JMP Group LLC
Q3 2016 Earnings Call Transcript

Published: 26 Oct 2016

[Operator:]

Welcome to JMP Group's Third Quarter 2016 Earnings Conference Call. Please note that today's call is being recorded. [Operator Instructions] I'll 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 our President, Carter Mack. 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 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 Group’s Chairman and CEO, Joe Jolson.

[Joe Jolson:]

Thanks Andrew. JMP Group produced better-than-expected operating net income of $0.13 per share for the third quarter, helped again by strong returns on our principal investment activities. JMP Securities also returned to profitability with net income of $0.02 a share, as equity capital markets fee revenues improved from the depressed second-quarter levels. The year-over-year growth of our M&A revenues continues to impress, increasing by more than 200% thus far in 2016 and already setting a new annual record with one quarter still to go. Our focus on broadening our M&A efforts since ECM activity was at peak levels during 2013 and 2014 has enabled JMP Securities to manage successfully through the current down cycle and invest in growth initiatives while still maintaining modest profitability this year. Going into 2016, we had anticipated the need to fund our cash distributions to shareholders solely through our investing activities. In the third quarter, we benefitted from improved corporate loan pricing and from a return of roughly 7% on our real estate investments. Net corporate income for the quarter was $0.11 per share, including a contribution of $0.18 per share from the publicly traded partnership that doubled our cash distribution paid of $0.09 per share. As a result, we were able to cover our current cash distributions and grow our adjusted book value per share, which increased to $5.94 at period-end. Shortly after quarter-end, Workspace Property Trust closed a materially accretive acquisition of nearly $1 billion of high-quality suburban office and flex properties. As a founding investor in Workspace, we expect to benefit from an estimated 30% increase in its adjusted book value per share, as well as higher returns on our $10 million of invested capital and our ownership interest in the manager going forward. At this juncture, without pro forma financial statements, our best estimate is that the transaction could add upwards of $0.05 a share to our fourth quarter operating EPS on a one-time basis. Before I continue, I’ll have Ray Jackson discuss some financial highlights. Ray?

[Ray Jackson:]

Thanks Joe. Adjusted net revenues were $29.6 million, up from $27.1 million for the third quarter 2015. Year to date through September, adjusted net revenues were $94.7 million, compared to $102.9 million for the first nine months of last year. Operating net income was $2.9 million or $0.13 per diluted share as Joe said, up from $1.3 million or $0.06 per share for the third quarter of 2015. For the first nine months, operating EPS was $0.35 versus $0.50 for the same period last year. As for expenses, our adjusted compensation ratio, excluding hedge fund incentive fees was 68.4% versus 67.8% in the third quarter of 2015. Year to date through September, the ratio was 69.2%, compared to 65.6% for the first nine months of last year. On the same basis, our adjusted non-compensation ratio was 24.4% for the first nine months versus 21.2% for the same period in 2015. Our adjusted operating margin, pretax operating earnings over adjusted net revenues, was 7.6% for the third quarter and 6.1% for the first nine months, compared to 3.1% and 12.9% respectively in 2015. From a balance sheet perspective, our recourse debt-to-total capital ratio was 43% at September 30. Shareholders' equity, all of which was tangible, was $121.8 million with adjusted book value per share which adds back accumulated non-cash depreciation and amortization expense related to our commercial real estate investments ending the period at $5.94, as Joe mentioned earlier. We paid out a total of $0.09 per share in cash distributions for the third quarter and have already announced fourth quarter distributions in the same amount. We bought back fewer than 30,000 shares during the third quarter costing us roughly $160,000 and leaving us with approximately 1.2 million shares to be purchased under our existing authorization.

[Joe Jolson:]

Thanks Ray. During the third quarter U.S. equity capital markets activity increased for the first time since a sharp downturn that took hold in late June of last year, though activity remains at relatively depressed levels. Our third quarter ECM fees of $6.2 million rebounded from a cyclical low of $2.8 million in the second quarter, but were still down 37% from the third quarter of last year. Total investment banking revenues however were up 26% year-over-year, thanks to a strong contribution from M&A, debt and convertibles, and a private placement fees. Through the first nine months of 2016, our strategic advisory fees equaled $22.2 million versus $7.1 million for the same period in 2015, an increase of more than 200%, and a total that surpasses our best year ever of $20.3 million set prior to going public in 2005. Our success on the M&A front this year can be traced back to a concerted effort since 2013 to expand our strategic advisory capabilities to catch up with our increasing ECM market share. Since founding JMP Securities in 2000, we have always targeted a balanced approach between our capital markets activity and our strategic advisory business. Our record results in 2016 are the result of a three-year effort to get back into balance both by hiring senior M&A bankers in each of our industry groups and over the past 12 months to 18 months by sharpening the focus of our existing bankers on the M&A product in a weakened equity placement [ph]. We will continue to focus on growing our M&A franchise with the goal of doubling revenues over the next five years to $50 million. To achieve that objective, we will need to add a few new M&A focused bankers per year, while also increasing the frequency with which we act as a sell side advisor to publicly traded companies. We believe that the current competitive backdrop in challenging market dynamics for peer firms both large and small could present us with an opportunity to recruit productive bankers who can leverage their relationships and expertise on JMP's platform. In addition to driving higher and more stable earnings for JMP in general M&A revenues were much more valued by investors and acquires alike. We are successful in demonstrating that this year's M&A fees are not an anomaly and that we can grow the business in an attractive rate over the next 3 years to 5 years. We were hopeful that our stock could be re-valued significantly higher. Of course, when the public market showed renewed strength, we will remain well positioned to benefit from that recovery and to make market share gains in that arena once again providing us with momentum in both key parts of our investment banking business. In addition to building our M&A franchise, we have continued to selectively invest in our institutional equities platform with the addition of experienced senior research analyst and seasoned brokerage professions. Given depressed ECM conditions there is a higher near-term cost to this counter cyclical growth strategy. Our dual objective though is to increase our ECM market share by 50% or more over the next five years and to stabilize and then modestly grow our net commissions’ revenues. Over the past few months, we have entered the alternative energy sector with the hiring of Joe Osha who recently launched covered of the solar power industry. We expanded our equity capital markets presence, particularly in technology and med devices with the hiring of Andy Mertz. And they have bolstered our convertible sales and trading desk with the hiring of Scott Margolis. We expect that we may make additional hires to broaden our research coverage in the next 3 months to 6 months. We are acutely aware that most investors do not believe that there is material franchise value for this business. Just look at the valuations of M&A boutiques versus ECM platforms. However in the late 1990s, 31 of the top 15 investment banks in the United States were purchased frothy evaluations based on their ECM product. There were very few surviving firms in the U.S. with established ECM businesses and even fewer that are well managed and profitable. We like to think that JMP Securities is one of them even though we are still sub scaling this business. At some point in the next five years, we would expect another up-cycle in ECM fees and increased interest in the ECM product from strategic players. Our asset management business continues to rationalize its existing fund strategies and to plant seeds of faster growth by adding newer and more synergistic private capital strategies. In the third quarter, we closed Harvest Financial Partners, but also launched JMP Reality Partners One to make equity investments and real estate related assets. We are in the process of setting up our first credit opportunity fund, JMP Capital One, which would leverage the successful track records of JMP Asset Management, Harvest [ph] Capital Advisors, and JMP Group. We hope to report a first close of this fund strategy on our next quarterly conference call. Down cycles can also present excellent opportunities for us to invest our capital. We enter 2016 where the expectations that our cash distributions to shareholders would have to fully cover our net investment - will have to be fully covered by our net investment income at the publicly traded partnership. While we were always on the hunt for new attractive investment opportunities, the timing of them has always been opportunistic and that’s difficult to forecast. For the third quarter, income from our principal investments covered 100% of our corporate cost and strategic growth initiatives and still contributed $0.11 to operating EPS, exceeding our cash distributions of $0.09 a share. Importantly, the PTP contributed $0.18 per share of net investment income or twice our cash distribution. Year-to-date net investment income was $0.29 a share, roughly equivalent to our total of our cash distributions, but it included $0.49 of earnings at the PTP level. The drag on JMP Group income this year is primarily the result of depressed earnings at JMP Securities, as well as the sale of riverbank, which lower the operating earnings of our Asset Management subsidiaries, but also materially increased our net investment income. In the third quarter, our capital invested and our hedge funds returned 1.9%, which was an improvement, but still below our hurdle rate. Year-to-date returns are only slightly positive and we have reduced our capital exposures accordingly. Our capital invested in our corporate credit strategy experienced much better than expected returns both for the third quarter and for the first nine months of the year, 5.8% and 16.3% respectively. As a result of a recovery in non-investment grade loan prices to par values and continued low loan defaults and losses. Partially offsetting these favorable conditions has been a decline in net interest margins because of an increase in three month LIBOR of approximately 60 basis points to 0.88%, as well as a continued repayment of our very low cost AAA rated CLO I debt as the final volume is down. Our capital invested in real estate properties also had a great third quarter of returning roughly 7%. After the quarter ended, on October 3, Workspace Property Trust and owner manager of suburban office space and flex properties completed the acquisition of nearly $1 billion of new properties and now manages approximately $1.2 billion in five suburban marketplaces. Closing the deal on schedule and on terms was a material accomplishment considering the original investor groups that did not commit to putting any new capital into the transaction. Kudos to the Workspace team run by industry veterans Tom Rizk and Roger Thomas. While we will not fair value our investment higher in the fourth quarter because we use equity accounting, our fourth quarter operating earnings will benefit however by upwards of $0.05 a share from the accretion of approximately 30% in workspaces book value per share from a new equity raise, some transaction-related fees on the deal and increased earnings going forward on an ongoing basis on the capital we have invested in the business, as well as our ownership at the management company. Thanks to our year-to-date investment returns we have covered our cash distributions of $0.30 a share, as well as our corporate overhead and strategic growth initiatives and have increased our adjusted book value by $0.17 a share this year to $5.94. In finishing, as always I want to thank JMP's employees and our independent directors for their hard work and dedication. Despite challenging industry conditions we have delivered an operating profit in each of the first three quarters of 2016, while investing in organic growth and positioning our company for even greater success in the future. I look forward to sharing our annual results on our next conference call early next year. Operator, we can take questions.

[Operator:]

[Operator Instructions] And we have a question from the line of Alex Paris.

[Alex Paris:]

Good morning.

[Joe Jolson:]

Hi Alex.

[Alex Paris:]

How are you?

[Joe Jolson:]

Pretty good. I guess you guys are feeling quite so hot this morning after the baseball game last night right?

[Alex Paris:]

Well you know we are used to it and we are hoping that it is just going to make them stronger tonight. So, we are hard-core fans here in Chicago.

[Joe Jolson:]

I know.

[Alex Paris:]

Just a couple of macro, I guess questions about the business, ECM and brokerage and that sort of thing, so I’ll start with ECM, congratulations on a great success on the M&A side of the business, it does look though however that you did participate in more public equity raises in the third quarter sequentially from the second quarter, how do you feel about your pipeline for ECM transactions in Q4 and beyond, seems like things are improving a bit relatively speaking.

[Joe Jolson:]

Carter is on the call, maybe I’ll let him address that and then if there is a follow-up I could chime in.

[Carter Mack:]

Sure. We definitely saw pickup in ECM activity kind of in the second half to September into October and it’s across the board, and we saw an increase in IPO activity. We were involved in a couple of strong IPOs and we are seeing more technology companies look to access the IPO market. We've been added to a number of tech IPOs, which look like they’ll be marching in early 2017. We've seen an increase in convertible activities, a scenario that we’ve put a lot of effort into and we expect to see a few more deals before year-end that we are involved in on the convertible side. So, yeah it has been a nice pickup in activity, I would say it slowed a little bit ahead of the elections and we’ll see post-election we would expect an uptick in activity again through the Thanksgiving holiday and then after, kind of through mid-December. So it’s good to see, it’s when the ECM market is open, we tend to do quite well. And we feel well positioned going into 2017. We think that there will be a much better environment for IPO activity in 2017.

[Alex Paris:]

[Indiscernible]

[Carter Mack:]

Yes.

[Alex Paris:]

And then on the brokerage side, it seems like the brokerage commissions continue to decline at least sequentially, and then I guess they are down year-over-year, and again it seems as though institutional cash equities volumes inventory industry-wide are still under pressure any color there you could offer?

[Joe Jolson:]

You know on the commission side, it’s been disappointing for a few years now for us. We’ve been as you know trying to grow that business in a difficult environment both on a secular basis, but in the last year plus on a cyclical basis. I think the decline is a factor, primarily of lower market activity, lower trading activity among active managers. You know we get the log and statistics with the quarter lag, but the statistics that we’ve seen with a quarter lag once again seems like we’re maintaining or slightly improving our market share. So, I think it’s more industry-wide, but obviously being a small player there we’d like to think that there is some opportunity to grow that business assuming even modest declines in this industry-wide. Third quarter is a pretty large decline however.

[Alex Paris:]

Got you and then over - obviously a key to grow there is adding to research, adding to trading capabilities, which you had mentioned earlier, though year-over-year and I believe sequentially your total headcount has come down, and it’s not significant, but if you are adding in that area where are you subtracting?

[Joe Jolson:]

We’ve made a few decisions to bet on some people's business plans and others we’ve decided the money and resources would be better spent in other areas. So you have seen us hire some people and lose a few people. I think the net headcount year-to-date is down about 6%, which obviously is well below what JMP Securities revenues are down year-to-date. So we’ve kind of absorbed that margin squeeze if you will this year in an effort to be able to recover quickly when conditions normalize as well as to gain market share through the down cycle Alex. I mean, we’ve never acquired anyone, so we started the firm with zero market share, and in our experience the best opportunities for us to gain share are continuing to keep our key guys intact through down cycles and selectively add top producers when other companies, particularly the larger companies are significantly scaling back. So, we are executing on that strategy this year. There is a cost to that of not slashing your headcount, as well as selectively looking to grow it and it’s probably around close to $0.10 a share in earnings this year and the question whether that’s a good investment, for shareholders it has been historically. We think it will be again and we’ll know when two or three or four years in the next up cycle whether that was a great business decision, it’s one of those things you’ve seen in the future, but in our judgment this is a good opportunity for us to advance the ball and grow the business.

[Alex Paris:]

Okay, and then I guess lastly share repurchase activity has slowed sequentially, you repurchased roughly 30,000 shares in this quarter, is that a function of industry conditions or revenue expectations, what are your thoughts on share repurchases going forward?

[Joe Jolson:]

Well, you know, as you recall, we are trying to focus on cash dividends to shareholders and I think that the purchasers are at this point are really opportunistic thing, if the stock is trading at a substantial discount to book value and there is nothing more than that that the stock moved up a little bit in the quarter, and was trading above our 10b-5 trading plan price. We're not rooting for big share repurchase because that would suggest the stock drops materially, right. So, I mean we are not, we converted to a partnership in part to be able to efficiently return capital to shareholders in the form of cash as opposed to prior to that we were focused mostly on share buybacks as C-Corp, which we really which weren’t, as we learned over time creating material shareholder value. So it all gets back to a couple of years ago when we changed to a partnership. So, if our stock were to sell off you will see a lot higher share buybacks.

[Alex Paris:]

Understood. Okay, well thank you very much, appreciate it.

[Joe Jolson:]

Okay.

[Operator:]

Your next question comes from the line of Jeffrey Briggs.

[Joe Jolson:]

Hi, Jeff.

[Jeffrey Briggs:]

Good morning guys. We’re feeling a little better in Cleveland here that Chicago possibly, but it is going to be a tight series. So, congrats on getting the Workspace Property Trust acquisition completed. The question is, so you mentioned about the uptick and book value and possibly book in the next quarter, in terms of ongoing operating profits from that is this, can you give us any idea about sort of what the returns are projected to look like on that or is it kind of too early? And kind of thinking about is that something in the main that could replace some of the earnings that were lost with the RiverBanc sale or is a little bit different size?

[Joe Jolson:]

Well we owned a bigger percentage of RiverBanc than we own of this, so RiverBanc we own 20% of just to put in perspective, and Workspace it’s a little under 8%. So, Workspace obviously is quite a bit bigger than RiverBanc at this point after this acquisition, so I think that the contributions are earnings on an ongoing basis will be similar, maybe forget about our investment in the actual assets and just look at the management company, where we are partnered to be few cents a share after tax per year, maybe $0.02 to $0.03, I think. So that’s similar to what RiverBanc was generating. Our investment in the assets, which is at cost, is $10 million. I think, this was highly accretive, obviously the book value per share and we own the same amount of shares percentagewise is up roughly 30% from this capital raise at a bigger dollar amount or much higher price. So, we’re expecting a similar kind of cash on cash return of 10%, but book value is up 30%. So that should be accretive by 300 basis points, does that makes any sense - over what it was before.

[Jeffrey Briggs:]

It makes sense.

[Joe Jolson:]

So that's investments at the PTP level, so that will add earnings in a little bit without having a corporate tax rate there. So, I think longer term, for us that potentially large hidden asset, I guess the way we look at it because we are carrying at a book value per share because of equity accounting and not fair value, like in - because the accounting rules as such, we own too much of the manager to carry it if fair value. Even though it is a little less than 8%. So, we will see over time if that company continues to make accretive acquisitions that would be positive. It could potentially go public down the road, and it could be materially accretive beyond this $0.05 plus a share we are talking about in the fourth quarter.

[Jeffrey Briggs:]

Okay that’s helpful, but it sounds like even if – in terms of the ongoing management fees that’s about – or it kind of came out just back of the envelop based on the deal size in estimating management, you know key performance there, but even if it kind of goes along just sort of how [indiscernible] that is already a win, so that is good. Next question kind of goes back to, kind of with the first question is sort of the mix at JMP Securities between the ECM part of the business and M&A and kind of knowing we talked about with the kind of cyclical hiring and moving on producers that might be switching from other companies and stuff like that. So obviously it is ticking down earnings in the near term, at some point assuming things assuming things go up, what do you guys have to do in terms of comp ratio, headcount, and stuff like that to sort of support the business if there is that big up cycle, is it mostly hiring, more - and associate type people or what does that look like if things do pick back up against again in ECM?

[Joe Jolson:]

I think as revenues scale up on ECM you should see our comp ratio get back to that 65% level that it had been at four three or four years and then potentially over time decline further as we get some leverage on back office in junior employees and research and investment banking. So, I mean I think that is a reasonable expectation. When we had revenues $70 million to $80 million in investment banking, you know we were even in high-60s we were running at a 65% comp ratio. And I think and obviously our non-comp expense was substantially lower. That’s where the real big squeeze has happened because our non-comp expense in aggregate dollars hasn't grown a lot, it’s crept up a little because some of our below market leases are rolling over in this environment, where - so we're having to pay market as these things roll over, but generally the dollar amounts have been pretty similar, just the revenue shrinkage is squeezed. The non-comp expense, revenues normalize for us not even go back to peak levels, you will see a 65% comp ratio and probably a non-comp ratio closer to 20% and so you kind of get back to that 15% operating margin that we have historically enjoyed and as well as targeted in that business.

[Jeffrey Briggs:]

Okay thanks.

[Carter Mack:]

Yeah and on the headcount issue, I don't think we need to add more people if we get back to more robust ECM environment. I think we are adequately staffed for that and so there’s lot of operating leverage to an increase in the ECM environment and our plans really going into 2017 are to focus on hiring a few more productive coverage M&A focused bankers, which we see in the results of our hiring efforts over the last few years and are increase in M&A revenues, so that’s really where we’re focused going into 2017.

[Jeffrey Briggs:]

Okay, thank you.

[Joe Jolson:]

I mean just to elaborate on the M&A side, I mentioned it in some of my remarks, but you know this year we are going to do somewhere around it was not on what assuming market doesn't dislocate in the last couple of months, we’re going to do somewhere around including debt advisory and private placements $30 million revenues that will be classified as an independent M&A boutique revenues. You know that if you just look at some significant discount to how those firms are valued based on those revenues, I mean that’s three quarters of our current market cap. And the interesting thing about those revenues are that they only need capital to be in that business and so that’s all franchise value on top of our tangible book value. So, we see that not just stabilizing and helping to grow our earnings over time for JMP Securities who also see it as substantial driver to our stock price.

[Jeffrey Briggs:]

Thanks.

[Joe Jolson:]

Sure. Any other questions, Operator?

[Operator:]

There are no further questions at this time.

[Joe Jolson:]

Okay, well summing up, I appreciate the interest and we’re excited about the prospects to build the business through this down cycle and look forward to updating everyone again in a couple of months in early 2017. Thank you.

[Operator:]

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