COHEN & COMPANY INC. The following discussion and analysis of the consolidated financial condition
and results of operations of
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" is based on our consolidated financial statements, which have been
prepared in accordance with
All amounts in this disclosure are in thousands (except share and unit and per share and per unit data) except where noted.
Overview
We are a financial services company specializing in fixed income markets. We were founded in 1999 as an investment firm focused on small-cap banking institutions, but have grown to provide an expanding range of capital markets and asset management services. We are organized into three business segments: Capital Markets, Asset Management, and Principal Investing.
· Capital Markets: Our
fixed income sales, trading, matched book repo financing, new issue placements
in corporate and securitized products, and advisory services. Our fixed income
sales and trading group provides trade execution to corporate investors,
institutional investors, mortgage originators, and other smaller
broker-dealers. We specialize in a variety of products, including but not
limited to: corporate bonds, ABS, MBS, RMBS, CDOs, CLOs, CBOs, CMOs, municipal
securities, TBAs and other forward agency MBS contracts, SBA loans, U.S.
government bonds, U.S. government agency securities, brokered deposits and CDs
for small banks, and hybrid capital of financial institutions including TruPS,
whole loans, and other structured financial instruments. We also offer
execution and brokerage services for equity products. We carry out our capital
markets activities primarily through our subsidiaries: JVB in the United States
and CCFL and CCFEL in Europe .
· Asset Management: Our Asset Management business segment manages assets
within CDOs, managed accounts, joint ventures, and investment funds
(collectively, "Investment Vehicles"). A CDO is a form of secured borrowing.
The borrowing is secured by different types of fixed income assets such as
corporate or mortgage loans or bonds. The borrowing is in the form of a
securitization, which means that the lenders are actually investing in notes
backed by the assets. In the event of default, the lenders will have recourse
only to the assets securing the loan. Our Asset Management business segment
includes our fee-based asset management operations, which include on-going base
and incentive management fees. As of March 31, 2020 , we had approximately $2.65
billion in assets under management ("AUM") of which 79.1% was in CDOs. A
substantial portion of our asset management revenue is earned from the
management of CDOs. We have not completed a new securitization since 2008. As a
result, our asset management revenue has declined from its historical highs as
the assets of the CDOs decline due to maturities, repayments, auction call
redemptions, and defaults. Our ability to complete securitizations in the
future will depend upon, among other things, our asset origination capacity and
success, our ability to arrange warehouse financing to originate assets, our
willingness and capacity to fund required amounts to obtain warehouse financing
and securitized financings, and the demand in the markets for such
securitizations. The remaining portion of our AUM is from a diversified mix of
other Investment Vehicles that were more recently formed.
· Principal Investing: Our Principal Investing business segment is comprised of
investments that we have made for the purpose of earning an investment return
rather than investments to support our trading, matched book repo, or other
Capital Markets business segment activities. These investments are a component
of our other investments, at fair value in our consolidated balance sheet.
We generate our revenue by business segment primarily through the following activities.
Capital Markets:
· Our trading activities, which include execution and brokerage services,
securities lending activities, riskless trading activities, as well as gains
and losses (unrealized and realized) and income and expense earned on
securities and derivatives classified as trading;
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· Net interest income on our matched book repo financing activities; and
· New issue and advisory revenue comprised primarily of (a) new issue revenue
associated with originating, arranging, or placing newly created financial
instruments and (b) revenue from advisory services.
Asset Management:
· Asset management fees for our on-going asset management services provided to
certain Investment Vehicles, which may include fees both senior and subordinate
to the securities issued in the Investment Vehicle; and
· Incentive management fees earned based on the performance of the various
Investment Vehicles.
Principal Investing:
· Gains and losses (unrealized and realized) and income and expense earned on
securities classified as other investments, at fair value.
Business Environment
Our business in general and our Capital Markets business segment in particular, do not produce predictable earnings. Our results can vary dramatically from year to year and quarter to quarter.
Our business is materially affected by economic conditions in the financial markets, political conditions, broad trends in business and finance, the housing and mortgage markets, changes in volume and price levels of securities transactions, and changes in interest rates, including overnight funding rates, all of which can affect our profitability and are unpredictable and beyond our control. These factors may affect the financial decisions made by investors and companies, including their level of participation in the financial markets and their willingness to participate in corporate transactions. Severe market fluctuations or weak economic conditions could reduce our trading volume and revenues, negatively affect our ability to generate new issue and advisory revenue, and adversely affect our profitability.
As a general rule, our trading business benefits from increased market volatility. Increased volatility usually results in increased activity from our clients and counterparties. However, periods of extreme volatility may at times result in clients reducing their trading volumes, which would negatively impact our results. Also, periods of extreme volatility may result in large fluctuations in securities valuations and we may incur losses on our holdings. Also, our mortgage group's business benefits when mortgage volumes increase, and may suffer when mortgage volumes decrease. Among other things, mortgage volumes are significantly impacted by changes in interest rates.
In addition, as a smaller firm, we are exposed to intense competition. Although we provide financing to our customers, larger firms have a much greater capability to provide their clients with financing, giving them a competitive advantage. We are much more reliant upon our employees' relationships, networks, and abilities to identify and capitalize on market opportunities. Therefore, our business may be significantly impacted by the addition or loss of key personnel.
We try to address these challenges by (i) focusing our business on clients and asset classes that are underserved by the large firms, (ii) continuing to monitor our fixed costs to enhance operating leverage and limit our losses during periods of low volumes, and (iii) attempting to hire and retain entrepreneurial and effective traders and salespeople.
Our business environment is rapidly changing. New risks and uncertainties emerge continuously and it is not possible for us to predict all the risks we will face. This may negatively impact our operating performance.
A portion of our revenue is generated from net trading activity. We engage in proprietary trading for our own account, provide securities financing for our customers, and execute "riskless" trades with a customer order in hand resulting in limited market risk to us. The inventory of securities held for our own account, as well as held to facilitate customer trades, and our market making activities are sensitive to market movements.
A portion of our revenue is generated from new issue and advisory engagements.
The fees charged and volume of these engagements are sensitive to the overall
business environment. We provide investment banking and advisory services in
A portion of our revenue is generated from management fees. Our ability to
charge management fees and the amount of those fees is dependent upon the
underlying investment performance and stability of the Investment Vehicles. If
these types of investments do not provide attractive returns to investors, the
demand for such instruments will likely fall, thereby reducing our opportunity
to earn new management fees or maintain existing management fees. As of
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A substantial portion of our asset management revenue is earned from the management of CDOs. As a result, our asset management revenue has declined from its historical highs as the assets of the CDOs decline due to maturities, repayments, auction call redemptions, and defaults. Our ability to complete securitizations in the future will depend upon, among other things, our asset origination capacity and success, our ability to arrange warehouse financing to originate assets, our willingness and capacity to fund required amounts to obtain warehouse financing and securitized financings, and the demand in the markets for such securitizations.
A portion of our revenues is generated from our principal investing activities. Therefore, our revenues are impacted by the overall market supply and demand of these investments as well as the individual performance of each investment. Our principal investments are included within other investments, at fair value in our consolidated balance sheets. See note 7 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.
Margin Pressures in Fixed Income Brokerage Business
Performance in the financial services industry in which we operate is highly correlated to the overall strength of the economy and financial market activity. Overall market conditions are a product of many factors beyond our control and can be unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors including the volatility of the equity and fixed income markets, the level and shape of the various yield curves, and the volume and value of trading in securities.
Margins and volumes in certain products and markets within the fixed income brokerage business continue to decrease materially as competition has increased and general market activity has declined. Further, we continue to expect that competition will increase over time, resulting in continued margin pressure.
Our response to this margin compression has included: (i) building a diversified fixed income trading platform; (ii) acquiring or building out new product lines and expanding existing product lines; (iii) building a hedging execution and funding operation to service mortgage originators; (iv) becoming a full netting member of the FICC enabling us to expand our matched book repo business; and (v) monitoring our fixed costs. Our cost management initiatives are ongoing. However, there can be no certainty that these efforts will be sufficient. If insufficient, we will likely see a decline in profitability.
In recent years, our mortgage group has grown in significance to our Capital
Markets segment and our company overall. The mortgage group primarily earns
revenue by providing hedging execution, securities financing, and trade
execution services to mortgage originators and other investors in mortgage
backed securities. Therefore, this group's revenue is highly dependent on the
volume of mortgage originations in the
COVID 19 / Impairment of
In
· The unprecedented volatility of the financial markets experienced in March
2020, has caused us to operate JVB at a lower level of leverage than prior to
the pandemic. Specifically, JVB has reduced the size of its GCF repo operations
and the volume of its TBA trading. We have determined that at our pre-pandemic
levels in these businesses, we were exposed to a higher level of counterparty
credit risk than we should have and were experiencing too much volatility in
our available liquidity to conservatively meet capital requirements and margin
calls in these businesses. We expect JVB to operate at lower volumes in both
these businesses for an indefinite period of time, which could unfavorably
impact the operating profitability of JVB.
· The financial market volatility, as well as the reduction in volumes in the GCF
repo and TBA businesses, that resulted from COVID-19 required us to reassess
the goodwill we had recorded related to JVB under the guidance of ASC 350. We
determined that the fair value of JVB was less than the carrying value
(including the goodwill). As a result, we recorded an impairment loss of $7,883
in the three months ended March 31, 2020 . See note 12.
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· We expect that our asset management segment will also be adversely impacted by
the pandemic. While it is difficult to determine the extent of the impact at
this time, we expect that raising capital for new funds may become more
challenging. In addition, lower returns earned by funds will adversely impact
our asset management fees and investors' need for liquidity may result in
reductions in AUM.
· JVB's mortgage group's operations are centered on serving the financial needs
of mortgage originators and institutions that invest in mortgage backed
securities. Prolonged high unemployment will most likely impact mortgage
originations and demand for and supply of mortgage backed securities, which may
have a significant unfavorable impact on the revenue earned by JVB's mortgage
group.
We will likely be impacted by the pandemic in other ways which we cannot yet
determine. We will continue to monitor market conditions and respond
accordingly. Subsequent to
Recent Events The 2019 Senior Notes
On
The 2020 Senior Notes
On
Pursuant to the Note Purchase Agreement, JKD Investor and RNCS each purchased a
Senior Promissory Note in the principal amount of
ViaNova
In 2018, we formed a new subsidiary, ViaNova, for the purpose of building a RTL business. RTLs are small balance commercial loans secured by first lien mortgages used by professional investors and real estate developers to finance the purchase and rehabilitation of residential properties. ViaNova's business plan includes buying, aggregating, and distributing these loans to produce superior risk-adjusted returns through the pursuit of opportunities overlooked by commercial banks.
On
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On
Paycheck Protection Program
Subsequent to
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Consolidated Results of Operations
This section provides a comparative discussion of our consolidated results of operations for the specified periods. The period-to-period comparisons of financial results are not necessarily indicative of future results.
Three Months Ended
The following table sets forth information regarding our consolidated results of
operations for the three months ended
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