JMP Group LLC
Q2 2017 Earnings Call Transcript

Published: 2 Aug 2017

[Operator:]

Welcome to JMP Group's Second Quarter 2017 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 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 the Company’s control. Actual results may differ materially from those indicated or implied. For a discussion of the uncertainties that could affect our 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. Happy to say that our operating earnings of $0.03 a share for the second quarter improved materially from the first quarter, primarily due to an pick-up in equity capital markets fees and the absence of any unusual losses on our principal investments. At JMP Securities, our investment banking revenues of $19.1 million were our highest in two years and were driven by $12.4 million of ECM fees compared to $6.9 million in the prior quarter and $2.9 million a year ago. Our overall capital markets revenues which includes all equity and debt origination fees as well as our institutional brokerage revenues were $19.5 million up 24% from the $15.8 million for the first quarter and more than doubled to $9.1 million for the second quarter of last year. The transaction momentum that built during the first quarter carried into the second quarter and was evident across all four of our core industries Healthcare, Technology, Financial Services and Real Estate. In the second quarter, we served this book runner of seven capital market transactions after book running five offerings in the prior quarter. As a point of comparison, we did not book run a single transaction the first half of 2016. Through the first half of this year, we participated in 11 IPO’s versus four in the first half of last year and nine in total during 2016. On the strategic advisory front, second quarter revenues of $4.7 million compared to $3.1 million for the first quarter. So far this year we were short of the run rate necessary to achieve our goal of more than $25 million in strategic advisory revenues for this year. Nevertheless, given the strong pipeline of M&A transactions that we hope to close in the second half of the year, we remain optimistic that we will hit our target. On the expense side, our compensation expenses rose to the slightly lower rate than did revenues. And we’ve benefited by roughly $0.02 per share from the operating leverage on our fixed comp cost. An increase in non-comp cost due to the move of our fall research conference from its traditional September date to this past June nearly offset this benefit, but it will be re-captured in lower non-comp expenses for the third quarter. Our operating margin at JMP Securities was 7.2% for the second quarter, versus just 1.7% for the first quarter and if revenues were stable or improved from current levels, we believe we will see further expense leverage in the second half of the year. Altogether JMP Securities produced its best results in more than a year contributing $0.05 to operating EPS for the second quarter after adding just $0.01 for the first quarter and loosing $0.06 a year ago. For all of last year JMP Securities made $0.05. So in one quarter of this year it hit the entire earnings of last year. Our decision to invest in people and to support our franchises over the last few years when industry wide ECM fee revenues fell by more than 60% has allowed us to respond quickly to improving conditions this year. If the current market environment is sustained following labor day 2017 could end-up being a solid year for JMP securities even though we had a very weak first quarter. Our asset management platforms, Harvest Capital Strategies, JMP Asset Management, JMP Credit Advisors and HCAP Advisors collectively lost $0.01 a share in the second quarter. Asset management related fee revenues for the quarter fell by 16% year-over-year to $4.2 million, reflecting a decrease in incentive fees. In addition JMP Credit Advisors experienced an operating loss in the quarter due to the negative impact on management fees of liquidating CLO I and CLO II in the first half of the year. And JMP Asset Management continues to absorb modest operating losses in its newest strategies our real-estate opportunities one as well as our more recent corporate credit opportunity fund strategies, primarily due to the start-up levels of their assets under management. Our principal investment activities generate net investment income which has historically more than covered corporate expenses and contributed to operating earnings through net corporate income. But after calling JMP Credit Advisors, CLO I in December of 2016 and redeeming capital from our hedge funds managed by Harvest Capital Strategies last year, we operated that we have operated with an unusually large investable cash balance in the first half of this year including going into the third quarter. As a result, for the second quarter, we produced net corporate expense of couple of hundred thousand dollars, which was a big improvement over the $2.4 million net corporate expense in the first quarter, but still well below a year-ago level of $1.5 million if one excludes the $6 million gain we got on our selling our interest in RiverBanc in the second quarter of last year. On a per share basis, our net corporate expense cost us a $0.01 of operating earnings in the second quarter. Now most of the larger GAAP net loss in the quarter can be attributed to our decision to take advantage of an improving CLO debt market, to refinance the funding underneath our corporate loan portfolios. In doing so, we transferred the loans underlying JMP Credit Advisors too as well as those backing our total return swap into a new securitization JMP CLO IV, which closed at the very end of June. While we believe our actions will benefit future operating earnings, the immediate result of this was an aggregate charge of $5.7 million or $0.26 a share for the early retirement of our CLO- related debt. At quarter end, we had $2.18 a share in investable cash that we continue to work hard to redeploy. Along these lines, yesterday afternoon, we filed an 8-K announcing the establishment of a new warehouse lending facility to begin accumulating loans for another CLO. Assuming stable market conditions, we hope to close this new CLO V in the next six to 12 months. If so, we will have reinvested most of our excess cash back into our corporate credit segment. So if that's successful, we believe net investment income should begin to make a positive contribution again on a regular basis to operating EPS sometime during 2018. We recently announced monthly cash distributions of $0.03 a share for the third quarter unchanged from the second quarter. Earnings per share at our publicly traded partnership improved in the quarter to $0.04 a share versus a loss of $0.06 in the first quarter due to a gain the liquidation of our total return swap as well as to lower loan losses. Our earnings were still far short of our cash distributions, however, as a result of our unusually high cash balances. Closing CLO IV at quarter-end will help shrink this gap, but to support, as I said earlier, our current level of distribution solely with net investment earnings at the publicly traded partnership, we still need to redeploy that excess cash. Which of course we hope to do, as I mentioned into CLO V at the latest, there may be other opportunities prior to that. To finish up, I wanted to thank all of our employees as well as our independent directors for all their hard work. Their dedication makes everything we do at our company possible. Operator, I'd be happy to answer any questions at this time.

[Operator:]

[Operator Instructions] Your first question comes from Alex Paris with Barrington Research.

[Alexander Paris:]

Good morning everyone.

[Joe Jolson:]

Hi Alex.

[Alexander Paris:]

I got a few questions and maybe a big picture sort of questions. So I'll just start. On the institutional brokerage side, obviously, there is a lot of leverage in an up cycle, we've not met an up cycle lately. My question is related to method and how you view that? Its impact maybe on the industry, on the competition, the best as you could tell and on JMP itself? What are your thoughts there?

[Joe Jolson:]

Well, I think, I have an opinion on that and let me just start by saying it's, obviously, just my opinion, I'm certainly not an expert on regulation or certainly in the U.K. and how it might impact U.S. institutions. But from what I gather, from talking to some of my relationships at U.S. institutional investors that run, kind of, global strategies, this could have a material impact on how they allocate commission dollars. In the sense that they will find it difficult, if not impossible, to run a different system for their U.K. based funds from just global funds under management. So we'll see if that ends up occurring like that, so let's just assume that it does for a second. That means that larger institutional investors that have global businesses will have to rationalize in a budget, how they're paying for research, as opposed to more flexibility that's afforded to them right now. So as a research boutique that has never been successful at breaking through the glass ceiling related to getting paid for research bodes to leverage it into just general trading commissions, I think, we're less exposed to that then many others. But if some people think that the result of that change might reduce the overall pie materially. So if you look at some industry experts that know a lot more about this and I do, Alex, they are forecasting a 25% or 30% shrinkage of the overall commission pie paid to the sell side based on trading. I don't know if that will happen like that or not. I think that most research providers for a long time think that they've been underpaid for what they do and it's possible that in the overall shrinkage of the pie, there could be a flat to increasing amount of it paid for research. But let's just assume the negative case that the pie shrinks by 25%, 30%. Our revenues in the commission side, in the trading side, are not large relative to the overall firms' revenues and certainly not large although we would like it to be a lot larger, but it isn't, and aren't large relative to the mix of revenues at our competitors, and also we have very limited concentration issues compared to others with large global commission payers, okay? So we think that we have a lot less exposure to that, than the average company, let alone our peer group. So we'll have to see what happens. If there is that kind of drop in the overall commissioned by, it might be the final catalyst for a lot of companies leaving the business. You look at a lot of companies out there that generate a lot of revenues on the commission side, but they don't make a lot of money. In fact, typically, they lose money on that business. So it could be the final catalyst to cause some major decisions by large firms to exit the business, which could create a opportunity for smaller more nimble firms like us to grow that business once the dust settles. So that's kind of the way we're looking at it right now is that we are less exposed to others, but we're fully functioning with the fixed cost already paid for, for being in that business and there may be an opportunity set that develops for the first time in probably 20-plus years in that business for growth depending on what a shakeout might be in that negative scenario. Anyway, that's kind of what – so we're waiting to see what happens. I hope I answered.

[Alexander Paris:]

I was going to say, I appreciate your thoughts. There's a lot we don't know, there's both risk and potentially opportunity. The ECM business, this is where the real upside is, ECM and strategic advisory for JMP. On the ECM business, obviously, it's doing a lot better this year versus last year in the second quarter versus same quarter as well as the first half. How would you characterize incremental margins in that business? Obviously, you could bring a lot of significant revenue, but what's kind of the margin flow through to pretax?

[Joe Jolson:]

Well, the non-comp cost of that are small, okay. Let's just assume, there are a few percentage points of those revenues on the margin. I mean, it's a small number. We have pretty tight control over that and when you see ECM pickup probably we're more active on non-deal roadshows and T&E and those kind of things because it's a more active market. So let's assume it's a few percentage points of extra non- comp cost, maybe, let's call it five points on those revenues just to be conservative. On the comp ratio side, obviously, we showed in the second quarter or maybe we didn't break it out specifically in the press release, but I mentioned in my remarks, there was a couple of pennies benefit from that at JMP Securities. So there is some leverage on the non-comp cost. For years we are operating under 65% comp ratio, for instance, and roughly speaking, in the last couple of years, it's been higher than that. Last year it was 70% and the first quarter it was similar to that. So we saw some reduction of that comp ratio at JMP Securities in the second quarter just from leveraging a lot of the fixed cost expense of non-client facing or junior folks, I think. So I think, there is more leverage on that as that business grows in terms of, but if you just assume, it was at the old ratio of 65% plus 5% non-comp expense then you get like $0.30 on the dollar dropping to pretax. It may be a little better than that, Alex, on the margin, but that's a conservative way of looking at it.

[Alexander Paris:]

Okay good that’s helpful. On the strategic advisory side, the M&A side, obviously, as you said in your prepared comments, you are running a little bit below what you thought should be – low relative to your full year target of $25 million plus, but you remain somewhat optimistic that you'll get there. So does that suggest you have a pretty strong pipeline for Q3 and Q4?

[Joe Jolson:]

Yeah, I mean if you look at, you can break this out in a couple of ways. But we actively look to get hired for larger transactions, right? At the same time, we have a bread and butter business, where average fee is around $1 million representing sell side firms, okay? And we have enough activity in the space with the feet on the street, the senior bankers that, in a normal year, we should be able to close somewhere – with the people that we have right now, somewhere between 20 and 25 kind of transactions normally, okay, without any upsized deal sizes. So then the question is what next larger transactions might we be getting hired for and where are they in the process? And there's one publicly announced deal, there were two that one closed in July that we're representing MVC Corp in the sale of U.S. Gas and that closed in July. And so not there was not a huge amount above like that kind of base level, but that was a public deal that kind of got pushed into early July, from late June closing because they got a topping bid. So, ultimately our fee was higher, that pushed out of the second quarter and the third. And similarly, another public company that is out there, Forestar that we represented where there was some thought that could close at the end of June. Also got a topping bid by D.R. Horton that they've agreed to and while that got pushed maybe late this quarter, early fourth quarter, I think, they said publicly they're expecting to close early fourth quarter, so we'll see. That ends up being a materially higher bid also, those are some, there are some other transactions in the pipeline as well that are above normal. So that's why we think we can close by year-end. So that's kind of an breaking it down a little bit for you why even though we have done whatever $7 million or $8 million in the first half, we still think that we're going to get to that $25 plus million by year-end.

[Alexander Paris:]

Great, I appreciate that. And then last question, what are the reasons, maybe, the primary reasons that JMP became public 10 years, ago, was to make acquisitions and you've made some in the past, but not recently. How do you view your M&A opportunities currently and going forward and what areas would you be most interested in? You got the excess cash…

[Joe Jolson:]

Yeah, I mean, that just to be clear, we haven’t really made any acquisitions since we went public. I mean, we kind of assumed we did a management buyout of our CLO business, we didn't pay anything for that platform, but, I guess, you could call that an acquisition with management technically, but it was really more of an investment in the financial assets that came with that first CLO. But we have looked at a lot of things. I would just say in 10 years, we probably bid on five or six things and so we, there's not that many things that we've seen that we think are good cultural fit that actually we think are within our ability to afford that hits our return criteria. It's not to say other people haven't done those things. We've looked at, in many cases they did, but just didn't fit our criteria. And we haven't – we've, obviously, been outbid on all those possible things in the past. So we continue to look and we spent a bit of time on meetings and that type of thing for that, Alex, but we have to assume or I have to assume that, that doesn't happen, obviously, in managing our business. But one day maybe, we'll do a series of acquisitions, it just hasn't happened yet and it doesn't mean we're going to stop looking. The main reason why we haven't acquired anything is – I think, is the very optimistic viewpoint of the acquirers out there on looking at the same businesses that we're looking at in the way of what they think that those companies are going to earn from them. Plus at least historically, most of the other buyers have a bogey to do an acquisition that's way below what we would have, okay? And I think that's dictated by just, like, it's accretive to earnings per share, which is an important bogey, no doubt, but with interest rates so low and cash on the balance sheet or the ability to borrow some money it's not really high bogey in terms of your return on equity longer term. And so I think that's the other factor. Not to criticize any of our competitors out there that are doing these deals, but I think those are probably the factors.

[Alexander Paris:]

Got you, and then what areas would be appealing to you then? That's the last and final question?

[Joe Jolson:]

Yeah, that is alright. I mean, I think that probably on the asset management side, it's a very difficult business for us to grow organically. I think just the cost of starting new strategies before AUM comes in the door. So I think, that our primary focus would probably be for interesting opportunities on the asset management side. We've looked at M&A boutiques before just to grow that business faster, just haven't done anything, but we have looked at a number of smaller M&A boutiques, small to mid-size. We really haven't found anything on the broker dealer sides that's of interest to date.

[Alexander Paris:]

Okay, fair enough, thank you so much for talking to me.

[Joe Jolson:]

No problem.

[Operator:]

Your next question comes from Jeffrey Briggs with Singular Research.

[Jeffrey Briggs:]

Good morning guys.

[Joe Jolson:]

Hey, Jeff.

[Jeffrey Briggs:]

Some of my questions got answered in the last exchange there, but I have got a couple of things to clarify here. The first is, I just want to make sure that I understand the sort of mechanics with taking the CLO II and the TRS and sort of packaging that with CLO IV, and the way that, that amortization gets accelerated. So if I understand correctly, is it basically the deal fees when you put together the CLO, your amortized over sort of the expected life of that deal, and then when you close it early, you have to take all that at once, but those fees are actually paid when you put the deal together.

[Joe Jolson:]

Yes. That's it. But in this case, there was also significant amount of OID as well on CLO II. So it was the same kind of accounting treatment, but it was a combination of those two and really the math was pretty simple, CLO II was in liquidation anyway, it was over a year through its reinvestment period. And as it liquidates, you are paying off the cheapest source of funds quicker. And so It's pretty easy, in this market, you can get a pretty good idea of what payoffs might be and it was pretty clear that within a quarter or two, the return on our equity in that CLO was going to be below our cost of funds. And, in fact, we thought it would be by the second quarter this year, which was the trigger point. And then you look at what a new CLO cost of funds would be relative to that as well as some of the other terms and the return in our capital for rolling into CLO IV was low double-digit expected. So it was an accretive trade for something that was going to become increasingly dilutive on our capital.

[Jeffrey Briggs:]

Okay, that is helpful.

[Joe Jolson:]

Now we rolled the assets into the CLO IV. And market values as well as from the TRS and so the average price was below par. So in theory, longer term when those loans pay off at par and CLO IV gets liquidated, some of that charge that we took will be recaptured down the road, right? But from an accounting point of view you put in mark of the assets to par, okay, when we did that. In the meantime, we'll tell if those assets are money good, but I think the average price might have been $98.5 or $99 right? And so that would have been a similar dollar amount to that charge, but just from the accounting point of view, obviously the charge is today and we will see overtime if those loans are all performing, if it's money good at par, right.

[Jeffrey Briggs:]

Yep, makes sense. And then the second question has to do with the two adjustments that you guys make to book value. So the second one with the loan loss provision on the CLOs that's pretty straightforward to me. The first one with the real estate depreciation amortization, I just want to know where in the portfolio is that, what assets are those?

[Joe Jolson:]

It is just Workspace Property Trust, our investment in that company. So, we are not padding back any normal depreciation or amortization, that from the normal course of business kind of thing. It is just related to essentially the private REIT that we invested in, right? If you look at publicly traded REITs, no one really cares what their net income is. They usually don't have much of any because of depreciation expense. So since this is reasonably material investment for us and if we're accounting for as the equity method, it all flows through our income statement. I mean if we were accounting for it as the fair value, none of that would be flowing through our income statement. So when we made the original investment, we owned over 10% of the company and the manager and we couldn't account for on a fair value basis. And then, when we did the follow-on acquisition and raised all that outside capital share price, we could have, but we were already accounting for the way we were, so we couldn't change. And that's why it's, we are adding it back because it's not an economic negative kind of thing.

[Jeffrey Briggs:]

So it's just basically just because of the accounting treatment at Workspace because basically for tax purposes they're depreciating the buildings, so what's on their books isn't market value of the building?

[Joe Jolson:]

It's also, it's that but also as a private REIT, so they are not, at least so far they're private – they are not really – they just want to minimize taxes, right, like in private companies. So they are heavily incented to adopt any acceleration of these kind of expenses that they can, right? So I think if it was public and we owned a piece of it and it flowed through maybe it wouldn't be as big a number too. So I think it's a combination of just as a private company trying to minimize taxes for their investors.

[Jeffrey Briggs:]

Okay. Those are it for me. Thank you.

[Joe Jolson:]

Yes.

[Operator:]

Your final question comes from Chris McCampbell with Hilltop Securities.

[Chris McCampbell:]

Good morning. Last month there was an extraordinary day where our stock traded as if a takeover was evident and apart from the 10b-5 sale by the CFO, long-term shareholders captured none of the advance. In facts, saw new 52-week close within a couple of days, respectfully, Mr. Jolson, do you think current share price reflects the true value of JMP? And if not, how can long-term shareholders realize that value?

[Joe Jolson:]

That's a great, great question. We don't know why our stock went up like that. As best we can, we could determine there was a trading error. Potentially, someone entered a market order thinking it was J.P. Morgan instead of JMP and for an unknown reason didn't monitor it and that was kind of late in the day of that one day that you are talking about. Of course, then when they, if that was the case, when they realized it was a trading error, they need to liquidate the position, someone sold them those shares. I looked at the last disclosed short interest on our Company. It's pretty small and it didn't go up. So they had to be long sellers of those shares by definition. So I assume someone benefited from it. Those shares that were sold by Ray were in a 10b-5 plan that was way above where the stock was trading on. It had been trading at the time that kind of kicked in. So the, I think that, so someone benefited, either individuals that sold or non-employees because we were all blacked out. So I think that there were some beneficiaries of that, so that's the first part of your question. The second part is, do I think the stock is fairly valued here. I mean, we continue to repurchase shares. In the quarter, we bought some back. And then in that sell-off that you are talking about that was in the third quarter, we bought some more shares back. And it was limited by 144 rules that we can only go in after the first half hour and we can't be in the market in the last half hour, which is, you probably know, that's where high percentage of the trading volume everyday happens in the first half hour and the last half hour. And then we're limited in terms of average volume and given our stock trading that's a relatively low daily amount but we have tried to execute at a certain price levels as much as we can buy back under those constraints. So in the last couple of years, management's, including myself, have bought back over 10 percentage points in the open market of the company's stock. So yes, we think that value was significantly higher than it's trading right now and we're hopeful as our earnings recover, which should be driven by successfully redeploying our cash balances as well as this normalization that seems to be occurring in the equity capital market side. We're hopeful as our earnings recover, that it'll drive our stock price significantly higher.

[Chris McCampbell:]

In one of the slides you have in your presentation that you'll give to the Street from time to time involves M&A. And in regards to, I guess, the first question and the regulatory environment that we're in, are we at a stage where we are almost limited in regards to the growth that we're able to accomplish with the scale that we have? I mean, would it potentially be better for all parties to be part of the larger entity? Whether that's you all going out and taking care of that or somebody else coming in? What's your…

[Joe Jolson:]

Well, no. I think that we're publicly traded company, so we're not, there's no special deal for any management people, there is no golden parachutes, they is no larger salaries for any of us or guaranteed bonuses or anything else. So we own close to half of the stock, just the senior management and if you include the employee basis, closer to 60%. So we're pretty well aligned with you guys. I think that as well as aligned as I could fathom in terms of a public company so I think if an opportunity came up to buy someone to get bigger in a accretive way for shareholders, we'd certainly look at it and try to do it. And as I mentioned to an earlier question, we keep looking for those kind of things. But by definition, if we haven't done one of those things and in part because buyers have a different set of calculus to look at these things then it's possible that, that will get scale by merging with someone else down the road. But our eyes and ears are always open to doing what makes the most sense for the shareholders. So I don't think there's, there’s certainly no disconnect between us and you guys in terms of that kind of stuff. I think that when you look at our stock as a former portfolio manager for 15 years and an analyst in this space before that, you look at our balance sheet and recently, we've had a lot of cash but if you go back on an annual basis without these quarters of trying to redeploy the cash, we've had excellent returns on our capital invested in our fund strategies over the last 10 years as a public company but even before that, well before that. So way above kind of what should clear the marketed book value. And then you look at our operating businesses, the asset management businesses and JMP Securities and while there is some cyclical components to that, over any period of time they've, even though they don't have scale, been able to generate a mid-to-high double-digit ROE, okay? And so another alternative to look at, for us is management but also you as a potential or an actual investor is what are those two parts' worth, right? One doesn't have scale but probably is averaged at 20% plus after tax ROE over a long period of time, at times it's been 40% or 50% a couple of years ago. And the other has generated really good returns recognizing right now we're sitting on a lot of cash that we need to redeploy but once that gets done, it should be back in the low double-digit kind of returns on our average investments. So I think we are significantly undervalued even without some kind of event that you are suggesting but time will tell.

[Chris McCampbell:]

Well, no we're kind of preaching to the quarter and certainly appreciate the stack that you have in the Company. And appreciate everything you're doing. Thank you.

[Joe Jolson:]

Thank you for the questions.

[Operator:]

And there are no further questions.

[Joe Jolson:]

Okay. I appreciate everyone's interest and we'll be back in three months to give you an update on the third quarter results. Thanks, operator.

[Operator:]

Ladies and gentlemen, this does conclude today’s conference call, you may now disconnect.