JMP Group LLC
Q2 2015 Earnings Call Transcript

Published: 24 Jul 2015

[Operator:]

Welcome to the JMP Group's Second Quarter 2015 Earnings Conference Call. [Operator Instructions]. I'll now turn the call over to Andrew Palmer, the company's Head of Investor Relations.

[Andrew Palmer:]

Good morning. Here with me today are Joe Jolson, JMP'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 get started, I'll 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 discussion of the uncertainties that could affect future performance, please see the description of risk factors included in our most recent 10-K. That said, I'll turn things over to our Chairman and CEO, Joe Jolson.

[Joe Jolson:]

Thanks Andrew. Good morning, everyone. In the second quarter JMP Group continued its strong performance with operating earnings per share increasing 22% year over year to $0.22. Led by JMP Securities, our taxable operating subsidiaries had another strong quarter, earning $0.14 per share with net corporate income which is net investment income less corporate costs, contributing a little bit over $0.07 a share. Our operating return on equity for the quarter was nearly 15%, of which we paid out approximately 50% which resulted in annualized earnings retention rate of more than 7%. We intend to retain most, if not all, of our taxable earnings from our operating platforms to support their growth. And as a result, book value per share jumped to $6.41 at the end of the quarter from $6.14 at the end of March. I'll ask Ray to touch on a few financial highlights. And Carter Mack will provide some color on our investment banking activities before I continue. Ray?

[Ray Jackson:]

Thanks, Joe. Adjusted net revenues were $38.3 million, down from $50 million for the second quarter of 2014, primarily as a result of a $1 decline in low margin incentive fees in our hedge funds. Operating net income was $4.9 million or $0.22 per share, up from $4 million or $0.18 per share. For the six months ended June 30, operating net income was $10 million or $0.45 per share, up 19% from a year earlier. As for expenses, we look at compensation and non-compensation ratios. Our adjusted compensation ratio excludes two items. First, any hiring costs related to strategic growth initiatives, though there were none for the first half. Second, all hedge fund incentive fees since the majority of these fees is passed through to the investment teams when earned. This ratio came to 63.7% for the quarter and 64.9% for the six months ended in June. On the same basis, our non-compensation ratios were 20.2% and 18.7% respectively. Our adjusted operating margin which is pretax operating earnings over adjusted net revenues, was 16% for the quarter compared to 13% for the second quarter of 2014. For the six months concluded in June, our margin was 16.4%, up from 14.5% a year earlier. From a balance sheet perspective our recourse debt-to-total capital ratio was 41% at June 30. Shareholders' equity, all of which was tangible, was $136.1 million with book value per share climbing to $6.41, as Joe said. Now I'll turn things over to Carter.

[Carter Mack:]

Thanks, Ray. JMP Securities had a solid second quarter and first six months of the year. Adjusted net revenues of JMP Securities were $28.9 million, a decrease of 2.2% from $29.5 million for the second quarter of 2014, but an increase of 7.9% from the $26.8 million recorded for the first quarter of this year. For the first half of the year JMP Securities had adjusted net revenues of $55.6 million, a 9.4% decrease from the record $61.4 million for the first half of last year, a difficult year-over-year comparison. JMP Securities continued to post strong operating margins and net income, with second quarter operating earnings per share of $0.13 and an operating margin of 16.4% compared to $0.13 in the second quarter of 2014 with an operating margin of 16.8%. For the first half of this year, JMP Securities contributed $0.26 to operating earnings EPS with an operating margin of 16.7% versus first-half 2014 EPS of $0.31 and an operating margin of 18.7%. While JMP Securities' revenue and earnings for the first half of 2015 didn't match our results for the first half of 2014, we still produced the second highest half-year revenues for JMP Securities in our history. I'm going to spend a minute talking about some of the trends we think are worth highlighting in our JMP Securities business so far this year. Average revenue per investment banking transaction increased to $609,000 for the second quarter versus $470,000 for the first quarter and $491,000 for the second quarter of 2014. Average revenue per transaction was $532,000 for the first half of 2015, roughly equal to the $535,000 we produced for the record first quarter of 2014, but up significantly from $434,000 for full-year 2013 and $415,000 for full-year 2012. These gains reflect our efforts to book run more transactions, increase our co-manager economics, win more high-margin IPM mandates and complete more high-margin M&A business. JMP Securities has served as an underwriter of approximately one in every seven IPOs executed in the U.S. in the last 2.5 years. For the recent 12-month period ended in June we were an underwriter on 31 IPOs which represented 13% of the 242 total IPOs priced in the U.S. market. Our increase in IPO activity is a direct result of our efforts to build our technology and life sciences practices over the past decade. These have been the most active IPO sectors in the U.S. over the past few years and we have significantly increased our share of public equity fees paid in those sectors. Our market share of equity underwriting fees in technology and life sciences has tripled from 50 basis points in 2007 to 1.46% for the latest 12 months. Such growth represents a compounded annual growth rate of more than 15% over the last 7.5 years. During this same time period we nearly doubled from 113 to 201 the number of companies under research coverage in these areas. Also during that time frame, JMP's market share growth in technology and life sciences underwriting fees outpaced its growth in names under research coverage in those sectors. We believe that this demonstrates the importance of our research coverage to our issuer clients and reflects that we're doing more business with companies under coverage, while also increasing our economics on those deals. Our results at JMP Securities continue to be driven by a high level of equity capital markets activity, particularly in our life sciences vertical where we're consistently generating greater revenues per transaction. Our healthcare industry group contributed 75% of our investment banking revenues for the second quarter of 2015 compared to 77% for the first quarter and 50% for the first half of last year. While this is a high concentration in one industry group, it reflects the concerted effort we have made to grow our healthcare group over the last five years into one of the top healthcare practices on the Street. As a result we've been well positioned to take advantage of record equity capital raising activity in the industry over the last couple of years. The healthcare vertical is JMP Securities' largest group by headcount across banking and research and is also its most productive. Average revenues per transaction in our healthcare vertical were $946,000 for the second quarter and we're consistently winning book run mandates and receiving meaningful co-manager economics on deals. We continue to feel good about the drivers of activity in this space as we have seen healthy life sciences IPO activity already in the third quarter, with deals performing well and a good backlog of transaction set to launch in the next month. The record IPO activity in life sciences over the last couple of years has also created many new public market clients for JMP and has resulted in increased follow-on issuance by these companies. This increase in activity in our healthcare vertical comes against the backdrop of a slowdown in equity capital markets activity over the past year in two of our historically strongest investing banking verticals, financial services and real estate. Overall U.S. equity and equity-linked deal volume for 2015 on an annualized basis is down 31% and 16% from 2014 for financial services and real estate respectively, according to Deal Logic and is down even bigger when you compare first-half 2015 to first-half 2014 with financial services down 45% in deal volume and real estate down 20%. In the past, such a slowdown in the sectors could've resulted in a large decrease in investment banking revenues for JMP Securities. However, our efforts to grow our technology and healthcare verticals and to expand our investment banking products over the past decade have resulted in a much broader and more diversified investment banking platform today that is much better suited to withstand the market slowdown in a particular vertical or product area. We continue to be optimistic about a pickup in activity in the financial services and real estate space in the second half of the year with a number of IPO mandates that should be completed before year end. We also saw lower than normal contributions from our convertibles, debt placement and M&A product areas in the first half of the year, but we have reason to be optimistic about a second-half increase in activity in those areas as well. In particular, we have a strong backlog of engaged M&A transactions in private debt placement and equity placements. And we hope to close a number of those transactions by year end. Back to you, Joe.

[Joe Jolson:]

Thanks, Carter. As a whole, JMP Group had a good quarter, but not our best quarter. It was weighed down by disappointing results in our hedge funds, as well as modest loan sale losses at JMP Credit. As Carter discussed, JMP Securities powered ahead again, earning $0.13 per share excluding all net investment income on a fully tax basis, similar to what it earned in the prior quarter as well as in the second quarter of last year. Now, JMP Securities has now sustained an impressive return on equity of almost 42% on a trailing four quarter basis with very little financial leverage. Our asset management platforms, Harvest Capital Strategies, HCAP Advisors and JMP Credit Advisor earned $0.01 per share fully taxed excluding net investment income, representing a latest 12 month return on equity of a little under 38%. Asset management-related fee revenues dropped more than 70% to $4.2 million for the quarter, with incentive fees falling to $1.3 million compared to $11.5 million a year earlier. As we've discussed in the past, the majority of our hedge fund incentive fee opportunity resides with Harvest Small Cap Partners which had an outstanding year in 2014 when it produced a net return of 32% to investors. But in the first half of this year is down modestly. So no incentive fees this year versus very large ones a year ago. We've been working on new growth initiatives in our asset management subsidiaries for the past few years that we hope will lead to substantial earnings growth in 2016 and beyond. Those initiatives include Harvest Capital Credit, a publicly traded BDC that we manage; RiverBanc Multifamily Investors, an investor and debt-in-equity of apartment buildings in the Southeastern United States; and most recently, Harvest Intrexon Enterprise Fund, an early-stage life sciences fund that is a joint venture with publicly traded $6 billion Intrexon Corporation, the market leader in synthetic biology. Total client AUM, including sponsored funds from which we earned fees, equaled roughly $2.5 billion at June 30, up 16% over the past year. Hedge fund client AUM including sponsored funds increased 5% during the quarter and 9% over the last year and ended the quarter at $952 million. At quarter end, 38% of our sponsored AUM was in hedge funds and 62% was in private capital strategies. JMP Credit Advisors currently manages three CLOs totaling $1.1 billion and we recently began accumulating loans in anticipating of executing CLO IV late this year or early in 2016, subject to market conditions. For the second quarter, as I mentioned before, the return on our hedge funds was disappointing at roughly 0.5% or 2% on an annualized basis. Obviously this fell short of our expectation which for internal forecasting purposes we typically assume a 10% annual return on our hedge fund investments. That's a target that we have historically achieved, actually since inception overachieved. And as recently as 2013 did well in excess of that. Including our hedge fund investments, CLOs securities, principal investments and subtracting the interest expense from our long-term debt,, our total return on invested capital in the quarter was 2.3% or 9.2% annualized. Net corporate income which takes this net investment income number and subtracts all corporate expenses, contributed $0.07 to our total operating EPS in the quarter of $0.22 and $0.16 in our operating earnings of 45% -- $0.45, sorry, in the first half. Now, these numbers equate to a return on average equity for our corporate line of 6.2% in the quarter and 6.8% for six [Technical Difficulty] year and both those numbers are annualized. Another way of looking at that is that when you take all of our corporate expense, we more than cover that and still generate what most people would say is a reasonable return on equity in this environment on a hedge basis of almost 7% for the first half of the year. Earlier this week we announced a third-quarter cash dividend of $0.12 a share payable in three monthly installments which represents an increase of about 8% from the dividend that we paid in the first quarter and 100% from the cash dividend we paid in the third quarter of last year when JMP was a C-corporation. We also declared a special distribution of $0.03 per share payable this month that will distribute most, but not all, of the excess net investment income generated at the publicly traded partnership in the first half of the year. Our conversion into a public traded partnership has allowed us to return net investment income to shareholders in a more tax efficient manner. On the other hand, all of our taxable earnings at our operating platforms have been retained thus far in 2015 to reinvest in our growth which was demonstrated by the jump in book value in the quarter to $6.41 a share. As always, I want to close by thanking JMP's employees and independent Directors for their dedication to our success. Because of their efforts, a solid first half of the year is now in the books. And I think we're well-positioned for the second half. I look forward to detailing our additional progress for you in the fall. Operator, we'll open the line for any questions. Thank you.

[Operator:]

[Operator Instructions]. And your first question comes from the line of Joe Janssen with Barrington Research.

[Joe Janssen:]

I appreciate Carter all your comments on the banking side it's very helpful. Just wanted to dive a little deeper. It sounds like strength in life sciences healthcare has been strong it's continues to be strong as you look at Q3. I also find it interesting your comments regarding kind of the fig group and REITs and see some strength in it consistent with what one your competitors that I'm just curious within those two verticals which has been relatively weak are you seeing in terms of the pipeline is that kind of broadly distributed our next the group's or is one outperforming the other in terms of the pipe.

[Carter Mack:]

Yes. I mean just in general we see that take up in IPO activity and that's in some areas that have garnered a lot of attention tech enabled blending and some Capital Markets areas so we expect to launch a couple IPOs in the fig sector in the next month or two. And we're seeing some increase in activity in M&A and private market transactions and financial services as well on the real estate side similar to a couple of IPOs that we're seeing that are coming in our pipeline. So it's early stages but if you look back over the last year there's been some pretty dramatic decrease in equity issuance in some areas that were typically very strong for us mortgage REIT BBC's some of the property REIT sectors and that's really what I'm focused on and we're not seeing a huge uptick in those areas yet but as the interest rate environment changes I would expect to see more activity.

[Joe Janssen:]

And then on the brokerage side comparing year-to-date versus prior year the business is down a bit. And I recall on the last quarter call Joe I think you made a comment you are still expecting to have an up year. You know I know it's still a challenging environment out there in terms of volume I'm just curious if obviously the goal to have it up year do you still view that as kind of the general comment and then maybe kind of look as you optimism if that's true in the back half of the year that you can get there.

[Carter Mack:]

Yes. I mean were still expecting to have an up year obviously less up than we might've been before the year started but yes we're still expecting to be up year-over-year. I think the third quarter year-over-year comparison there is a little bit easier than the first quarter was. And then we have a cup tougher comparison were quarter which is often our strongest quarter in that business. In terms of collecting for research and the like at the end of the year. So we're still expecting to have an up year maybe up low single digits versus maybe at the beginning of the year we were hopeful it might be in the high single digits or 10% so it's a little bit disappointing but we're still working hard in that business and they're optimistic that we're going to gain some market share as the year goes along.

[Joe Janssen:]

And Joe one last general question. I'm not sure if I've asked this in the past but just kind of what your view is in terms of acquisitions whether that be Smalltalk ins either in different verticals are different revenue streams I'm just curious general thoughts.

[Joe Jolson:]

We continue to be out there trying to see what's available in companies looking to sell in our business lines that we're in which are basically the investment banking research sales and trading at JMP Securities in the alternative asset management area at Harvest capital as well as potentially kind of the corporate credit manager JMP credit -- just because we haven't done anything doesn't mean we don't look. Our problems frankly historically is our stock is way too cheap relative to kind of where some of these acquisitions that we would even consider clear the market and that's one of the reasons we bought back so much stock historically is just comparing the return on our capital from buying ourselves versus buying other people but we continue to look and I would be -- I'd be disappointed in the next one to two years if we didn't actually announce some meaningful acquisitions because we're active it's just we haven't done anything. Nothings actually come to fruition.

[Operator:]

Thank you. And your next question comes from the line of Doug Doucette with KBW.

[Doug Doucette:]

I'm just getting back to the expenses on a comp issue I know it dropped again sequentially. And this is not of instead of incentive income so could you just give me some more color on what might be driving that lower. Is that like a business makeshift or any color would be appreciated.

[Joe Jolson:]

Yes. I mean we haven't changed any of our operating subsidiary kind of comp ratios so I've been you mentioned net of incentive fees obviously that's the biggest driver I think in my comments I referred to a big drop in the Harvest small Incentive fees. That can turn around pretty quickly historically they've had some really strong quarters but you still slightly down for the year at the end of June and that makes a lot of revenue volatility but virtually all of those incentive fees not 100% but a very high percentage as we discussed gets passed through which is why we're trying to disclose those ratios excluding that. But I think that the other thing driving that mix a little from quarter to quarter would be investment income where we're essentially paying a Portfolio Manager a management fee and a carry above a hurdle so it's typical of what incentive fees would be in a fund so that's obviously a much lower comp ratio on our investment income than you would get on the operating businesses and even though the hedge fund return on our capital was disappointing this quarter we did have some positive results in incentive or in other principal activities in the quarter and so I think that that coupled with a very low incentive fee quarter which we already discussed kind of reduced the mix. I mean we continue to think that net of incentive fees that that comp ratio is going to be in the low 62.5% to 65% kind of range as it has been historically.

[Doug Doucette:]

And then just one more. Regarding the debt in convertibles investment banking activity I see a nice sequential increase in that item. How should we really be thinking about that going forward.

[Joe Jolson:]

I just said we had a couple nice transactions on the convertible side. We continue to be actively pitching on the debt private placement side and have a number of engagements their so we'd hope to close a number of those in the second half of the year and then the convertible side we're in front of clients on a regular basis with that product and it tends to be fairly volatile issuance year-over-year. We would hope that we'd see a nice uptick in that area in the second half of the year as well but it just happened that we had some a couple the transactions on the convertible side in the second quarter. Just to give you some color on that in 2000 Just to give you some color on that in 2013 the convertible area was roughly $15 million in revenues for us and it's a little bit countercyclical to the stock market if you kind of think about it. If you have a growth company looking to raise capital and they think their stock is undervalued often they will consider issuing a convert because they are essentially issuing if the stock does well longer term at a price that could be 20% to 50% higher than what they'd issue in equity offering. But the surge in stock market in the last year and a half two years that benefited our equity capital market line of a lot has also been a damper on the converged side. That were still actively pitching that product and it's a little bit countercyclical I think in terms of the equity capital market side. On the debt side we've added a couple of people to that group in the last year and a half and greatly expanded that calling effort and we have a pipeline there that we're hoping to execute on in the next ex months successfully. And so I mean if I could just take a little setback obviously when we see Life Sciences has been huge and that was an investment that we made over more than a decade but in particularly five years ago we decided to really grow that business and at a bunch of analysts as well as bankers in that business when it was out of favor. And we're getting the benefit of that today. At some point that area will normalize and we're aware of that as a management team so we been making investment in some of these other areas within investment banking the debt convert side the M&A side with the hope that we can grow through that still. But I think one of those areas is on the debt side that we're hopeful we'll have a lot of upside in the next couple of years.

[Carter Mack:]

Last thing I would add and address is pretty well is on the convertible side we're I think one of the most active underwriters of converts among boutique investment banks and we do get opportunities to lead or so manage a lot of transactions in that space when we do get transactions so it's a high revenue per transaction kind of area so when it does tick up it's a good contributor as joint pointed out in 2013.

[Operator:]

Thank you. And your next question comes from the line of Jeff Briggs with Singular Research.

[Jeff Briggs:]

I have got two questions for you, the first one has to do with the partnership that you guys announced with Intrexon. I guess in general I've taken a look at that and just want to see if I can get a little better handle on exactly how it works. I guess my understanding of it is basically you guys are forming a captive BC fund if you will in the Harvest Capital Strategies for spinoffs from Intrexon technologies and I guess I was just curious one how does that work is it just like a normal venture capital fund where you guys are getting investors, there is a management fee you carry and but because these seem to be really early-stage spans were going to have to develop management team for the spin our company and that stuff -- how does that all that stuff work and then just a little bit of handle on like what the capacity is this fund might be is it just a small sort of add on an Harvest Capital Strategies or is it something that could eventually be a material impact on earnings.

[Joe Jolson:]

I'd like to be able to answer some of those questions that were still in the process of raising money for this fund so that's -- in fact I mentioned it briefly in my remarks only because Intrexon put out a press release when it had a first close that JMP hasn't put out anything in the public area yet but it's out there a little bit that there was a closing. And I can just tell you that the goal when we launched this thing was to raise $200 million plus in commitments and we're pleased with the progress thus far and when we have a final close which we're hoping and is this quarter than we've put out a press release and talk and be in a position to answer your questions and more detail. But it has a similar kind of free structure that a typical venture fund with have. I think obviously we're pretty excited about the potential there with that partnership with those guys. And we think down the road if we can execute on that funding strategy and we -- or sexes fossil at raising kind of that target level that can lead to in material carried interest for JMP in for five years but the carried interest of those kind of fun is kind of back and waited obviously.

[Jeff Briggs:]

All right and especially because it sounds a these are very, very early type things. It's not like late stage stuff that down the road.

[Joe Jolson:]

Yes.

[Jeff Briggs:]

I know Intrexon is a pretty unique company and you guys have obviously as you mentioned before really been doing well in the healthcare space. Is this a model that can work in some repeatable fashion with other types of companies or is it just sort of a very unique one off think that was a good opportunity.

[Joe Jolson:]

Well what we're trying to do in asset management is identify strategies that we think can be at least $300 million if not hopefully billions of dollars over time where we think with the team we've attracted to manage it that we have a sustainable edge and we're looking at least so far we've looked exclusively that alternative asset strategies where we're getting attractive management fee and some profit participation. As a public company having -- we think that plan of having an economic interest in a diversified group of those types of strategies is a very valuable public company franchise and right now we have around 10 of these strategies in five different asset classes. We'd like to have 15 or 20 in 2 to 3 years so we're looking at new things all the time. Besides the Intrexon I also mentioned Harvest capital credit which is now a separate public company. So if you're going to be in the alternative management strategy and you want to develop a very valuable asset management business there having access to public capital in that way is expensive to get those things from inception to being public but once there at that point if they do well it's kind of more open ended how big a business that can be. So really optimistic about Harvest Capital Credit and that business and I think that we really haven't seen the earnings leverage for the earnings impact from that yet in our numbers but we think will start to see that next year and beyond. I mentioned RiverBanc multifamily investors. We cofounded that business in the management of that company and this is a company that I can't really talk about right now because they've been in registration to go public and even though JMP Securities isn't part of the underwriting group there in that process right now so our fingers are crossed that sometime we might have another public company franchise there that were significant company interest in an. We're really interested in doing more of those types of things where not only it build our earnings in our asset-management business materially but also reinforces our overall franchise of the company. And all the stuff that we do and so we're off to a good start their we'd like to have maybe five or 10 more of these bits of things over the next four or five years so hopefully will be able to do that.

[Jeff Briggs:]

One more quick question. In this kind of gets back to something you're answering and another question before in regards to looking for acquisitions and the return on equity investing in say a new line of business or add on line of business or in your own operating platforms is significantly higher than the money you guys have invested in things of that nature. Let's say that one of those things comes along and you're able to deploy some of that capital into an acquisition. Does that affect materially the I guess net investment income available for distributions if that were to happen. I mean obviously the return would be higher by making that investment but does that change your net investment income enough that the distribution profile with the down.

[Joe Jolson:]

It's a good question and I think that it would depend right. If we acquired the company and it was all for stock and that was fully taxed operating subsidiary then to have it be accretive to the overall firm's earnings it would have to -- our return would have to be pretty great on that acquisition given the piece of the firm's earnings are coming from net investment income right so that would be a challenge but it's something that we're hopeful we can figure out. If we're presented with the right opportunity that makes sense. If we on the other side if we acquire something that generates net investment income plus an asset management stream but we're net investment income is a significant potential piece of that it could be wildly accretive to the dividend as well as the overall firm's earnings so we kind of have flexibility in the structure our thing to look at those. As I said in my comments we've kept all the earnings at the operating companies and we intend to continue to do that but we can always dividend up earnings at the operating company to the partnership level to distribute to investors. So if we pursued something that maybe diluted the dividend per share at the PTP because we issue shares but was highly accretive at one of the operating subsidiaries we can always start the dividend up some salt percentage of this company's earnings to be in a position to not just support the dividend that we're paying out but also grow it.

[Jeff Briggs:]

Okay you just have to pay tax on those earnings?

[Joe Jolson:]

Yes it just doesn't -- it would be -- if we dividend up money from the operating subsidiaries it's already been taxed once so it be a qualifying dividend under the current tax code so would be a pretty low marginal tax rate for investors but there'd be a small layer second level tax there.

[Jeff Briggs:]

Okay. Obviously I [indiscernible] just thinking about it.

[Joe Jolson:]

We think about that stuff all the time. It's an interesting dynamic that we think is a positive but that most companies don't have to think about because it doesn't come into play.

[Operator:]

And there are no further questions at this time. I would like to hand it back over to the presenters for any closing remarks.

[Joe Jolson:]

Thanks everyone for being on the call and your support for JMP and we're excited to get back on in three months in give you an update on our third quarter. Take care.

[Operator:]

Thank you and this does conclude today's JMP group second quarter 2015 earnings conference call. You may now disconnect.