JMP Group LLC
Q1 2019 Earnings Call Transcript

Published: 4 May 2019

[Operator:]

Welcome to JMP Group’s First Quarter 2019 Earnings Conference Call. Please note that today’s call is being recorded. [Operator Instructions] I’ll now turn the call over to Andrew Palmer, the Company’s Head of Investor Relations.

[Andrew Palmer:]

Good morning. On the line with me today are Joe Jolson, JMP Group’s Chairman and Chief Executive Officer; and Ray Jackson, the Company’s Chief Financial Officer. We’re joined by Carter Mack, President of JMP Group; and Mark Lehmann, President of JMP Securities. Before we begin, please note that some of this morning’s comments may contain forward-looking statements about future events that are out of JMP’s control. Actual results may differ materially from those indicated or implied. For a discussion of the uncertainties that could affect the Company’s future performance, please review the risk factors detailed in our most recent 10-K. With that, I’ll turn things over to JMP’s Chairman and CEO, Joe Jolson.

[Joe Jolson:]

Thanks, Andrew. We had better than expected first quarter, thanks to very strong investment results with operating net income of $0.08 per share. JMP Securities normally a very meaningful contributor of earnings faced a stiff headwind in the form of a partial government shutdown and lost $0.05 per share in the quarter with the SEC’s closure dramatically curtailing capital markets activity for much of the period. Asset management fee income and investment income combined to contribute $0.12 per share, compared to a loss of $ 0.07 per share for the first quarter of 2018. In an important strategic shift, we executed the March sale of a controlling interest in JMP Credit Advisors to Medalist Partners, raising additional growth capital for our corporate credit business and adding approximately $0.08 to operating EPS. With the closing of the Medalist transaction, we completed an aggressive corporate simplification process that began in the fourth quarter of last year with the goal of making our business simpler for us to manage and easier for investors to understand. Going forward, we do not expect that our CLO investments will be consolidated into our financial statements, which means a decrease in our total assets from $1.4 billion to approximately $220 million at March 31st and a decrease in our long-term debt from $1.2 billion to approximately just $84 million. Additionally, the sale of our largest hedge fund, Harvest Small Cap Partners, at year-end substantially reduces the volatility of not only our revenues, specifically quarterly incentive fee income, but also our closely-watched compensation ratio. Finally, the IRS recently approved our previously disclosed election to be taxed as a C Corp for 2019 and beyond, increasing our corporate tax rate going forward but removing substantial corporate costs and eliminating Schedule K-1s for investors. I want to take a few minutes to expand on that summary report detailing the thinking behind these strategic moves we’ve recently made. JMP securities was hurt by the extended SEC closure that lasted until early February just before financials went stale for companies and registration and delayed nearly all IPOs and many follow-on offerings in the quarter. Equity capital markets activities in our four sectors were at its lowest level since the 2016 trough roughly 50% from year-ago levels. However, given the recent rally in US equities, we are optimistic that we can recapture much of the business lost in the first quarter of 2019 as the year progresses. Advisory revenues can vary significantly quarter-to-quarter, depending on the timing of closings, especially when large transactions and large fees are in the balance. After a strong end of the year of 2018, the first quarter of this year was more ordinary with no larger deals closing. Nevertheless, our transaction backlog continues to grow and we remain optimistic that 2019’s advisory revenues could surpass 2018 to record total even though last year’s results were well ahead of our long-term 15% organic targeted growth rate. In asset management, fee income included some noise given all the changes in the first quarter, but we still expect 2019 to be a profitable year after a loss of $0.04 in this business area in 2018. Earlier in April, we had a first closing for JMP Realty Partners II of roughly $27 million including sidecar commitments. We’re actively marketing the fund with an overall target of $70 million to $100 million of committed capital within the next year. In addition, we are drawing up documents for a third venture fund to be launched later this year. The Medalist transaction we have already discussed is expected to add a few cents to operating earnings this year and potentially more if CLO VI is completed, and that doesn’t include the upside for our continued 45% ownership interest in future earnings growth. As mentioned earlier, the star of the first quarter was the outperformance of our capital invested in our fund strategies, which excluding the $0.08 per share initial gain from the Medalist transaction contributed $0.14 a share of operating earnings versus a loss of $0.03 a year ago. Harvest Agriculture Select had a bounce back quarter, up more than 10% after a difficult 2018 and JMP Realty Partners I recorded a material increase in its NAV based on updated property valuations and its year-end audit. Our CLO strategies benefited from very low credit losses in the quarter with net interest income also increasing 17% year-over-year since the funds are now fully invested. Workspace Property Trust also delivered improved results, thanks to lower vacancies and higher lease rates in the period, as well as the absence of dead deal cost incurred in the first quarter of last year following its unsuccessful IPO. The momentum in this business could continue as this year progresses we think since new leases signed year-to-date and those being actively marketed could have a material effect by the fourth quarter. Given the transformational changes that occurred in our business in the first quarter, I wanted to also take a few minutes to explain why we think they are beneficial both short term and long term for shareholders. First, given the recent tax reform, our decision to be taxes at corporation in 2019 and beyond will be materially accretive to most individual shareholders after tax dividends, even though JMP’s corporate tax rate will increase to roughly 26% going forward from 13% last year, when net investment income earned by our pass-through entity was untaxed. While our reported earnings will be negatively affected by the higher tax rate for 2019, we expect to offset some of this with expense savings from reduced professional fees and the elimination of the K-1 process. As a C-Corp, we plan to retain roughly half our operating earnings to invest in the growth of our M&A business and to retire more of our long-term debt. Our first quarter dividend that we recently declared a $0.04 per share reflects this retention strategy and we spent $0.02 per share of potential operating earnings in the quarter to hire new advisory-focused senior bankers, one of which joined us in March. We are hopeful that our change in tax status will increase our stocks appeal to institutional investors. Only 12% of our shares currently are owned by institutions versus 49% in June of 2014 when we announced our restructuring as a publicly traded partnership. Like most companies, we do believe our stock is materially undervalued. But unlike most companies, we are putting our belief into action with consistent share repurchases, as well as open market purchases by management. When we went public 12 years ago, senior executives and Board members owned 31% of our Company and today through active buying in the market that percentage is over 53%. Second, the sale of Harvest Small Cap Partners to its investment team was structured to be slightly accretive to our results going forward. On a pro forma basis, we will lose roughly $12 million of asset management fee revenues compared to last year, but there was a very low operating margin on those revenues. Instead due to a revenue sharing agreement, we will recognize other income that should modestly exceed our previous earnings from that business. The fund, as it has been, was a material contributor to our Company’s success over the past 12 years. In particular, during 2008 global financial meltdown our share of the large carried interest fees and the return of more than 30% on our capital invested in the fund enabled JMP Group to report positive cash earnings in the wake of the crisis. The sale of this business should materially reduce the volatility of our quarterly revenues and compensation expense that it stemmed from large swings in incentive fee income and should improve our operating margins over time as well. We wish the Harvest Small Cap team great luck with their new company and will continue to provide them with transition services until June of this year. Third, the March sale of 55% of Medalist Partners Corporate Finance, the former JMP Credit Advisors, is expected to add $0.01 to $0.02 a share to our asset management fee earnings this year with potentially much more over time if we are successful in growing the platform that currently manages about $1.3 billion. Given the substantial capital that we’ve already invested in that business, we did need to attract new investors to expand this scalable business meaningfully. Our remaining 45% ownership creates an excellent alignment of interest and we are very excited to work with our long-term partners at JMP Credit, now Medalist, along with our new partners at Medalist Partners to achieve a great outcome for all. The other material benefit to the transaction was the deconsolidation of the CLO strategy from JMP Group’s financial statements. As of March 31st, for the first time in a decade, our balance sheet depicts what has always been a relatively simple and straightforward company once the distorted effects of CLO assets and liabilities are excluded. Total assets were $222 million, funded with tangible equity of $87 million and long-term debt of $84 million, meaning leverage of under one to one. Of our total assets, the $122 million or 55% is invested for return primarily in our fund strategies. The simplified structure will result in materially reduced expenses going forward as audit fees will decrease and the CLO non-comp costs will no longer appear on our income statement. Additionally, credit costs will now be reflected in our yield on the CLO securities we continue to hold. Summing up, these changes are immediately accretive to our pre-tax earnings in a material way and provide additional long-term benefits to shareholders, which include faster potential growth in our advisory business, more stable and higher operating margins, delevering opportunities as capital allocated to our CLO investments return to us over the next few years and we retain more of our operating earnings; easier to understand financial statements that better reflect our straightforward business model and increased appeal, we think, to institutional investors that could help revalue our shares materially higher. I want to thank our employees and Directors for their constant efforts to establish JMP Group over the past 20 years. We just actually had our 20th birthday party last week. While it’s been an interesting journey thus far, we still think the best is yet to come. And operator, with that, we’re happy to try to fill in questions that people might have. Thank you.

[Operator:]

[Operator Instructions] We have a question from Alex Paris with Barrington Research. Please go ahead.

[Alex Paris:]

Good morning guys. Good morning, Joe. How are you?

[Joe Jolson:]

Hi, Alex. Happy Springtime.

[Alex Paris:]

Yes, exactly. We’re starting – in Chicago, we just go straight from winter to humid summer, so we’re kind of at that point now, I think. A point of clarification; where does the gain on the sale of the CLO business come into the P&L, is that in investment income?

[Joe Jolson:]

It’s about $0.08 a share after deferred bonus accrual and after-tax and cost attached to the investments, so it’s different lines. The revenue from it is comes in principal transactions.

[Alex Paris:]

So now that it is deconsolidated, it’s not part of the balance sheet, but given your 45% ownership as there is income, it will come through that principal transactions line?

[Joe Jolson:]

The other income, I think, is where it would come through. I mean, that’s where we’ve at least historically booked our income on the sponsored funds to the extent that is a material number, maybe we might look at breaking it out separately, but historically that’s worked the line that these businesses come through its other income.

[Alex Paris:]

And then, were there any other gains in investment income in the quarter, like for – well, I guess it would be in the quarter, but JMP – the Harvest Small Cap strategy, is there any gain or loss? I guess that was booked in the fourth quarter if there was, right?

[Joe Jolson:]

No, there – I mean, we don’t have any basis in any of these businesses, but I think that the Harvest Small Cap was structured as earn-out and it’s based on a revenue share, so it depends on the revenue. So we didn’t book any one-time gain on that. So we earned that into income over time. The Medalist transaction, we tried the – well, the initial gain we booked may leave some upside on the table over the next few years. We feel like we were reasonably conservative in how we value that.

[Alex Paris:]

And by the way, let me also say that I applaud these efforts to make JMP simpler and more understandable. It was definitely a challenge with the CLO accounting for sure, but even the Harvest Small Cap strategy that would bandy about the compensation ratio that needed to be explained. And then again the C-type Corporation just having covered the Company for back in 14 pre K-1, it’s definitely hard to get institutional interest if there is an additional K-1 that has to be dealt with. So that ought to help us going forward and I applaud that.

[Joe Jolson:]

Well, thank you. I mean, I’m going to – I have allocated, as you know, a chunk of time over the last month and over the next few months traveling around to meet with potential investors, so making the effort to reintroduce the Company aggressively to potential investors in our stock.

[Alex Paris:]

Yes. We’ve done a bit of that with you and we look forward to doing more of that with you going forward. Shifting to my next question, JMP Securities, obviously, a tough quarter as you kind of outlined in your prepared remarks due in no small part to the SEC shutdown for what 35 days or something like that. How – bigger question is, how is Q2 shaping up now that is behind us?

[Joe Jolson:]

You know, I think that some of the deals that didn’t happen in the first quarter, particularly IPOs, the numbers went stale at Valentine’s Day – September numbers, so they had to get audited at year-end. So I think that’s been occurring. So you’re starting to see some of these IPOs in the market now and so we’re pretty optimistic. We have – but there are only – we only completed two IPOs in the first quarter because of the closure, and one, the Lyft IPO, I think was in the last few days of the first quarter. So, it’s just a delay in getting numbers audited, re-filing and getting it through the SEC, but you’re starting to see that backlog come to market now. For us, we have a number of companies particularly tech companies that are either in the market now or should begin their road shows in the next few weeks. So we’re pretty optimistic. Obviously, the ECM business is somewhat dependent on market conditions, but, of course, the markets have been pretty robust in the last month or so, there’s been a big rally. So we’ll see what happens, but we’re optimistic that business gets executed. On the M&A side, I’m not sure that the SEC being close really had any impact on that. It’s just taking deals that were engaged on through normal process and you could see from the closings that we had a little bit less closings this quarter, but the main thing was we didn’t have any larger deals closed. So I think, there are some larger deals in the backlog here and every year, we get larger deals. So that can move the quarterly numbers around quite a bit. But our current M&A pipeline is very strong at record levels and some of the M&A bankers that we hired – the four that we hired in the second half of last year, are starting to get engaged on assignments and we would expect that backlog to continue to grow. So we’re still optimistic, even though last year was up over 40% over the previous year to a record level that we still have a good shot at having another record level in that business this year.

[Alex Paris:]

Which would be great and that would kind of get you closer to your 2021 target of $50 million in annual revenue in that business.

[Joe Jolson:]

I think that we’re tracking that. And I mentioned we hired one new banker this year in March. He joined us and we’re in conversations actively right now with two or three more, and you know – I mean, so we’ll see what happens. I mean, we spent $0.02 a share in the first quarter to grow that business. That’s not a small number relative to our current earnings, right, and so we’re making a large investment in growth. That $0.08 gain that we booked initially on the Medalist transaction, if we could find five plus M&A bankers this year that were – that we though could be highly productive on our platform, we would probably hire than and not may spend some of that $0.08 investment gain as the year goes along to grow faster. This is strategically the most important area for us and has been to grow. And I think, as you know, it’s not just accretive to our earnings that growth and our margins and return on equity, it’s also much higher valued in the public market, and I think that you could easily do the math and come up with much higher stock price for us, if we’re successful in building that business.

[Alex Paris:]

I’m counting on it. So with all these corporate actions, you’ve accomplished a lot in recent months. I’m just curious, are there anything – are there any actions left to be undertaken in that corporate simplification process or are we complete now and nose to the grindstone growing it from here?

[Joe Jolson:]

There is only one thing that we’d like to see that’s left to simplify our reporting, we can’t control it, and that’s some type of monetization of the Workspace investment that we made 3.5 years ago. I mean, the investment has been highly successful. So it’s a very good contributor relative to what we – cash that we invested in the business in our operating earnings. So we’re not – if it doesn’t – it get monetized, it’s a great return on our investment. But we’re carrying the investment in our book value to zero because of GAAP accounting and our adjusted book value adds back that delta. So that’s the only adjustment now that JMP Credit is deconsolidated, is just the add-back. And you know, I mean, the NOI has been going up given what we think they’re going to sign in leases as the year progresses, NOI could go up a lot more. They kind of locked in their financing a year ago before the bulk of the rate increase occurred. So the increase in NOI is dropping to cash earnings for the company, so they are doing very well. Time will tell if that goes public or sold or whatever, but we think that the value could be above what we add back. Now, as a C-Corp, it won’t be taxed now on it as opposed to before. So – but that being said, that would be the only thing, we own about 8% of the company. So we’re obviously among the Board, but we don’t have any control over that event.

[Alex Paris:]

So just to be clear, the difference between adjusted book value and book value, the only difference is $0.65 or so, and that’s the value of Workspace, which have you grossed it up, it’s $13 million, $14 million…

[Joe Jolson:]

Well, it’s a – it’s just adding back the accumulated depreciation and amortization expense that we have to run through our P&L over the last 3.5 years because of GAAP accounting. We valued it originally under the equity method because originally we’re 27% or 8% owner of it, but since then they’ve raised more outside capital at much higher prices and our ownerships declined because of that percentage wise to about 8%, but on a – the last sale, we put in $10 million originally and the capital was raised, I guess, about two years ago now, the last round and now was at around $19 billion valuation. And things have improved since then. I mean, you never know about these things, Alex. But I mean, we are pretty confident it’s worth more than zero, which is where it’s carried on our books, right. So if you just look at adjusted book, we’re back to like $100 million plus kind of number.

[Alex Paris:]

And then last question, I think you answered this in your prepared comments, but the $92 million in marketable securities, you said it’s primarily invested in fund strategies – growth fund strategies?

[Joe Jolson:]

The big increase – yes, the big increase in that was due to the deconsolidation and so, Ray might have the exact number in front of mind, I’ll remember it, off the top of my head, but I think something like $70 million somewhere around there was the mark on the CLO investments, the securities that we own in the III CLOs. And we chose to carry those as held for sale. And so, those will get marked through our balance sheet every quarter, up or down, but the initial valuation that we did was based on a 15% discount rate. And when we underwrote those deals originally, the discount rate that was used was between 11.5% and 14% from CLO III to CLO V. So we marked them more conservatively than we did originally and we still had a slight gain on that. So that’s an indication of the funds are performing much better than originally booked at. But 15% is a good return on that capital over time, but given that we have them both as available for sale, depending on other uses of the cash and other kind of alternative returns over time, we may – they are salable and we may opportunistically look to sell some of those – sell down those positions and redeploy the money into other more accretive opportunities.

[Alex Paris:]

And then last, but related, what’s your – the interest rates you pay on your long-term debt?

[Joe Jolson:]

We have two tranches; the 2023 notes were paying coupon of 8%, including issuance costs that get amortized, that all in is like 8.6%. And then, we have $50 million at 7.25% with the issuance that’s due in 2027, issuance costs added into that you get more like 7.6%, 7.7%.

[Alex Paris:]

So the delta and cost of capital versus return through the CLO is obviously very positive based on conservative assumptions at this point?

[Joe Jolson:]

Yes, it’s a good investment and we think we have it marked around, if we sold it around where we could sell it for in a normal market, may be even positive to that, but we’re not in any hurry to sell them. We just – that’s a good return, but it gives us now that we don’t have to keep the capital based on the regulatory change; nine months ago, we don’t have to keep our capital in anymore. It gives us opportunity now and plus we raised a substantial amount of other capital in selling down to 55% – 45% ownership of that business. It gives us the opportunity now to look to redeploy that money opportunistically for shareholders.

[Alex Paris:]

Okay, well, thank you very much for additional color. Appreciate it and good luck on the balance of the year.

[Joe Jolson:]

Thanks, Alex.

[Operator:]

Your next question comes from the line of Greg Garner with Singular Research.

[Greg Garner:]

Hello, good morning, Joe.

[Joe Jolson:]

Hey, Greg.

[Greg Garner:]

Hi. My question really been already answered, but I really want to focus just on perhaps on additional info if you might be able to convey on the investment banking side. I mean, I agree, this is a big value-add component to JMP. Can you – you mentioned how the backlog is growing there after the government shutdown and some of the delays. Could you – is there any way to characterize how that pipeline might be biotech versus IT or you also mentioned you hired one new banker this year. It seems like there might be more if it was $0.02 a share. I’m just wondering how – where the flow of new bankers come in the last year, how they might be moving up to being productive?

[Joe Jolson:]

Well, Greg, just to be clear, the $0.02 was what we accrued in the first quarter based on a budget for what we’re looking to hire this year, and by later in the year, we’ll adjust that up or down depending on our success it bringing in more bankers, but that would be based on hiring maybe three bankers this year. So if we get lucky and we can attract four or five, it could be – we could spend some of that investment gain that we had on the Medalist deal in the first quarter or some more of it than we spent; $0.02 was the budget. Okay? So – and those folks are mostly looking at M&A business. So there is a – when we hire an M&A banker, more times than not, they’re walking away from an engaged pipeline. So there is a cost to them and current comp to join us and we tried to get them somewhere close to being whole on that and then as they go through the year, the M&A business is much more a lag than the ECM business, which is much more at the moment, driven by market conditions. So it typically takes anywhere from three to nine months for – once one of these guys joins us to fully start their book engagements again on our platform number; they walked away from an existing engaged pipeline and then it takes three to six months after that to actually close deal. So there is an inherent lag in that growth strategy in revenues. And on the IPO side, I’m not sure that we’ve been disclosing this in the past, certainly not by sector, but the color I can give you is that, we did two in the first quarter and we have somewhere around 15 IPOs in our pipeline over the next three to four months. And market conditions are willing those get done, I don’t really want to talk about sectors, but most of those IPOs would be in technology and healthcare.

[Greg Garner:]

Okay. And just one…

[Joe Jolson:]

And you know, to be clear, industry wide, there weren’t – because the SEC was closed and you can’t do an IPO without having a deal though effective with the SEC, there – that was an issue that affected all US equity capital markets companies, not just JMP.

[Greg Garner:]

Okay. Sure, industry-wide phenomena, definitely. Just want to overall question on the comp expense relative, it seems like it’s down quite a bit. Was there any anomaly there other than the decline in some of the investment banking business?

[Joe Jolson:]

No. I mean, that’s really our normal comp expense, Greg. I mean, the difference is that we sold the Small Cap fund back to the management team at year-end, right. And the thing that distorted our comp ratio historically was our Small Cap fund that was highly successful over more than a decade earned its incentive fees on a quarterly basis. And depending on how they did, it could be a pretty large incentive fee number; it could be $5 million or $10 million in a given quarter, which compared to our overall revenues in the quarter, could be a big number. And most of that 95% plus or minus got passed through to the investment team on the incentive fee side. And it had a really distortive effect to the comp ratio on a quarterly basis. Now, we used to disclose what the comp ratio was if you exclude the incentive fees to try to give people an idea that there wasn’t that kind of volatility in our underlying comp ratio. So, not – one of the reasons that we looked at spreading that out was just to make our business more simple for investors to understand.

[Greg Garner:]

Okay, all right, thank you. Thank you very much.

[Joe Jolson:]

Sure.

[Operator:]

And there are no further questions in queue.

[Joe Jolson:]

Okay, great. Well, we appreciate everyone’s interest in our Company and we look forward to reporting more positive news as the year goes forward. Thank you very much everyone.

[Operator:]

Thank you for participating in today’s conference call. You may disconnect at this time.