Cohen & Company Inc (COHN) 2010 Q1 法說會逐字稿

Good morning, ladies and gentlemen, and thank you for standing by. Welcome to the first quarter 2010 Cohen & Company, Inc. earnings conference call. My name is Paula and I will be your operator for today.

During the presentation all participants will be in listen-only mode. After the speakers' remarks you'll 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 made 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 and in our SEC filings. Please read the statement in today's release regarding forward-looking information.

I would not like to hand the call over to your host for today's call, Mr. Daniel Cohen, Chairman and CEO. Please proceed.

Thank you, Paula, and welcome to Cohen & Company first quarter 2010 earnings call, which is our first full quarter as a public company. With me this morning are Chris Ricciardi, who is the President and CEO of our broker-dealer, and Joe Pooler, our Chief Financial Officer.

I think the results speak for themselves. During the quarter we delivered positive enterprise net income of $4.4 million and positive adjusted operating income of $7.7 million. These results were driven by an increase in trading revenues by 101% compared to last year's period and growing principal investment revenues.

In the quarter, we continued to develop our silos of activity in the fixed income space as European trading activities grew and we added significant capacity to her firm's product offerings. We differentiated ourselves from smaller competitors by completing our first asset-backed securitization since the credit crisis and by our cross-border activities.

Our investment in our many managed -- in our many vehicles continued to give us good revenue and good opportunities from the management side as well as providing the ability to invest in asset classes that we know well and where we have differentiating experience. We have reinvested our profits in attracting talent and adding synergistic capacities while retaining our core knowledge focuses and concentrating our activities in areas where the asset recovery still isn't complete.

And we do this for ourselves and for our clients, as when we joined two substantial coinvestors and others in successfully re-capitalizing our managed vehicle, Star Asia, which Chris will talk about. To preface Chris's comments about our platform, I want to reiterate that the quarter illustrates our positioning to grow top and bottom line as we continue to strengthen and expand our operating platform.

As a public company, we have better access to capital and better transparency, which should allow us to continue to do develop the quarter's results as they began to show. Given the improvement in the liquidity of the credit environment, our increased platform, we believe we are well positioned to create long-term value for our shareholders.

In the coming months we intend to be more visible and proactive in telling our story to the investment community. Chris will now give a review of some of the operational highlights from our first quarter and later Joe will discuss our financial results. Chris?

Thank you, Daniel, and good morning, everyone. I would like to give a bit more of a detailed overview of the drivers of the first quarter's results and how things are progressing relative to our strategic plan.

First, let me say that I am generally pleased with the strategic progress we are making at Cohen & Company. Our strategy is to focus on credit, fixed income, and credit-like products where we feel we have the ability to be a top-tier player.

Further, we are also concentrating our efforts on underserved customers who demand the services that we provide. We believe these areas provide us with double opportunities to sustain a very meaningful business.

As it relates to our performance, our goal is to create a stable baseline of revenues and profitability by maintaining a solid business foundation while also looking for incremental and potentially less consistent but also larger profit opportunities.

Our base revenue consists of the core asset management and credit fixed income secondary trading businesses which we already have and which we constantly look to scale. These are relatively high volume and historically consistently profitable businesses.

We are also adding other businesses which fit nicely into this portfolio. For instance, the new CD origination and small ticket fixed income dealer business we recently added fits well in this strategy.

On top of our revenue baseline, we also try to add higher-margin though potentially less consistent revenue items. Our capital-light strategy of using reasonable amounts of capital to facilitate client trading and fixed income products falls into that category, as does our new issue debt origination.

We remain, however, in a difficult credit cycle for our type of new issue origination which focuses on middle-market issuers. However, in the first quarter we were able to complete one small auto loan securitization.

Next, I would like to focus on the specific drivers of revenue in the quarter. First and foremost, our trading results overall were strong in the quarter as we saw solid performance in our existing trading businesses. These areas also benefited in part from our capital-light strategy and from the general increase in sales and trading professionals.

Our European products trading in the quarter also improved thanks to our enhanced focus and expansion in the region. We consider our European footprint a competitive advantage as not all of our peers can match our ability to trade legacy products both among European clients and in cross-border trades.

We believe going forward we will continue to capitalize on and expand our position in the region. We also more than doubled our overall capital markets headcount over the year, increasing from 44 to 96, which included significant expansion of the European capital markets team.

We benefited from increases in value of the inventory we held during the quarter. It may come as no surprise that many credit products increased in value this past quarter, some substantially. This increase does provide a relatively large benefit to our revenues and of course we remain focused on managing our capital at risk while constantly looking for opportunities to do so more effectively.

On the principal transaction side, there were two primary drivers in the quarter. Our in investment in Deep Value Mortgage Fund represents an interest in non-agency mortgage-backed securities. If you are following the sector, you know that it continues to sustain a fairly sizable rally as general credit conditions improve and some liquidity returns to the market.

We still hold our position, which has increased in value, and we have started to receive significant cash flows now that the fund has begun to distribute capital to investors including to us.

The other notable catalyst in the quarter relates to Star Asia. As we have previously mentioned, Star Asia was formed as an externally managed Asian commercial real estate debt investment company in 2006, the first of its kind in Asia.

The original intention was to grow the company in a way that resembles commercial mortgage REITs in the US, but with the onset of the credit crisis the company was unable to get access to new financing and there has been significant concern about the ability to refinance existing debt. The company has been deleveraging ever since.

In order to maintain the financing -- in order to complete the refinancing of the remaining debt, we worked with Star Asia's lenders to remove mark-to-market on the debt and to extend the term of the debt to match the company's assets.

The structure the company settled on called for the shareholders including us to provide financing secured by two assets, one the Japanese commercial mortgage-backed security class which was senior and the other a note secured by Tokyo Inn hotel property.

As part of the transaction the third-party lenders refinanced their loans and those shareholders who participated in the transaction, the secured lending transaction, received greater ownership in Star Asia.

The end result of all these transactions are that Star Asia has moved to a more stable financing, third-party lenders were able to reduce their loan amount, Star Asia participating shareholders including us made a loan secured by what we believe are attractive assets, and we increased our ownership in the company. The value of our investment in Star Asia increased as a result.

Now despite the good results of the quarter, there is still much to do to reach our goals. We need to scale some of the -- some of our established businesses to drive the bottom line as efficiently as we can. We also need to get our recently added businesses up and running to the point where they are contributing meaningfully to the bottom line. We need to continue to look to add businesses which fit nicely on our platform.

Notably we are mindful that though the revenue building activities are important to our business, we must keep a watchful eye on expenses. While some expenses are avoidable, especially when in a ramp-up mode, we need to do everything in our power to keep them in check and this will continue throughout the process.

Generally as of today we are in line with our strategy and goals and we expect to remain so in the future. In closing, let me share some thoughts on the potential for new issue securitization business. Clearly one of the biggest potential drivers of new revenue, potential upside for us would be the reemergence of a strong new issue securitization business.

While it is still too early in the cycle to confidently predict the return of securitization, it is worthwhile to consider some recent positive signs. As mentioned we did one small auto securitization in the quarter for California-based CPS. We also continue to work on similar projects.

You may have also seen that Redwood Trust recently completed the first new issue non-agency mortgage-backed security securitization since the start of the credit crisis. Several CLOs are currently being marketed by competitors and prices of secondary CLOs continue to increase in value in the market. We have even started to see rating agency upgrades of old CLO classes.

All this is very positive and points to an increasingly healthy environment for potential new issue securitization activity, continuing to look -- continuing to work hard to be sure to capture our share of the activity as it develops.

Now I will turn it over to Joe Pooler, our CFO, to describe our financial results result in more detail. Joe?

Thank you, Chris. We will have some brief remarks on both our statement of operations for the first quarter and our balance sheet as of March 31, 2010. In the first quarter, we experienced significant improvement in all profitability measures compared to the prior year period as our stronger capital position allowed us to take advantage of opportunities in both trading and principal investing. From the prior year period, our net revenue increased nearly $25 million to $41.7 million. Our operating income increased $12.6 million to a positive $6.3 million and our adjusted operating income increased $12.3 million to a positive $7.7 million.

As Chris noted our net trading revenue increased 101% from the prior year period, primarily due to our increase in overall capital markets headcount to 96 as of March 31, 2010, compared to 44 as of March 31, 2009. This increase included a significant expansion of our European capital markets team.

The net trading revenue increased -- also increased due to improved results as we transitioned to a strategy of using some risk capital including the impact of the substantial rally in leveraged credit products on our trading inventory. Our principal transactions in other revenue was $11.5 million for the quarter, which included gains on our investments in Star Asia Finance and our first Deep Value Fund.

During the quarter we completed a recapitalization of Star Asia Finance in which Star Asia raised additional equity capital from its existing investors in a rights offering and used the proceeds to pay down a portion of its outstanding financing arrangements. In exchange for the paydown, Star Asia's lenders agreed to forgo periodic margin calls and to provide term financing matching the underlying collateral.

This recapitalization was designed to preserve equity value by giving Star Asia the flexibility to either hold its remaining assets to maturity or to opportunistically sell such assets, and also by reducing the likelihood that Star Asia would need to rapidly sell illiquid assets to meet margin calls.

A substantial portion of the equity capital raised was done so through a special-purpose entity which then purchased select assets from Star Asia Finance with the proceeds of the offering, thereby providing the investors in the rights offering a very strong collateral package in the special-purpose entity.

We, along with two other third-party investors in Star Asia, each agreed to acquire our pro rata share of the rights offering and one third of any unsubscribed shares. Although Star Asia's net asset value did not change materially as a result of the rights offering, our ownership percentage increased as a result of our participation in the oversubscription, which resulted in an overall increase in the value of our investment in Star Asia as other investors who did not participate were diluted.

The revenue gains in our net trading and principal transactions activity more than offset the $2.5 million reduction in our asset management revenue from the prior year quarter. The decline in revenue from asset management was generated by our -- was a result of less revenue generated by our management of collateralized debt obligations.

Our asset management revenue was down by only $600,000 from the fourth quarter of 2009. It is noteworthy that our Deep Value Funds had a combined return of 6.7% during the first quarter of 2010 and that our overall mortgage securities asset management platform ended the quarter with total net asset value under management of $485 million, up from $452 million at the end of 2009 and $136 million at the end of the first quarter of 2009.

During the quarter, we announced to investors in the Brigadier fund that those funds would be liquidated. Brigadier was formed in 2006 and earned life-to-date returns of 74%, representing an average annualized return of 16%.

In addition to earning good returns for its investors during the recent unprecedented credit crisis, Brigadier never imposed gating restrictions on investor redemptions. Since the fund has generated only $1.3 million of revenue for us in 2009, we do not anticipate the liquidation of Brigadier having a material impact on our results in 2010 compared to 2009.

In the new issue and advisory revenue category, we served as an adviser and placement agent in a $50 million subprime auto loan securitization. Our operating expenses for the quarter increased to $12.2 million, or 53% from the prior year quarter.

The increase includes a $9.7 million increase in compensation and benefits and a $2.7 million increase in professional services and other operating expenses. The increase in compensation and benefits is a direct result of significantly higher revenue for the quarter. The increase in professional services and other operating expenses includes the impact of higher professional fees, insurance premiums, subscription costs, and recruiting fees.

These increases are primarily the result of incremental costs of being a public company and of continuing to recruit and hire professionals for our capital market segment, as well as incremental costs related to our evaluation and consideration of certain strategic opportunities.

In terms of the non-operating components of our statement of operations, we repurchased $5.1 million notional amount of contingent convertible Senior Notes from an unrelated third party for $4.1 million. The notes had a carrying value of $5 million at the time, resulting in a gain from repurchase of indebtedness of $900,000. We will continue to explore opportunities to extinguish some of our more near-term maturing indebtedness at discounted rates.

We completed our analysis and determined that our federal net operating loss and federal net capital loss carryovers assumed through the merger of Cohen and Alesco are not currently limited by section 382 of the Internal Revenue Code. In other words, we did not experience an ownership change as a result of the merger.

We estimate that we have approximately $48 million of net operating losses and $69 million of net capital losses as of December 31. Assuming we do not have an ownership change in 2010, we should owe no federal income taxes as we used these available net operating losses and net capital losses.

Our provision for income taxes for the remainder of the year should only include state, local, and foreign taxes. Please see the tax footnote of our first quarter 10-Q for a more complete discussion of our tax situation.

In terms of our balance sheet, we ended the quarter with cash of $29 million. The $35 million in receivable from brokers, dealers, and clearing agencies has primarily comprised of the net settlement receivables from regular-way trades. These receivables from unsettled regular-way trades were collected in full in the early part of the second quarter.

There are four components of the Company's consolidated indebtedness. The first component is the operating company's revolving line of credit. As of March 31, 2010 there was a zero outstanding, $1.3 million being used for letters of credit and $20.9 million available to be borrowed.

The second component of our consolidated indebtedness is $9.4 million of operating company subordinated debt. The third component is $49.6 million par value of parent company trust preferred obligations which are carried at $17.2 million on the balance sheet. And the final component is $21 million par value of parent company convertible Senior Notes which are carried at $20.4 million on the balance sheet.

We believe that our cash balance of $29 million combined with our available credit of $20.9 million is sufficient to fund our near-term business model. We expect to file our 10-Q no later than Monday, May 10.

With that, I will turn it back over to Daniel for some closing remarks.

Thank you very much, Joe and thank you very much, Chris. As I said before, I think that the results speak for themselves. They're results we are happy with and we believe are sustainable going forward into the future. They describe a business that we continue to build, an operating platform that continues to develop, and a situation that continues to differentiate itself from other competitors in the fixed income space.

So with that, Paula, can I ask you to open up the lines for questions?

(Operator Instructions). Devin Ryan, Sandler O'Neill.

Good morning, guys. In the capital markets business, you guys have obviously been adding personnel and starting new businesses. Can you just give us a sense of what businesses are still the biggest priorities if you can to add people, and then maybe if there are some areas that you are currently not in that might be complementary to your platform?

Okay, let me turn that over to Chris.

Hi, Devin, how are you?

Good.

So let me first start talking about the businesses that we are currently in. These are the ones that we have had the longest and the ones that are most fully developed for us. That basically consist of corporate bonds, investment-grade corporate bond trading as well as all types of mortgage and asset-backed securities -- agency, non-agency, residential, commercial -- and we have the mirror of those structured product businesses in Europe as well.

So those are the ones that we set up the first and are the most -- the furthest along in their development. And those of the ones currently contributed the most stable revenues and profitability for us. On all of those businesses what we really just need to do is scale them up a little bit.

And I don't mean by a lot. Like in mortgage and asset-backeds, our sales force is not significantly smaller than even the largest competitors in the market. But there is still always opportunities to grow at the margin. When you get into some of the newer businesses we have, like high yield, that area is newer for us and actually can benefit from significant additional scale.

So there are businesses like that and then we have some businesses that we recently added that are almost complete startups for us. That would be primarily the addition of the CD origination and distribution business and that group also does basically small ticket transactions in a variety of fixed income products with regional broker-dealers. But that group really just joined us and so they are not up and running yet.

As far as other new things we are looking at, we just recently added a team that hasn't even started yet that does equity derivatives, primarily the brokerage of equity derivatives between dealers, and we are looking at areas that are -- that fit within our strategy, which is basically credit products or credit-like products.

If you read through the introduction I gave at the end-of-the-year conference call, I go through all the different possibilities. The one of them -- a few of them that might fit into that category would be municipal bonds as well as emerging market bonds. And those are things we are looking at all the time.

Yes, and as we add product lines, we are focusing on institutional and financial and institutional clients both small and large that are underserved and not adding at all in the retail space.

Yes, we don't do retail. And just one other point about what -- I said it in the script but maybe it didn't stand out enough. What we are really looking to do is create a baseline of consistent revenues that -- and that is one of the reasons why things like the small ticket trading of bonds and CDs as well as brokerage of equity derivatives, that appeals to us as well as our baseline business.

It appeals to us because it is very consistent revenue. So we know that we can do that. We can drive a certain amount of consistent revenue and profitability and then we can use the overall platform that we have built to do much higher-margin businesses like new issue, risk capital trading, things like that.

Okay, got you. And then just I guess a follow-up to that and maybe your comments, just trying to get a sense of what you guys are seeing in the recruiting landscape.

It seems like things have obviously become more competitive. Some of the larger players of throwing around a lot of money again. So is that changing the dynamic of all and do you expect that the pace of hiring will remain a similar going forward I guess as it has maybe in the recent past?

Yes, that's a great question. The pace of hiring will slow down because we are not looking to hire as many people. I'll start by saying that. But also I think the competition for good people has increased. Notably some of the bigger companies have increased their efforts to grow their particular sales forces. So that is an additional source of competition.

What we feel we offer is something a little bit different from the largest banks and also from some of our smaller competitors. What we are trying to do is create what we think is the best of both worlds for our professional employees and we believe what that is is a combination of the full platform that you might find at a bigger firm, so for example we have a lot of services like research, and analytics, and technology, and capital we use in our trading, and excellent traders by sector, and all of the things that you would expect if you were at a large bulge bracket firm, but the other thing we offer that they tend to not offer is commission payouts.

We think that motivates a lot of the very best professionals to work at a place like ours relative to some of the bigger places where, sure, they can bring you in at a high salary and maybe even a guarantee, but there is not a lot of clarity as to how you get paid. If you are very, very confident in your ability to drive business forward, you tend to gravitate towards a set commission formula, which we do offer.

Great. Okay, I got you. And then I guess just looking at the balance sheet, do you guys feel like you are at the right level currently of leverage? With the bulge brackets coming back into the market in using their balance sheets more, is there a feeling that you may have an opportunity or should be increasing the level of capital that you are committing?

Yes, another good question. We feel as though the right way to use capital is to facilitate the needs of our clients to transact in these products. So right now we feel as though that level of capital is sufficient to do that. As we continue to grow, we will probably need to add more capital.

But again, we think that the right place to be is somewhere between where the very biggest guys are, where capital almost overwhelms their entire strategy and may or may not be the best thing for their clients at all points in time, but some of our competitors are way too small. They have no capital or effectively no capital and that doesn't really work for our clients either.

So again, we try to be right in the sweet spot which we think is to have enough capital to drive the client business that needs to be done in trading but not have the whole thing overwhelm what the clients are trying to do.

Got you. And then I guess just on that, how do you guys think about risk management and what you doing to make sure or to try to make sure that there is no major issues with using capital?

Well, we have always had a robust risk management function that reports directly to the Board of Directors. We manage our capital at risk. Our leverage comments in the more easily leveraged and safer products, where we run a lower level of leverage than most of our competitors and we probably err on the side of caution.

We will be diversifying our businesses like bank CDs where we may use leverage as well and that might increase somewhat the overall leverage, but especially on our liquid or more illiquid assets, because today most assets are now becoming liquid again, we have been controlling our use of leverage. And that is going to be our firm philosophy going forward.

In thinking about I guess maybe on the expense side of the equation you know the infrastructure of the Company or just fixed costs, how much capacity is there to really add personnel without significantly increasing your fixed costs currently?

Well, we believe we can actually reduce our fixed costs from this quarter because there were certain strategic initiatives that were involved. So we don't expect -- or we are -- one of the themes that we have going forward is not to expand our fixed costs as much as possible while providing the systems that we need.

And our investment in systems has been an almost a decade-long investment, building proprietary databases and other information technology systems that we use in our business on a regular basis. Joe, do you have any comment on that?

No, I agree, Daniel. First quarter we will generally be a little bit of a higher quarter for us in terms of fixed costs and we think we can do a lot better just from some control and as a result of it being the outlier quarter.

And this is Chris. Just your question about compensation or adding employees and the cost of that, the philosophy is to try to make this variable. So the people we are hiring are generally on a variable compensation system and not a large fixed compensation system. We very rarely provided guarantees and certainly never big guarantees.

Again, we look to hire professionals that are confident in their ability to generate very substantial compensation for themselves but doing so by performance. So we believe that this is a sustainable variable compensation structure that we have.

And then in just the asset management business, what are you guys doing to demarket some of the funds that are currently doing pretty well?

Daniel, do you want to take that or would you like me to --? I will take that.

The primary funds that we have right now that we are marketing relate to the Strategos, which is the mortgage asset-backed platform or products that we have. Those you can see that they have actually been growing pretty substantially in terms of capital under management. I forget the exact numbers that Joe threw out but it is close to $600 million right now, and that is up from less than $200 million about a year ago.

So we have people -- internal marketing force and sometimes we use external marketers and they are out talking with a variety of different institutional investors as we speak. They actually do quite a lot of investor contact. So generally speaking, what we would hope is that the solid performance coupled with the attractiveness of the sector should be enough to generate some interest in those funds.

The other funds that we are marketing currently are in our European financial space and I don't have the numbers of the top of my head, but those have also grown pretty substantially, at least in percentage terms from about a year ago, again primarily due to performance and attractiveness of the sector.

All right, good. I will leave it there. Thanks, guys.

(Operator Instructions). Rich Sherman, Oppenheimer.

Yes, hi. Most of my questions have been answered. Going back to leverage for a minute, is there a -- do you have a cap on leverage? Is it 10 times, 15 times from a firmwide standpoint where you won't go above a certain number?

From a firmwide standpoint, we are not going to get near those leverage numbers right now. Joe, do you have any comment on that?

No, yes, just looking at our assets to equity now we are nowhere close. And like Daniel said, the leverage that we are taking in the way of repos or shorts is all in agency highly liquid securities. So we can react.

And I just want to clarify that our first-quarter period-end leverage was not substantially lower than the intra-period leverage.

Okay. When it came to expenses, going back to last quarter's number I was only in a listen-only mode on the web so I couldn't ask a question. What was the --? There must have been some -- quite a number of one-time charges that were going on due to the merger and things like that. Is there any way to break out sort of what it might have looked like if those things had been factored out?

And in terms of the quarter just reported, is there some way to put more color on breaking out like some one-time things that basically were occurring during the first quarter that won't be repeating themselves going forward?

Joe.

Well, in terms of the first quarter, I can tell you we expense our audit costs when the auditors are working and this year because of the merger they didn't do as much interim work. So there was some extensive tax work performed on the NOL analysis. There is about $700,000 of audit and tax fees in the first quarter that -- audit fees, sure, we are going to get them again next year but they won't be a recurring second, third and fourth quarter.

In terms of the merger costs last year we did -- the merger process took quite a bit of time. If you recall we signed the agreement back in February of '09 and we didn't close it until December. And we had two or three amendments to the agreement, two or three credit agreement amendments in the process. I would say last year's total cost was in the $2.5 million range that we would attribute to the merger and the transaction and some of the related such as the credit agreement transaction.

You know we really think we want to target like our two non-compensation cost lines right -- if you look at them through the first quarter, it would imply more like a $31 million run rate. We think we can target more like a $24 million to $26 million number.

Again absent -- there are certain strategic things that we are exploring that are incurring some consulting fees and legal fees and the litigation costs that aren't covered by the D&O insurance are a little bit of a wildcard, but we are targeting $24 million to $26 million.

Great. One thing, I am not sure if I heard it correctly. You mentioned that there was a -- you had bought back some debt and had a gain of I think $900,000. Was that in this -- was that as part of your profits for this quarter or was that sometime before. I didn't catch --

No, that is in the first quarter. It is below operating income.

Okay. Thanks.

At this time there are no further questions. I will now turn the call back over to Mr. Daniel Cohen for any closing remarks.

Well, thank you, everybody, for asking questions and I will look forward to reporting on our next quarter's earnings and the development of our company with Chris and with Joe on our next conference call. So thank you again and goodbye.

Thank you. This concludes your conference. You may now disconnect.