Oppenheimer Holdings Inc. — Q3 2013 Form 10-Q
Reporting period: Three and nine months ended September 30, 2013; financial statements are unaudited. Amounts below are in U.S. dollars. Financial statement amounts are generally in millions unless stated otherwise.
Business context and reporting period
Oppenheimer is a diversified financial-services firm spanning private-client brokerage, asset management, capital markets, and commercial mortgage origination and servicing. At quarter-end, it reported $81.8 billion of client assets under administration, $23.8 billion of assets under management, 96 U.S. offices and 3,544 employees.
Financial performance
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $243.4 | $231.8 | $726.4 | $703.2 |
| Income before tax | $8.2 | $5.3 | $20.6 | $6.6 |
| Net income | $5.5 | $3.0 | $12.5 | $2.5 |
| Net income attributable to Oppenheimer Holdings | $5.2 | $2.3 | $11.7 | $0.09 |
| Diluted EPS attributable to Oppenheimer Holdings | $0.37 | $0.16 | $0.83 | $0.01 |
| Dividends declared per share | $0.11 | $0.11 | $0.33 | $0.33 |
Revenue increased 5.0% in Q3 and 3.3% year to date. Pretax margin, calculated as pretax income divided by revenue, was approximately 3.4% versus 2.3% in Q3 and 2.8% versus 0.9% year to date. Compensation and related expenses were $161.1 million in Q3 and $480.3 million year to date; compensation equaled 66.2% and 66.1% of revenue, respectively, compared with 65.6% in both prior-year periods.
Q3 revenue gains came chiefly from commissions (+6.0%) and advisory fees (+13.4%); principal transactions declined 28.0%. For the first nine months, advisory fees rose 13.2%, while investment banking revenue fell 6.4%, principal transactions fell 16.8%, and interest revenue fell 6.0%. Results also reflect $2.3 million of Q3 litigation expense.
Liquidity, cash flow, debt and balance sheet
- Cash and cash equivalents were $105.4 million at September 30, down from $135.4 million at December 31, 2012. Cash from operating activities was $22.9 million for the first nine months, compared with cash used of $25.5 million in 2012. Investing activities used $12.6 million and financing activities used $40.3 million, leaving a $30.0 million net cash decrease.
- Total assets were $3.00 billion, up 11.9% from year-end, primarily reflecting greater government and agency securities inventory. Total liabilities were $2.48 billion and stockholders’ equity was $515.3 million.
- Senior secured notes were $195.0 million, bearing 8.75% interest and due April 2018; the company reported compliance with note covenants. Bank call loans were $94.8 million, down from $128.3 million at year-end. The filing reports a gross leverage ratio of 5.8.
- Repurchase agreements were $630.9 million on the balance sheet; gross repurchase and reverse-repurchase balances were $3.2 billion and $2.6 billion, respectively. These are collateralized financing balances, not equivalent to funded corporate debt. Management said operating funds, capital and available credit facilities should meet foreseeable liquidity needs, while noting funding availability can depend on market conditions.
- Oppenheimer’s regulatory net capital was $159.0 million, $132.8 million above its minimum. The filing does not present a conventional current ratio or a single consolidated measure of immediately available, unrestricted liquidity.
Segments and material changes
| Segment | Q3 revenue | Q3 pretax income | Year-to-date revenue | Year-to-date pretax income |
|---|---|---|---|---|
| Private Client | $144.3 million | $15.1 million | $431.0 million | $48.1 million |
| Asset Management | $21.5 million | $6.4 million | $64.5 million | $20.3 million |
| Capital Markets | $68.5 million | $4.3 million | $201.5 million | $8.8 million |
| Commercial Mortgage Banking | $9.3 million | $2.8 million | $26.9 million | $8.0 million |
Private Client and Asset Management revenue and pretax income improved year over year. Capital Markets revenue was nearly flat in Q3, while year-to-date revenue declined. Commercial Mortgage Banking Q3 revenue grew, but pretax income fell; year-to-date both revenue and pretax income declined. The company separately reported Commercial Mortgage Banking as a segment following growth in that business and revised prior segment presentation.
Outlook, commentary, risks and unusual items
- No quantified near-term earnings or revenue guidance was provided. Management’s longer-term priorities include hiring experienced financial advisers and investment professionals, expanding capital-markets capabilities, investing in technology, managing expenses, and growing commercial mortgage and international businesses.
- Management described market volatility linked to expectations of Federal Reserve tapering, rising longer-term interest rates, and U.S. budget and debt-ceiling uncertainty. It highlighted sensitivity to securities-market activity, interest rates, credit and liquidity conditions, competition, regulation, and legal outcomes.
- Auction-rate securities (ARS) remain a significant exposure. The company held approximately $85.9 million of client ARS purchased under settlements and had further commitments of $36.2 million through 2016. Clients held approximately $185.7 million of ARS at the firm, subject to stated exclusions. The company recorded a $7.9 million ARS valuation adjustment; values depend on less observable assumptions, and management said it could not assure a liquidity solution for all clients.
- For legal proceedings with at least a reasonable possibility of loss where a range could be estimated, the estimated aggregate loss beyond accrued amounts was $0–$24 million; some matters could not be estimated and actual losses may exceed the estimate. On October 25, 2013, the company agreed to settle the Providence matter for $10.0 million, with $4.9 million of insurance proceeds, and a related matter for $0.5 million. Both were fully reserved at September 30 and remained subject to court approval.
- The company had a $25 million deferred acquisition payment in escrow amid a breach-of-contract dispute with CIBC, which also sought payment through arbitration. A FINRA arbitration award against Oppenheimer in the U.S. Airways ARS matter resulted in a $30 million payment in February 2013; the firm was pursuing recovery from Deutsche Bank Securities, with no assurance of success.
- Oppenheimer paid a $1.425 million FINRA fine and agreed to an independent consultant review concerning penny-stock supervision and anti-money-laundering controls. The SEC had issued a Wells Notice related to penny-stock sales; the company had responded. Separately, asset-management affiliates settled SEC and Massachusetts matters concerning valuation disclosures, including disgorgement and penalties totaling approximately $3.0 million and an independent consultant review.
- Standard & Poor’s lowered its rating on the company and notes to B from B+ in March 2013, citing weak operating results and legal and litigation costs; Moody’s affirmed its B2 ratings in June. Management cited possible indirect effects from regulatory changes, sovereign-credit concerns, and changing funding conditions.
Most important facts for investors to verify
- Whether revenue and earnings improvement can continue, particularly given higher compensation as a share of revenue and weaker principal-transactions and investment-banking revenue.
- ARS repurchase obligations, client exposure, valuation assumptions, and the effect of future redemptions, settlements or client claims on cash and earnings.
- Liquidity and collateral capacity under stress, including reliance on repo financing, bank call loans, and market availability of short-term funding.
- Potential outcomes and cash costs of the CIBC dispute, ARS matters, U.S. Airways recovery effort, and other legal or regulatory proceedings; some possible losses are not estimable.
- Commercial Mortgage Banking loan commitments, warehouse funding, servicing-right valuations, and performance relative to origination and servicing growth.
- Note covenants and rating developments, the $25 million escrow, and approval and payment status of the October 2013 settlements.