Cohen & Company Inc (COHN) 2009 Q4 法說會逐字稿

Good day, ladies and gentlemen, and thank you for standing by. Welcome to the fourth quarter 2009 Cohen & Company Inc. earnings conference call. My name is Clarissa, and I will be your operator for today. During the presentation, all participants will be in a listen-only mode. After the speakers' remarks, you will be invited to participate in a question-and-answer session.

(Operator Instructions)

As a reminder, this conference is being recorded. Before we begin, the Company has asked me to read the following statement. You are cautioned that many statements during this call are forward-looking statements that are based on assumptions regarding the economy and financial markets and that are subject to a number of risks and uncertainties as set forth in our earnings release in our SEC filings. Please read the statement in today's release regarding forward-looking statements information. I would now like to hand the call over to your host for today's call, Mr. Daniel Cohen, Chairman and CEO. Please proceed.

Thank you, Clarissa. And welcome, everybody, to Cohen & Company's quarterly investor's call. With me are Chris Ricciardi, President, and Joe Pooler, our Chief Financial Officer. 2009 was a transition year for the Company as we built a significant platform in the debt capital markets business, which Chris will describe. Our platform is now robust. In the fourth quarter, we generated $600,000 of adjusted operating income and $2.6 million of adjusted pre-tax income, excluding non-cash items while we added significant personnel in each quarter of last year, including the fourth and now have several new silos of capacity that should start to perform and generate revenue in 2010.

Notably, we have capacities in high-yield sales, trading and investment banking with a team led by experienced professionals, and we have continued to build out our ABS trading and sales business. We expanded substantially our European business under new leadership and will continue to do so. We launched a new business raising money for companies for acquisitions in China and elsewhere and completed in this business our first IPO. We expect to reap the rewards of our investment in this base over the next two years and consolidate our position in these businesses going forward.

Our asset management business has launched new products in the fourth quarter of last year, and we expect to see robust growth in our alternative assets products with new and old key managers. We are committed to continue building this platform as we see an opportunity to become a world-class institution over the next two years in the fixed income and alternative spaces.

The Company is ten years old now, built strongly through the last cycle, and we expect to be able to build robustly as we continue to reposition ourselves due to changes over the last two years in the financial markets. Chris Ricciardi, our President and CEO of our broker dealer, will go over our strategic vision for the Company. And Joe Pooler, our CFO, will go over the financial highlights, and then we will open the line for questions.

Thank you, Daniel. For today's call, which is our first as a newly merged company, I thought it would be helpful to provide a big picture overview of our strategic thinking behind the Company. And I apologize in advance. it's a somewhat long presentation, but again, I think it's helpful as we introduce the -- this newly merged company.

Let me start by saying that we don't make our strategic plans in a vacuum. We are continually monitoring the opportunities presented to us by the marketplace and the competitive landscape in which we operate. By now, everyone realizes that events of the past two years have created some fundamental changes in the global financial markets. The events have caused market participants to rework their business models and strategies. The conditions have also opened the door for unprecedented opportunities for those who can move quickly and aggressively to seize them.

Given our understanding of these opportunities, our mission for the Company is to be the premier boutique investment bank within ten years. By boutique we mean that we'll not be a universal bank. Rather, we will focus on areas where we believe we can be a top competitor. And the primary focus area that we have had and will continue to have is credit products and credit markets.

There are several reasons why we believe we should focus on the credit markets. The first is that credit markets are enormous and diverse and offer many opportunities. There are fewer bigger competitors than in the past, and the -- and those competitors have been going up-market by focusing their efforts on larger transactions and larger clients. We're not unrealistic about our ability to compete with large and extremely well-resourced banks, but we believe there's significant market share being left behind by the biggest banks.

Relative to other competitors, we believe that we're very well positioned. Very few of these competitors have meaningful amounts of capital, sufficient scale and other resources such as technology and infrastructure. We, on the other hand, have tremendous resources relative to credit. We've invested heavily in technology. We have decades of collective experience and hundreds of key relationships built over those decades.

Next I'm going to talk briefly about the specific businesses we're in now and some of the issues that drive those businesses. First, our asset management business consists of approximately $16 billion of credit-related fixed income investments managed through funds, managed accounts, and structured investment vehicles.

The asset management business is very scalable once you have the platform in place, as we do. For example, we can launch new funds or take on new managed accounts in the same products areas we have and with the same platform and the same people. And while launching new investment vehicles is currently challenging, we can purchase existing contracts or potentially we can acquire whole companies which manage these.

I wouldn't rule -- count out the return of new issuance of vehicles like COOs. These have performed reasonably well, even through the credit crisis, and while large numbers of new issues don't seem to be a reality today, there's the overhang of secondary offerings. These things do tend to go through cycles and could come back before too long.

If that were to happen, it could allow us to directly reenter the business of originating, securitizing, and managing corporate loans. While it's impossible to predict the timing of this potential market return, analysts such as those at several large banks have been calling for it to happen before yearend.

One final word on our performance, clearly through the down part of the real estate cycle, the performance of funds that have long exposure to real estate faced extreme challenge -- challenges. And our funds are no exception. This is true if they had direct exposure through mortgages, for example, or indirect exposure through bank credit.

On the other hand, we believe that there are funds that were not exposed to real estate, or were started at a different point in the real estate cycle, performed well to exceptionally well. Non-bank corporate credit, non-profit and municipal, and insurance-related funds all did well, even if they were long only.

Our Brigadier hedge fund has had a good long-term performance and now has over three years' track record. Our deep value funds have had strong performance in part because, even though they're real estate-related, they were started on an upswing part of the cycle. And finally our European insurance credit investments have performed very well. We plan to leverage off the strong performance in all of these areas to continue to raise new capital for these funds and new funds within the credit space.

Now let me turn to our other division, our capital markets division. We have three main activities in capital markets -- fixed income sales and trading, new issue origination of corporate and securitized debt, and advisory services. We have approximately 80 people involved in sales and trading for our institutional clients of the following products -- investment-grade corporate bonds, high-yield corporate bonds and loans, all types of mortgage- and asset-backed securities, whether they be agency or non-agency, residential or commercial, or consumer credit securities. We also trade SBA bonds, Small Business Administration bonds, other agency debentures, taxable annuities, and most recently, brokered bank deposits, or CDs.

Our approach to trading is what we call capital light. We use capital, but in a relatively small amount, such that it gives us a tremendous advantage versus many of our competitors, some of whom have no -- or have very little capital, but it also isn't a key driver of our trading strategy, and it's used in such a way that we believe we can effectively manage the risk to the franchise.

Our business is global, and it, in fact, we've recently significantly built out our European effort. The group now consists of 12 people covering European institutional clients for European corporate and securitized products and non-European products. We've been involved in a significant and growing business of cross-border trading of fixed income assets. This is a distinct competitive advantage compared to most of our competitors who are not global.

One final word on our sales and trading capabilities. We just recently made a significant step towards building out our effort to diversify our distribution channels by adding a team that covers small broker dealers and independent financial advisors. These clients are seeking the same types of products we already trade, obviously in smaller size, but also with relatively high volume.

This group adds a significant origination opportunity for us as well. They originate broker deposits, or CDs, from small banks and sell through their distribution channels. This fits exceptionally well with us here since we have maintained our relationships with nearly 500 banks through our capital raising and advisory activities which, when combined with the new teams existing relationships, could create a good origination opportunity for us. We look forward to strong results from this new group in the coming quarters when they're integrated into our system.

Our historical origination activities have typically been of the middle market variety. Because we're middle market-focused, our activity is usually highest in terms of greatest liquidity. Of course, we've not had much liquidity in the middle market credit space recently. Consequently our activity has been limited to a small handful of transactions, compared to what it is -- what it has historically been. In fact, we used to enjoy very significant revenues from origination activities. But we do expect that when the cycle more fully turns, we'll again see high revenue in this area.

In the new issue securitization market, we also have a middle market type approach with similar consequences in this part of the cycle. In the past, this was a big business for us, and we expect it to be bigger when the cycle more fully develops.

In the meantime, we're focused mostly on government agency-type securitizations. We're one of approximately 11 active, licensed, SBA pool assemblers, where we buy government agency guaranteed loans and securitize them in guaranteed pools. We've also been fairly active in the structuring of new issue agency collateralized mortgage obligations, also known as CMOs.

In the equities business, we're a niche player, currently focused on new issue IPOs, known as special purpose acquisition companies, or SPACs. SPAC we priced in December was, we believe, the first one to be done in nearly 18 months. We continue to look for SPAC opportunities to add to our growing pipeline.

Our advisory business focuses mostly on small and mid-size banks and provides them with MNA advisory and help with asset sales. We also provide valuation services to all types of financial services companies. And perhaps the area with the most exciting potential is to assist insurance companies in their valuation efforts. We understand that the National Association of Insurance Commissioners, or NAIC, is evaluating a policy change to allow insurance companies to use statistical methods for evaluation of their mortgage-backed securities instead of ratings. Insurance companies will require significant advisory services if this becomes a reality.

So that's a pretty full summary of the businesses we're currently in. As you can see, nearly all the business lines are credit product businesses. We're also evaluating expansion opportunities outside of credit. Still, we're looking for products that are credit-like. And by that we mean that they have the competitive characterization -- characteristics of the credit markets we previously discussed, and they can fit easily into our platform without major reworking of our infrastructure. We identify the following products as being attractive possibilities -- municipal bonds, emerging market debt, energy and alternative energy, commodities, and certain niche equities.

Next let me talk about how we plan to reach our goals over the next ten years. We believe that we're building something meaningful and lasting, and it takes time to accomplish this. 2010 is clearly an important year for us. This year we expect to primarily focus on continuing to build the basic platform. Much of the work has been ongoing, and significant progress was made in 2009. But there's still much to do.

One major goal is to add to the scale of the businesses we're already in. Most of our businesses were smaller than we want to be. Additional scale should help to increase the profit margins by amortizing the fixed costs over a larger revenue base. And in businesses like sales and trading, scale actually creates more business opportunities. We want to continue to look for acquisition opportunities that will accelerate our pace of scale building, or which bring us new product lines that are difficult to build, if they can be gotten at attractive valuations.

Expense management is also key. We want to put several one-time and merger-related expenses behind us and optimize our spending. During a growth phase, this can be difficult, but it's also very important to separate the expansion expenses, which are necessary for growth, and just too much spending. Balance sheet optimization will also be important. We continue to look for opportunities to reposition ourselves for long-term growth. So those are the main goals for 2010. And of course, we'll strive for solid profitability while building a strong platform, which will hope -- which we hope to use for much greater profits in the future.

In 2011, another key year for us, we should realize more of the benefits our efforts -- of our efforts to scale. By then, improving our revenue margins will be the main focus. We also hope that the cycle will have sufficiently matured so that we'll be able to do significantly more new issue business and book corporate debt as well as securitized products. And we'll continue to work to optimize our capital and balance sheet.

The year starting at 2012, more difficult to predict with great certainty, but it's our intention to be running at full potential in our core businesses and looking to grow and change with the evolving market opportunities. Over that time, we expect to mature from a mainly niche player into a more mainstream competitor, and we'll hopefully have built the resources, relationships, and reputation that allows for that. It is in those years that we will hope for very strong profitability. This is clearly a gradual process that requires lots of hard work and focus. We have a plan that gives us confidence we can achieve these goals.

Finally, I wanted to conclude with a short discussion of some of the main variables that provide downside as well as upside potential to the plan we have. First, the downside variables -- one, there's a risk that reckless risk-taking by the big competitors returns, and they're might be little room to compete with prudent use of capital. We think this is unlikely in the current regulatory environment, given the lessons learned over the past years.

Two big banks could go down market into our space. We also think this is unlikely, given the relatively small revenue they would hope to get compared to the costs. Three, smaller competitors may get desperate and create unprofitable pricing structures. We think this is actually a reasonable possibility, but we believe that such actions are imprudent and may result in failure of firms that are too aggressive with their pricing because their people may leave for stronger platforms. So, in a way, this might just be a way for competitors to segment themselves with those offering very little resources able to only obtain limited profitability.

Four, regulatory and legal issues have been and will continue to be difficult to predict. And five, despite prudent risk-taking, we can and sometimes do make mistakes. Good risk management is the key to minimizing the impact of those mistakes.

And now the upside potential to our plan. Besides just executing our plan, which itself should create solid performance, the following items are things that could prevent -- present sizable upside revenues and profits. One, credit default swaps, or CDS, may go into exchanges or other accessible clearinghouses. This is a multi-billion dollar revenue business that we would be in today if we only had access to it. The financial reform legislation currently winding its way through Congress has language in it that should allow for more open access to companies like ours. If the legislation passes with such language, we plan to enter the business. And this could happen in 2010 or 2011.

Two, private securitization could reemerge. While this market has remained quiet, the basic requirements for reemergence are there. And by that, I mean there's a general feeling among professional investors and regulators this is a very valuable financing tool. Yes, it was involved in poor performing asset classes, like subprime mortgages, but also many, many good financings of essential loans that make our economy work properly. Notably, the regulators have actually embraced securitization through several programs, such as the TALF program. And this used to be a good business for us, and its return would be quite good for us also.

Three, it's possible that the FDIC can start the so-called legacy loan program that they designed to help banks securitize their loans. And if they do, we believe that we're very well positioned to make that a good business for us. We have all the securitization capabilities, and we also have the relationships with many banks that can make use of the program.

And finally, we think there's a good amount of revenue to be made with prudent use of our capital combined with our other resources and experience. So these are exciting prospects, indeed, and while we won't count on this potential or budget for it in any way, it's just one -- if just one of them becomes a reality, it becomes a significant upside to our business. I appreciate your patience as I present this information. I hope it will provide a good framework for helping understand our company and our strategy. I'll now turn it over to our CFO, Joe Pooler.

Thank you, Chris. We will have some brief remarks on both our statement of operations for the fourth quarter as well as our balance sheet at yearend, including some comments about our accounting for the merger. During our discussion, keep in mind that our consolidated financial statements include the operations of only Cohen Brothers through December 16, and the combined operations of the merged company from December 17th, the day after the merger, through the end of the year.

The impact of the merger on our statement of operations for 2009 was not meaningful. However, the impact of the merger was material to our yearend balance sheet. In terms of the statement of operations, our net trading revenue for the fourth quarter was $12.2 million, an increase of 35% from the 2008 quarter. Our net trading revenue included $11.9 million of riskless trading earned from 833 trades of $3.7 billion notional securities with 240 counterparties.

Our risk net trading revenue was only $300,000 for the quarter. We expect risk trading to become a more meaningful component of our results as we utilize the capital in the combined company after the merger. Our asset management revenue was $7.4 million in the quarter, a decrease of $8.5 million or 53% from the prior year quarter. The decrease is a result of declines in both the asset management revenue generated by collateralized debt obligations as well as by our investment funds. The CDO revenue decreased due to continued defaults and deferrals of underlying assets as well as the fact that we sold certain asset management contracts in the first quarter of 2009.

Investment fund revenue decreased primarily due to the significant redemptions in our Brigadier hedge fund. These declines were partially offset by higher revenue generated from the management of our deep value funds by Strategos, our mortgage platform. Our first deep value fund had a 45% return during 2009 and ended the year with a net asset value, or NAV, of $217 million. It is important to note that any incentive fee earned from the performance of the first deep value fund will not be received and booked until the fund winds up in three to five years from its initial closing in 2008.

In the fourth quarter, our mortgage platform, Strategos, also began managing $227 million of capital for a state retirement system. The total net asset value of funds that Strategos is managing as of yearend is $452 million. Our principal transactions revenue in the current year quarter includes $1.5 million of gains on our investment in the first deep value fund. We invested $15 million in the second quarter of 2008. The current value of that investment is $19.2 million.

Our operating expenses for the quarter increased $2.5 million or 11% from the prior year quarter. The increase includes a $4.1 million increase in compensation and benefits, and a $900,000 increase in professional services and other operating expenses.

Fourth quarter compensation and benefits includes $3.3 million of equity compensation expense including the expedited vesting at the merger date of premerger Cohen Brothers equity compensation. This equity compensation expense is a result of premerger equity grants whereby, in essence, founding partners were willing to dilute their ownership in the Cohen Brothers LLC in the interest of growing the platform. The remaining increase in compensation and benefits versus the prior year quarter relates to the mix of our revenue and the variable cost of compensation for our net trading revenue being greater than the variable cost of compensation for our asset management revenue.

The increase in professional services and other operating expenses includes the impact of certain merger-related professional costs, higher insurance premiums, and higher recruiting fees as we continue to recruit and hire professionals for our capital market segment.

In the non-operating section of our statement of operations, the gain on sales management contracts is a result of our sale of the three employer COO contracts in February 2009. We received net proceeds from the sale of $7.3 million. In addition, we are entitled to up to $1.5 million of contingent payments based on the amount of subordinated management fees received by the buyer.

$4.3 million of the gain was recorded in the first quarter of 2009, and $3 million of the gain was recorded in the fourth quarter of 2009. The $3 million gain was recorded in the fourth quarter because that portion of the gain was contingent upon the completion of the merger with AFN.

As Daniel noted earlier, our adjusted operating income was $600,000, and our adjusted pretax income was $2.6 million for the three months ending December 31, 2009. Adjusted operating income and adjusted pretax income are non-GAAP measures of performance that add back to operating income and pretax income non-cash items, depreciation and amortization, impairments of intangible assets, and share-based compensation expense.

We believe that these metrics are useful and appropriate supplemental measures of our performance which help us to evaluate the performance of our operations without the effects of certain expenses that do not have a direct cash impact on our earnings.

In terms of our balance sheet, we think it's important for us to first give a brief explanation of the accounting for the merger to more fully understand the merged company's balance sheet. The merger transaction was accounted for as a reverse acquisition, and Cohen Brothers was deemed to be the accounting acquirer. Cohen Brothers' net assets were carried forward at their existing accounting basis, while all of AFN's assets and liabilities were revalued at fair value as of the acquisition date.

The fair value of consideration transferred by Cohen Brothers to acquire AFN is simply calculated by taking the net amount of AFN's shares outstanding as of the merger date, or approximately 6 million shares, and multiplying that amount by the closing stock price on the date of the merger, or $6.50. Note that this $6.50 closing stock price of AFN on December 16th is after adjusting for the AFN one-for-ten reverse stock split that was effectuated on that date.

So the total consideration transferred amounted to $38.9 million. The amounts of net identified assets acquired and liabilities assumed by Cohen Brothers at the acquisition date totaled $38.1 million. $200.1 million of assets, and $162 million of liabilities. Line item detail of the assets acquired and the liabilities assumed is presented in the earnings announcement. The difference between the $38.9 million of consideration transferred and the $38.1 million of net assets acquired resulted in $800,000 of goodwill. The goodwill is effectively the difference between the fair value of AFN's net assets and its market cap as of the merger closing date.

It is also important to understand why AFN's acquired assets totaled $200.1 million at fair value as of the merger date versus the $3.9 billion that they last reported in the AFN stand-alone balance sheet as of their last public filing date in September. As of the -- as a result of the merger, Cohen acquired interest that AFN held in various securitization structures. These structures were previously determined to be variable interest entities as defined by generally accepted accounting principles.

In accordance with the accounting rules governing consolidation, AFN had since inception been required to consolidate these entities. Between the date of AFN's initial determination that it was required to consolidate these entities and the date of the merger, these entities suffered significant levels of defaults and losses. AFN continued to consolidate these entities because the accounting rules do not allow for reconsideration of consolidation status solely based on deterioration of the value or operations of the consolidated entities.

However, in accordance with the same accounting rules, the merger was deemed to be a reconsideration of that. Upon the merger we concluded that the merged company was no longer required to consolidate these variable interest entities. Therefore, our interest in the entities are now carried as investments on our balance sheet in either of the investments trading or other investments at fair value line items. We believe that the combined company balance sheet will be more transparent going forward as a result of this deconsolidation.

Primarily as a result of the merger, Cohen's total assets grew from $106 million as of September 30 to $299 million as of yearend. As previously mentioned, approximately $201 million of the asset growth came from the acquisition of AFN. Cohen's total liabilities grew from $68 million as of September 30 to $222 million as of yearend. Approximately $162 million of the increase in liabilities came from the acquisition of AFN. And finally, Cohen's total equity grew from $38 million as of September 30 to $78 million at year end with $39 million of the growth coming from the acquisition of AFN.

On the completion of the merger, the holders of Cohen Brothers membership units who elected not to convert their membership units to AFN shares still directly hold approximately 33.8% of the membership units in Cohen Brothers, which is the public company's sole direct operating subsidiary. The public company owns the remaining 66.2% of the membership units of Cohen Brothers. The 33.8% ownership interest is accounted for as a non-controlling interest. The earnings announcement presents a detailed calculation that results in the non-controlling interest of $21.3 million on the balance sheet at yearend.

In terms of some of the other line items on the balance sheet, at yearend, the investments, trading and receivables under resale agreements on the asset side of the balance sheet net of the securities sold not yet purchased line item on the liability side of the balance sheet totals $41.1 million.

This net total of $41.1 million represents our aggregate net trading book. By asset class, this net trading book is broken down as follows -- $15.4 million of SBA loans, $12.5 million of structured product, $11.7 million of agency MBS and CMOs, $1 million of other MBS, and $500,000 of US Treasuries securities.

The other investments at fair value line item consist primarily of our seed investments in sponsored and managed investment vehicles. The $43.6 million fair value includes $19.2 million of our first deep value fund, $14.1 million of Star Asia finance, our Asian real estate permanent capital vehicle, and $4.1 million of the Brigadier hedge fund. The remaining $6.3 million represents investments in various other permanent capital vehicles and sponsored CDOs.

There are four components of the combined company's consolidated indebtedness. First, the Cohen Brothers revolving line of credit. There was $10 million outstanding under the line at yearend. Another $1.3 million was being used to support letters of credit, and $16.1 million was available to be borrowed.

Second, there's $9.4 million of Cohen Brothers subordinated debt. Third, there's $49.6 million par value of AFN's trust preferred obligations, which were marked to a fair value of $17.3 million during purchase accounting. And finally, there is $26.2 million par value of AFN's convertible preferred obligations which were marked to a fair value of $25.4 million during purchase accounting.

We believe that as of the end of the year, our cash balance was $69.7 million, combined with our available credit of $16.1 million, is sufficient to fund our near-term business model. We expect to file our 10K during the week of March 8th, next week sometime. With that, I will turn it back over to Daniel for closing remarks.

Thank you, Joe. You've heard a lot about our strategic vision, how we're building a specialist investment banking and trading firm. As we continue through this year and next year, the results should become apparent. We have built an infrastructure for growth. Now, Clarissa, could you open the line now for questions from institutional investors and analysts? Clarissa, are you there?

(Operator Instructions)

And you have no audio questions at this time.

Okay, well, that's disappointing. Then, let me thank everyone for listening to our long oration. And I'll look forward to reporting to you on our next quarter's results on the next earnings call. Thank you very much.

Ladies and gentlemen, that concludes today's conference. Thank you for your participation. You may now disconnect. Have a great day.