JMP Group LLC
Q3 2017 Earnings Call Transcript

Published: 4 Nov 2017

[Operator:]

Welcome to JMP Group's Third 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 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 our control. Actual results may differ materially from those indicated or implied. For a discussion of the uncertainties that could 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. Our results were better than expected driven by record third quarter investment banking revenues at JMP Securities and continued progress in redeploying our excess cash. JMP Securities share of the U.S. equity capital markets business has increased as evidenced by year-over-year jump in equity underwriting revenues of 41% for the third quarter and 77% year-to-date. In contrast the broader industry has recovered more slowly from a two year slump with U.S. ECM fees down 11% year-over-year for the third quarter though up 26% for the first nine months of the year according to deal logic. At period end we had a $1.49 a share in investable cash compared to $2.18 a share in June. In July we announced a $200 million warehouse facility that enables us to accumulate loans for our fit CLO over the next 6 to 12 months. If we successfully execute CLO V we may once again be able to cover our fixed corporate costs on a consolidated basis and also fund our current cash distributions completely with net investment income from our publicly traded partnership. We are off to a good start in the fourth quarter as our investment banking momentum has continued with the closing of a large M&A transaction for Forestar. Thanks to a more normalized capital markets environment we're also executing an increasing number of IPO's and follow on offerings, in addition workspace property trust recently filed a registration statement in connection with an IPO and as a founding investor we are hopeful for a successful transaction. JMP Securities contributed $0.13 per share to operating earnings for the third quarter up from $0.05 last quarter and $0.02 in the third quarter of last year. Our asset management platforms lost less than a penny a share on an operating basis while our net corporate expense cost us $0.02 a share. All told we produced operating EPS at $0.10 a share for the quarter up from $0.03 for the second quarter but down from $0.13 a year ago. For the first nine months of this year operating earnings were $0.03 well below the $0.35 we earned for the first nine months of last year but improving rapidly. Against that backdrop I want to spend a few minutes reviewing our results relative to plan year to date and updating everyone on the progress we've made this year on our four key corporate initiatives. Overall our results have been slightly below expectations through September. On the negative side we have seen a modest increase from historically low loan loss provision levels in our CLOs and experienced a more meaningful loss on a principal investment with our loan to Blue Jay Capital Management, the two combined cost us $0.08 a share year to date most of that was the latter not the former. In addition a reversal of unrealized gains on our total return swap prior to its liquidation earlier this year cost us roughly $0.05 a share. Offsetting a shortfall in net investment income which was primarily in Q1 has been improved performance of JMP Securities which has earned $0.19 a share year to date in a recovering capital markets environment. Assuming that conditions remain fairly stable through year end we are very optimistic about a strong finish to 2017 at JMP Securities. Now onto our four corporate initiatives, first to grow our advisory revenues to $50 million by 2021 by adding productive M&A bankers to our platform and increasing our average fees per deal focusing more attention on publicly traded companies within our coverage universe and competing more effectively for larger transactions. We made good progress in 2017 increasing our average fee for M&A deal to a $1.5 million so far this year compared to $850,000 just a couple of years ago. Our goal this year was to hit $25 million in total advisory revenues which have achieved which still be about 12% below our record 2016 level but once again more than double our 2015 results. We're still hopeful about hitting that goal given a strong start to the fourth quarter. Our second initiative has been to continue to invest in JMP Securities capital markets platform to protect our franchise value as one of the few remaining research boutiques in the consolidating industry. I'm very pleased to report that our capital markets revenues had been up 56% year to date versus a much more modest recovery industry wide. Well it has cost us some earnings in 2015 and 2016 to maintain our sector franchises, our countercyclical growth strategy to gain market share through downturns appears to be paying off thus far into the recovery. Some numbers just to share with you on a trailing 12 month basis our market share of the four industry verticals that we're in was about 1.4% and that's at record levels and our market share for the last 12 months of U.S. ECM business including everything not just the four verticals was 0.63% and that’s also at a record level, that number is average about 1% over the last three years versus 1.4% year to date in our targeted verticals. In the third quarter this year we served as book runner of six capital markets transactions after book running seven deals in the second quarter. During the first nine months of this year we were a book runner of 18 offerings compared only three offerings in the same period a year ago. Through the end of October we have now participated in 14 IPOs this year versus nine for the whole year of 2016. As our revenue growth has accelerated we have benefited from tight cost controls and the excess capacity we maintain through the down cycle. Year-over-year non-comp costs have risen just 1% while headcount has been relatively flat, as a result JMP Securities operating margin expanded to 9.6% for the first nine months of this year versus only 2.4% for all of 2016 and in the third quarter actually was 17.3%. The fully tax return on average equity of JMP Securities was 45% for the third quarter and almost 20% for the first nine months of the year with just 0.75 to 1 to debt equity capitalizing the business. Our third corporate initiative has been to look for opportunities to grow our asset management platform, 2017 was expected to be difficult due to the redemptions of CLO1 and 2 early in the year which reduced our assets under management and our credit business from over a $1 billion at year end to just $360 million prior to completing the $450 million plus CLO4 at the end of the second quarter. JMP Credit is a scale business and we maintain our cost structure even as AUM declined sharply since our intent was to redeploy our capital in two new deals over the next 12 to 18 months. As a consequence earnings this year decreased to about breakeven levels in addition to that incentive fees at HCAP Advisors have been clawed back this year due to a series of loan losses and fair value declines on investments eliminating much of that business as earnings. While 2017 will likely result in a small loss for our combined asset management platforms prospects for 2018 are much brighter. Assuming that CLO5 is completed around mid-year and Harvest Capital credits fair value marks are not material we expect the segment to return to profitability in 2018. Finally our fourth initiative has been to redeploy our unusually large investable cash balance which was created by the turnover of the capital in CLO 1 at the beginning of this year and redemptions from hedge funds that we closed in 2016. We could fully accomplish this objective through the accumulation of loans in our warehouse facility during the 6 to 12 months if we can conclude that process with a successful execution of CLO 5 underwritten to expected returns of those at least matching our last deal. We are optimistic about our near term outlook. Thanks to a clear path to redeploying our excess cash in a accretive manner and improved capital markets environment though not one close yet to 2014 peak levels and the potential for successful IPO near term for workspace property trusts. We recently announced monthly cash distributions of $0.03 a share for the fourth quarter which is unchanged from our regular distributions, our third quarter operating earnings cover these cash distributions for the first time this year which is a good sign obviously. We are hopeful that net investment income at the publicly traded partnership level will improve and will cover our normal quarterly cash distributions as more loans get added to our warehouse line during 2018. To finish up as always I want to thank our company's employees and independent directors for their dedication and effort. JMP Group's success is the result of their hard work. Operator I'm happy to answer -- all of us are happy to answer any questions from the listeners. Thank you.

[Operator:]

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

[Unidentified Analyst:]

This is Chris sitting in for Alex. I had a question surrounding the workspace property trust, what percentage do you own and following up on that based on the expected filing range what type of gross proceeds are your expectation?

[Joe Jolson:]

Just to start off JMP Securities is a passive book runner, the deal is limited in what I can say at this point but there are two places I would point you to that have publicly available information. One is our last filed 10Q that shows what the dollar amount we invested for JMP Group is in workspace not our cost basis which has been depreciated through just our normally the company running through a high degree of property depreciation and amortization. So you can look at that and find that number and since its closed it's essentially $10 million. The other place you can look is in the red herring since workspaces on its road show right now that you know you can look and it shows you got to go into the middle of long document but there is a table in there, sorry I don't remember the page number that shows all the original investors what the value will be of their investment. Now I want to caution you that our investment includes some affiliated funds that we managed, that invested in as well so it shows it's not apples and apples but the percentage increase is relevant to our cost basis. So that would be helpful. Obviously it depends on where the deal prices is and we will be locked up for six months so we intend to whatever the gain is we will conservatively book at some lock up discount like we have when we've had similar things like that in the past. So we won't book the entire gain on day one and some of it will be deferred into the future months as the lock up runs off. The other thing that's also material about that deal is that our operating earnings have diverged pretty materially as well as our adjusted book value from GAAP since we made that investment and that distortion will go away. So there's two adjustments to book value that we make, a GAAP book value one is general loan loss reserves which is a number that will go up and down with assets under the CLOs and it's an non-cash reserve. The other thing that we adjust for is the property depreciation to amortization on workspace that's a much bigger number at the end of September that was around $0.50 a share that number as well as in the quarter it was almost $0.12 a share. So when you look at our GAAP loss of $0.06 that getting rid of that $0.12 depreciation we would have had a GAAP profit of $0.06 so it's pretty distorted. So you know to the extent that it potential investors screen for ideas based on GAAP not what we adjust for operating, I think that might have benefit for our stock. The other distortion just so I close the loop there between what we call operating and GAAP that is meaningful is just we expense when we pay people in a given year we expense all the deferred comp on day one in our operating earnings and of course GAAP may she defer that overtime. So there are some times doing that where our GAAP earnings are actually a lot higher than our operating earnings, if we're having really good year and there's a lot of deferred comp and you know we've always done that and we're going to continue to do that because we think the GAAP accounting is actually overstates what you earn when business is good and understates on the other side of a cycle. So we're still going to do that but that would be the only material difference between GAAP and operating going forward.

[Unidentified Analyst:]

And in regard to Forestar would you be able to provide any additional color as far as the size of the deal is that an average sized deal would you say?

[Joe Jolson:]

You mean the fee or the size of the deal?

[Unidentified Analyst:]

The M&A fee.

[Joe Jolson:]

That isn’t public but it's representative of a normal percentage of the consideration of around 1% plus or minus now just to caution you because you got into a bidding war there some of our fee was given in a multiple fairness opinions in the second and third quarter already so those get credited against the total so it wouldn’t have been 1% of the dollar amount in the fourth quarter, but it was still a record M&A fee for us in the fourth quarter.

[Unidentified Analyst:]

Okay. And then you highlighted the increasing number of IPO's and follow on offering's that you're seeing in the environment. Is this within the typical JMP sectors or are there some new ones that we should pay attention to?

[Joe Jolson:]

You know we're very focused on our four sectors, I think the other sector over the last 18 years of being in business is never much of a number and I don’t even think -- I think it's zero year to date so we're a 100% focused on our niche areas that we think we add value in and so we haven't added any new sectors. In terms of the breakout within the sector so one of the interesting things about where we are now versus when we had a peak results in 2014 is the diversification within the industry groups. If you go back to our PowerPoints in 2014 and even into the first quarter to 2015 healthcare was a extraordinary percentage of very large number in terms of peak results for us, it was over 70% and at the time I told people that it's great that we're in life sciences it's our biggest area we have the biggest commitment with senior analysts and investment bankers but 70%-75% was punching way above our weight class there and at more normal level given the percentage of seniors MDs that we have would be 40% maybe a little more and so far year to date it's about a third. So the point I want to make there is it went from a risk factor two or three years ago to an opportunity and I think that we've seen some pick up in the last couple of months in terms of follow-ons in the space and some IPO. So we'll see how the fourth quarter plays out for us in life sciences but year to date it's only about a third of our investment banking revenues and that includes healthcare M&A which for us is not necessarily life sciences. We have a little niche area in the healthcare services side.

[Operator:]

Your next question comes from Ann Dai with KBW.

[Ann Dai:]

I wanted to start on the CLO 5 warehouse and just getting update for how things are going there, is there's some color you can give us and how that ramp it going and whether the dynamics you're seeing in the market today are fairly similar to that of prior CLO?

[Joe Jolson:]

I think that the market itself if you just look at the trillion dollars or close to trillion of outstanding broadly syndicated corporate credits out there is actually pretty frothy and it has been for quite a while and so what we've chosen to do is build that loan book slowly through new issuance because a typical new issuance we can still get allocated a reasonable share and it's priced typically at some discount at par, unfortunately not much of a discount anymore versus history but still a discount where if we were to go into the actual market to buy secondary existing debt it would be at a premium unless there were some issues attached to the credit then it could be at a discount but we're not looking at taking excess credit risk it's a pretty conservatively managed portfolio. So we don't really disclose the commitments in that but I think when you -- you know it's on our balance sheet at the loans that we've accumulated through September, I don't know -- is the number can they see it its slight $10 million. But on new issues you're committing to the deal and there's usually two lag between that and when it closes. So if we bought in the secondary market you know it's a much quicker settlement process. So in any case that's kind of at the end of September that's where it was we just started the warehouse line in August, beginning of August and August was kind of as you would think there weren’t a lot of new issues happening in August. So it's picked up a lot in September. I think that we're on track still to -- if we continue with the current pace which could accelerate if the market sells off. We will pick up our activity but we're on track you know for sometime in the middle of next year to look to execute a deal market conditions willing. So that's on that side of it. Today the returns are actually better in the market than they were when we did CLO 4. I don't know if that's going to be the case in the middle of next year when we look to execute a deal but today they're better and you can see there better by just if you follow that market you see a lot of regionally issued CLO managers are refinancing the debt and we've done that, we did that once earlier this year and we're kind of considering maybe even doing it again and there's a short term early debt retirement charge attached to doing that but there's a substantial improvement going forward and in the IRR on that is pretty appealing so that kind of if you follow the CLO market that's a good indicator, debt returns are improving a lot when you see people refinancing regionally issued CLOs. You see what I'm saying if you want to track that.

[Ann Dai:]

My second question is on the brokerage business just given the recent SEC fee waivers on [indiscernible] and as we're heading into the end of the year and its about to be I guess live in January I guess I was hoping you could give us some update on how you're thinking about that impact your business and is there a general theme coming out of those conversations with clients and what proportion of your clients you think are subject to it?

[Joe Jolson:]

You know I think for JMP it'll be a modest negative impact only because the amount of revenues that we have in the brokerage business particularly if you ex-out check revenues and just look at trading revenues and you know is a small percentage of our overall revenues and also within that context we've focused on trying to grow that over time but only if we can do it in a profitable manner so you know that's the main reason why it's smaller not because we like it being smaller, we'd like to be a lot larger if we could grow it profitably. So I think the impact on us will be modest. The percentage because it's so low you can imagine the percentage of our net commissions business is generated by the global managers is well below the industry. So we have quite a bit less exposure than the average industry participant would and we've talked to every -- we've met with every one of our Top 50 clients in most cases they don't expect any material impact. There's a few that will be changing the way they do things and so we'll see what happens. I mean one could make the argument that we might pick up a lot more business if people drop out because they're much worse affected than we are. I mean like I said we'd like to grow this business a lot if we could grow it profitably and that's the reason that we haven't been able to grow it in the last three or four years. So if people start to drop out and we pick up enough market share it could be opportunity as we go through 2018 to maybe look at growing that business more rapidly. So we've kind of been cautious for the last three or four years because of the opportunity set and that could change in our favour to where we might enter 2019 or more you know beyond actually that business growing again for us. So we'll see.

[Ann Dai:]

Last thing's on capital management, as we think about next year how are you thinking about the return of capital between distribution and buyback? Seems like you picked up the share repurchase a little bit this quarter but if you look further out you know how much of that can you do you given the current liquidity and is there a point at which you would maybe consider some kind of special distribution?

[Joe Jolson:]

Well you know I think that the buyback is a function of where our stock sells. We bought some yesterday for instance not a lot, it doesn't trade that much so we're limited by the buyback rules but you know it's in a 10b5 plan that we don't change a lot and there's a limit kind of based on a guess [ph] of what you know book value might be and then if it trades it some discount to that then we might be active in the in the market subject to the rules right, so I mean we bought back over 1% of the stock in the third quarter given all those constraints. So if you annualize what we bought back in the third quarter if the stock continues to sell down here for whatever reason probably retire 5% of the shares if that gives you any guidance there but that's not our goal to go private one share at a time here. Our goal is to get the stock more fairly valued but if people are somehow interested in selling us shares down here we will keep buying it back. In terms of the cash dividends you know that's driven more through operating earnings in particular net investment income at the publically traded partnership level and year to date we haven't earned the dividend on either measure. Now the third quarter we did earn the dividend for the first time this year on operating earnings but not on earnings that publically traded partnership -- it's a thing with $0.06 so we're still little below that $0.09 at the publicly traded partnership level. And of course we think that will continue to improve sequentially as we add more loans you know obviously the quarter that you add the loans doesn't help that quarter really, it helps the next quarter, so there is a lag in the impact on that but you know we're hoping that by the middle of next year that we will have enough loans on that warehouse or would have completed another CLO that will be able to cover that dividend you know that's essentially why we've maintained it at the level we have even though we haven't earned it at the publically traded partnership level year to date. So hopefully over the next few years we will be in a position to raise the dividend which we haven't been in quite a while. Now in terms of the buybacks we're just looking at if its accretive to net asset value per share we have a lot of cash. So they're not mutually exclusive. So the buybacks are coming out of investable cash not operating earnings.

[Operator:]

There are no further questions.

[Joe Jolson:]

Okay. Thank you operator and we look forward to updating everybody else on our progress sometime in February of next year. Thank you.

[Operator:]

Thank you. That does conclude today's conference call. You may now disconnect.