have been $41.74 million using Star Asia’s unadjusted NAV. The investment also creates substantial Japanese-yen exposure.
- CCS reached an agreement in principle to settle Sentinel litigation for an initial $3.0 million and a further $2.25 million payment, subject to final documentation and court approval. IFMI accrued $4.36 million, net of estimated insurance proceeds and discounting, as a Q2 non-operating expense.
- A separate U.S. Bank lawsuit filed June 29, 2012 alleges breach of contract over trustee fees; the company said it intended to defend the action. The filing provides no clear estimate of potential loss for this claim. An Alesco XIV guarantee had a recorded liability of $1.08 million and maximum potential loss of $8.75 million.
- On July 19, 2012, PrinceRidge repurchased former executives’ equity and profit units for $8.23 million. The filing says it expects to record $2.10 million of compensation expense, partially offset by expense reductions from forfeited unvested awards, in Q3.
- Market sensitivities disclosed at June 30 included a $2.46 million loss for a 100-basis-point yield-curve rise, $3.72 million for a 10% adverse equity-price change, and $3.23 million for a 10% adverse foreign-exchange change. Management said available cash and its trading portfolio should meet near-term needs, while warning that future financing may not be available on acceptable terms.
- Broker-dealer subsidiaries exceeded stated minimum net-capital requirements. Disclosure controls were deemed effective; integration of PrinceRidge controls was expected to be completed by year-end 2012.
Important facts for investors to verify
- Whether trading performance and expense reductions can be sustained, and whether the first-half investment losses continue.
- How AUM and management fees evolve as CDO collateral defaults, prepayments, and liquidations affect the managed base.
- Liquidity and collateral capacity given cash of $12.94 million, substantial repo activity, the PrinceRidge borrowing, and scheduled redemptions and debt repurchases.
- Valuation assumptions and realizability of Star Asia and other Level 3 investments, including Japanese-yen exposure.
- Final terms, court approval, and insurance recovery for the Sentinel settlement, and developments in the U.S. Bank litigation and Alesco XIV guarantee.
- Q3 accounting for PrinceRidge’s former executives’ unit repurchase and forfeited awards, and subsequent effects on compensation expense and equity.