JMP Group LLC
Q2 2018 Earnings Call Transcript

Published: 29 Jul 2018

[Operator:]

Welcome to JMP Group's Second Quarter 2018 Earnings Conference Call. Please note that today's call is being recorded. [Operator Instructions] I will now turn the call over to Andrew Palmer, the Company's Head of Investor Relations. Sir, you may begin.

[Andrew Palmer:]

Good morning. With me today are Joe Jolson, JMP Group's Chairman and Chief Executive Officer; and Ray Jackson, the Company's Chief Financial Officer. We are joined by Carter Mack, President of JMP Group; Mark Lehmann, President of JMP Securities; and Craig Johnson, our Vice Chairman. Before we begin, please note that some of this morning's comments may contain forward-looking statements about future events that are out of our 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. JMP Group had an excellent quarter with operating earnings of $0.16 per share, primarily driven by record investment banking revenues, increased net interest income due to the accumulation of loans leading up to CLO V’s June pricing, and a favorable exit from a principal investment. JMP Securities contributed $0.12 per share to operating results for the second quarter and $0.45 per share for the trailing four quarters, which equated to an annualized return on average equity of roughly 36% for both periods. Distributable earnings at the publicly traded partnership improved to $0.13 a share and more than covered our $0.09 per share in cash distributions, thanks to higher net interest income and better-than-expected credit performance. Looking ahead to the second half of the year, we are working hard to close on a record pipeline of M&A and private placement transactions, while simultaneously benefiting from an open window for growth-oriented companies to raise capital in the public equity markets. So all was good essentially. JMP Securities has added four senior M&A focused investment bankers to its platform in the last few months, which should increase our already strong momentum in this attractive business over the next few years. If CLO V closes shortly, as anticipated, we will have completed the 18 month cycle of plowing our capital back into our credit business at attractive IRRs. JMP securities enjoyed its best investment banking quarter ever producing $28.6 million of revenues. Our success over the past four quarters is all in part to a strategic decision made during the 2015-‘16 industry downturn to maintain our headcount and protect our ECM franchise. This choice which at the time cost shareholders in the form of modestly lower earnings did position us to gain market share in an improved environment which we are now experiencing. We estimate that our share of the US ECM revenue pie for the last 12 months in our four industry verticals has increased over 1% compared to 80 basis points in 2016. This is best evidenced I think in the increase in our average fee per capital markets transaction, which was nearly 700,000 during the first half of this year versus a little bit over 400,000 in the first half of 2017. We are optimistic about our strategic advisory business for the second half of the year and beyond for three reasons. First, we continue to add high quality mandates to an already substantial pipeline which is demonstrated by a 20% year-over-year increase in the average fee per M&A transaction this year to 1.2 million. We now anticipate a record year for M&A and private placement revenues in 2018 based on the substantial increase in transactions expected to close during the second half of the year, some of which have already closed this month and are expected -- or are expected to close in early August. Second, our industry focused bankers continue to build out this aspect of their business, leading to an increase in the number of strategic advisory assignments in our pipeline. And third, we continue to add more senior M&A focused investment bankers to the platform for so far this year with a plan to add a few more by March of 2019 and two to three more annually in the next several years. Given the near-term cost of aggressively growing our advisory business, we continue to manage our overall headcount and our controllable non-comp costs in a very disciplined manner to convert the increased productivity we are experiencing into higher compensation for our producers as well as higher earnings for our shareholders. Our institutional brokerage business had a better-than-expected quarter, increasing net revenues by over 7% year-over-year. Thanks in part to a June that was our best month in the last couple of years. For the first half net revenues are down just 2.4% despite a negative environment, driven by the adoption of MiFID II, at the beginning of the year for all sell-side firms. While it is still early days under MiFID II, we are encouraged by our results to-date and we will continue to evaluate any opportunities that could arise from a potential industry shakeout. In sum, JMP Securities is poised to have its best year ever with the capital markets environment remaining relatively open and stable. While the hiring cost of aggressively growing our M&A footprint may temper some of the earnings upside in the near term, the potential return on this investment is very exciting for future growth, reduced cyclicality, and as well as the franchise value of the business. Now our asset management business showed improved results in the second quarter with an operating loss of under $0.01 a share compared to $0.03 loss in the first quarter. The second quarter featured a variety of encouraging developments on the asset management front. In June JMP Credit Advisors price its fifth CLO despite an increasingly choppy market, which increased assets under management to 1.1 billion versus 820 million a year earlier. Recently, the US government lost its appeal to include the 5% risk retention capital requirement for asset-based securities issuers under Dodd Frank. Accordingly, we are no longer limited by our balance sheet and growing this business and we are currently formulating a more aggressive three year growth strategy. Each cap advisors, which manages our [publicly] traded BDC Harvest Capital Credit Corp is busy working to redeploy its excess capital which should improve earnings for the company as well as restarting our incentive fees in the second half of the year. Recently, again, a positive legislative development occurred when the BDC rules were changed to allow for 2-to-1 maximum leverage. Now it’s early days here, but it could be materially positive for us growing this business over the next few years. Looking ahead, we continue to explore opportunities to partner with established asset management businesses rather than seeding de novo funds. We have found that investing in profitable businesses where potential synergies with our own activities in a current need for new capital, provides a much better use of our investment dollars and time spent as demonstrated most recently by our partnerships with Astor Investment Management last year and Workspace Property Trust two years ago. Including these two sponsored funds, we manage over $5.5 billion currently, and hope to continue growing the total through both additional partnerships as well as organic growth. We recently launched marketing efforts for our second [hedge] fund and currently considering a third venture fund within the next year. From an investment standpoint, we had a good quarter overall, highlighted by a gain on the exit of our investment in the core group holdings, which contributed $0.03 a share to operating earnings and also by a substantial increase in net interest income. Our average loan balances increased to nearly $1 billion for the second quarter from roughly $700 million a year earlier and credit losses were better than budgeted. As already mentioned, our $400 million CLO V which priced in June is scheduled to close shortly. Based on underwritten IRRs that assume all-in credit costs of roughly 50 to 60 basis points a year, we believe that net investment income at the publicly traded partnership could cover both our fixed corporate costs and our cash distributions going forward. Recognizing that on a quarterly basis, credit costs can be lumpy. Also occurring in June, Workspace Property Trust successfully refinanced its long-term debt on attractive terms which substantially limits interest rate risk from any future increases in short-term rates. Based on recent appraisals just conducted in June of roughly 150 properties with a borrowing base, the value of our investment appears to be solidly above our cost basis. Importantly, property level NOI continues to grow at a much faster rate than the industry average, which bodes well for the future value of this business. In conclusion, we are enjoying strong earnings momentum which we expect to continue, assuming relatively stable capital markets. The recycling of our investment capital back into our CLO business should support our current cash distribution levels. And finally, we continue to look for ways to simplify our story for investors going forward. The first installment of which is a much condensed press release for the second quarter. As always, I want to thank our employees and independent directors for their continued hard work and dedication to the success of our company. Operator, I’m happy to answer any questions at this time.

[Operator:]

[Operator Instructions] Your first question comes from Ann Dai with KBW. Your line is now open.

[Ann Dai:]

My first question I think is on the recruitment and the growth within your banking business. So I imagine maybe some of the higher comps this quarter was maybe impacted by that, obviously largely driven by better JMP results, Securities results as well. But should I just be thinking about some of that being attributable to a higher fixed cost base, are we going to see the impact of the new [investment] banking for the third quarter and beyond?

[Joe Jolson:]

Well the -- we haven’t changed any of our comp ratios. So the increase in comp was 100% tied to the higher revenues. The cost of hiring the M&A bankers is on top of our normal ratio, and it cost the second quarter a penny a share. And of the four people we hired, three of them didn't start till third quarter. And so, I think that for the next couple of quarters, it could be a couple cents a share per quarter. And it takes about a year, hopefully sooner, but often a little bit longer than that, when an M&A banker joins our platform to get a backlog of transactions and then close on them. So there's a little bit of a lag, and that's primarily the timing difference in that cost. But if we've identified the right people and we think we have within a year or two certainly and beyond it’s usually accretive in the payback period on the initial cost. We just have a 50% batting average on picking the right people is two years or less, say it’s within the second year, it’s all payback. So it's a pretty good attractive organic growth method for us.

[Ann Dai:]

Could you give us a sense for banker headcount today? And maybe how that relates to bank period a year or so ago? And then looking forward, if -- when you look at the bankers that you currently add or you hope to add and beyond that the two to three annually over the next several years, where should we be thinking about those areas of focus?

[Joe Jolson:]

I mean Carter can jump in here too. But I looked at this before the call just to get my own sense of it. I mean a lot of our bankers have more of a blended business plan where they do equity capital markets converse but also M&A. And obviously we've been shifting that focus a little bit more towards M&A over the last few years. But we also have some more M&A exclusively focused bankers. And so, I’d say, I did this, it’s not scientific but we probably right now, before these four people were added, have something like 10 to 12 weighted M&A bankers. And I think there were 17 MDs and directors. So that’s just weighting the business mix to get a sense of what that impact could be. So we added four M&A focused bankers. So that might give you a sense over the next couple of years. It’s pretty material. So I don’t know Carter if you want to add?

[Carter Mack:]

I mean the overall headcount in banking I think is relatively flat. But we’ve just kind of changed the mix of senior bankers to tenure bankers but it’s overall relatively flat.

[Joe Jolson:]

So I think that the real question is, over the next few years it’s a pretty -- percentage-wise it's a material add as well as our plan to add more and I think that we are hoping that that’s a big driver to that business.

[Carter Mack:]

Yes. And from an industry perspective, we’ve added a couple of MDs on the healthcare side, we've added a senior banker in real estate, we’ve added a senior M&A generalist. And going forward, we’re continuing to look to expand on the technology side and we will add more folks in healthcare as well.

[Joe Jolson:]

Hopefully, that’s helpful.

[Ann Dai:]

Yes, it is. Thank you. Last one from me, just on brokerage. Was there anything specific that contributed to the much stronger quarter? I mean I think it’s fairly similar to some of the trends we’re seeing across the group. But just curious whether there is anything you would call out for your own business whether it’s feeling like there’s market share gains right now or just getting some clarity around those early negotiations with clients that maybe helped?

[Joe Jolson:]

I think that as clearly market share gain, and unfortunately, we get those numbers with -- from glogg and with a pretty big lag, so we’ll have to wait to see what that ends up being. But I think that the mix at least earlier this year had gone up a lot, then it settled back down. So I don't think that volatility is -- in terms of active commission generators, is really causing it. I think that -- we’ve talked about this in the past and basically our commission business has historically been to pay for research and I think MiFID probably increases the focus materially from the guys paying for researches to what they are spending their money on. And so, it's caused a lot of companies to make sure they're spending their money appropriately. So it's been very positive to get this feedback that we’re valued at what we do by our clients. And so, I think that we’re excited about that actually and we’re small but we’re excited about it and well hopefully the trend will continue, and there will be opportunities, literally for the first time since we started this company to potentially grow that -- grow other areas based on opportunities that might arise from this.

[Operator:]

Your next question comes from the line of Alex Paris with Barrington Research. Your line is now open.

[Chris Howe:]

This is Chris Howe sitting in for Alex Paris. I had a question. Now, last quarter you had talked about the potential for the conversion to a C-corp. I just wanted to get an update on that, has there been any movement this quarter in regard to your stance on that?

[Joe Jolson:]

We've evaluated it. And I think that our analysis is kind what you would expect, it -- it’s dilutive to our earnings outlook,k not as dilutive as it would've been without the tax law change, but dilutive. And so, we’re continuing to think about it and trying to weigh the benefit of potentially more eligible institutional investors for our stock versus how much in earnings we would lose. I think if the current tax law was in effect, we wouldn't have converted to a partnership. Our partnership, it’s a question of tradeoff there. And unfortunately, unlike KKR and some of the other guys that are bigger than us that have decided to go to be a C-corp. We were a C-corp for seven years and so we do have some experience as a microcap C-corp with the business mix that we have. And so it isn’t an unknown for us. But nothing to decide today but we will continue to look at it. And by the way, we are open to opinions from you guys that cover us as well as our shareholders. I mean it’s not so clear-cut. It’s maybe 15% to 20% dilutive to our earnings outlook, so it's not immaterial. So the question is, do we get a bigger pick up than that and evaluation could cause us to do it. And that’s current math.

[Chris Howe:]

And you’ve talked previously about the acquisition environment. Just kind of, what are you seeing out there as far as pricing and any -- how attractive the environment is right now?

[Joe Jolson:]

We -- I’m not sure what -- I don't think we caught.

[Carter Mack:]

You mean for acquiring?

[Chris Howe:]

Potential acquisitions, yes.

[Joe Jolson:]

For JMP? I don’t think we have commented on the acquisition environment. So -- but I mean we do look at things as …

[Carter Mack:]

Things are expensive.

[Joe Jolson:]

Yes, I mean, we …

[Carter Mack:]

Hence, we are not doing anything.

[Joe Jolson:]

Yes, we have timely looked at a number of things and haven't done any of them. We had put in offers on a few things over time and we are substantially outbid and we will continue if something comes up that we think is attractive for what we're doing to be active there. But as Carter just said, we live in an environment where there seems to be competitors that have a lot more aggressive at their outlook for the acquisitions than we are, they are expensive.

[Chris Howe:]

And then my last question. You kind of already talked about it but just wanted to see if there is anything additional that you might add. Just about some of the drivers within ECM that came to fruition in the quarter? And what's your current pulse on the market? You mentioned you have some deals that already came through this month and some more potentially in early August. Just anything additional to add for some color -- further color?

[Carter Mack:]

Sure, the drivers on the ECM side, we've had a pretty robust environment in healthcare and biotech through the first half of the year. We've also seen a pretty significant pickup in activity in the technology space, especially in IPOs for technology companies. And we have a pretty big pipeline of IPOs going forward in tech. We also saw a nice uptick in our financial services space, covering specialty finance, mortgage REITs. Those were pretty active in raising capital in the second quarter. So those all contributed on the ECM side, and we continue to see a fairly open market. We have a pretty robust convertibles effort. And we had a lot of activity in that product in the second quarter and continue to see people assessing, issuing converts in the second half of this year. And then on the M&A front, our pipeline is pretty weighted to closings in the second half of the year. And as we mentioned, we had a large private placement close already this quarter, this month. We have one of our large M&A transactions that we advise on is closing early next week. And just a number of other deals are scheduled to close through kind of mid-August. So we expect it to be a good second half for our M&A business.

[Operator:]

There are no further questions at this time. Presenters, please continue.

[Joe Jolson:]

Well, we appreciate everyone's interest. And we look forward to updating everyone on our progress when we report our third quarter I guess in late October. Thank you.

[Operator:]

This concludes today’s conference call. You may now disconnect.