JMP Group, Inc. (NYSE:JMP)
Q1 2016 Earnings Conference Call
April 20, 2016 10:00 AM ET
Andrew Palmer - Head, Investor Relations
Joseph A. Jolson - Chairman and CEO, JMP Group and CEO, Harvest Capital Strategies
Raymond Jackson - CFO
Christopher Howe - Barrington Research
Jeffrey Briggs - Singular Research
Welcome to JMP Group's First Quarter 2016 Earnings Conference Call. Please note that today's call is being recorded. [Operator Instructions] I'll now turn the call over to Andrew Palmer, the company's Head of Investor Relations.
Thank you. Good morning. And along 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 Carter Mack, President of JMP Group; Mark Lehmann, President of JMP Securities and Craig Johnson our Vice Chairman.
Before we get started, I'll point out 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 JMP’s future performance please see the description of risk factors included in our most recent 10-K.
With that I'll turn things over to our Chairman and CEO, Joe Jolson.
Joseph A. Jolson
Thanks, Andrew. I apologize in advance, my voice is a little hoarse today. So I will do the best I can but JMP group produced better than expected first quarter, despite the continued headwind of a volatile capital markets environment, thanks to record quarterly strategic advisory revenues.
Operating earnings per share were $0.10, more than double the $0.04 we made in the fourth quarter of last year. The sharp sell-off in the markets to start 2016 primarily hurt our equity capital markets revenues and our returns on our principal investing activities.
Our ECM fees for the quarter fell more than 60% from near-record levels a year earlier. Our net corporate income, which to remind you is net interest or net investment income less all corporate costs, was modestly above breakeven after contributing significantly to last year’s first quarter. The recent upswing in the capital markets, if sustained, bodes well for our ECM business later in 2016. Meanwhile the investment we have been making to grow our strategic advisory business appears to be gaining traction.
I'll have Ray go through some financial highlights before I continue. Ray?
Thanks, Joe. Adjusted net revenues were $36.6 million, down only slightly from $37.6 million for the first quarter of 2015. Operating net income was $2.2 million, or $0.10 per share, as Joe mentioned, down from $5.1 million, or $0.23 per share, a year earlier. As for expense our adjusted compensation ratio was 74.1% versus 66.1% for the first quarter of 2015. Excluding hedge fund incentive fees, since the vast majority of these fees is passed through to the investment teams, the ratio drops to 70.7% for the quarter compared to 66% a year ago. On the same basis, our adjusted non-compensation ratio was 22.5% versus 17.1% a year prior.
Our adjusted operating margin, which is pretax operating earnings over adjusted net revenues, was 6% compared to just under 17% for the first quarter of 2015. From a balance sheet perspective, our recourse debt-to-total capital ratio was 43% at March 31st. Shareholders' equity, all of which was tangible, was $122.7 million with book value per share ending the quarter at $5.79 resulting in an annualized operating ROE of 7%.
During the first quarter we paid out a total of $0.12 per share in cash distributions and bought back nearly 487,000 shares at an average price of $5.39. Back to you Joe.
Joseph A. Jolson
Thanks, Ray. As the capital market surged in recent years our equity capital markets business drove material upside to revenues and earnings at JMP Securities, that is until conditions changed abruptly in mid-2013. While we were more cautious than many others in our industry during the late stages of the upswing we could not avoid the effects of the market's sharp decline. This year started much as last year ended with an uncooperative market and very little equity underwriting activity. For instance, there are only nine IPOs in the entire first quarter of 2016 compared to 36 a year earlier.
Our ECM revenues understand ably suffered with our public equity underwriting fees falling to $6.2 million from $16.6 million for the first quarter of 2015. That said our underwriting revenues as a percentage of all U.S. equity underwriting revenues paid in the trailing four quarters in our four targeted industry sectors equaled a little over a 100 basis points, a level that has been holding relatively steady since the industry’s peak year in 2014.
Our longer term growth strategy has been to drive market share gains which tend to get accomplished during downturns and they are not always evident until the next up cycle. That’s what happened in 2008 when our market share appeared to decline versus the prior year only to rebound significantly and more than doubled in the following couple of years. So we’re very encouraged that in this downturn our position has not weakened as in the past cycles.
Since inception we have aimed to balance our ECM business with a strong strategic advisory platform and M&A fees have made up a large portion of our investment banking revenues at times in the past. In an effort to keep pace with our increased equity underwriting market share we made a decision in 2013 to invest in the expansion of our strategic advisory capabilities. In the last few years we’ve hired five managing directors with strong M&A backgrounds.
While M&A fees could be lumpy on a quarterly basis we’re very happy to report that our strategic advisory revenues reached a record high of $12 million this quarter. That compares to $2.7 million a year earlier. Given the dislocation in the public equity capital markets our calling efforts on that front have shifted towards alternative capital raising solutions for clients. We expect to play an active role in the increased issuance of convertible securities, structured equity and private debt in 2016 and are less reliant on public equity underwriting fees to achieve our revenue targets this year.
Of course if the public equity markets continue to show strength we are well positioned for recovery in this part of our business. Our institutional brokerage operation was resilient in a very volatile and choppy trading environment, producing revenues that were essentially in line slightly above last year’s result at $6.1 million. We are continuing to look for ways to grow this key part of our business, both through better blocking and tackling as well as by taking advantage of opportunities in a down cycle to strategically enter new industry segments.
Compounding the 9% year-over-year decline in revenue at JMP Securities this quarter were increased costs to run the business, as we had configured -- reconfigured I should say our New York office space as well as investing in business development costs, including higher conference costs and T and E cost to drive revenues going forward. While we are likely to face higher rents as our below market rates reset in a better economy we believe we have good cost discipline and will provide positive operating margin leverage down the road when revenue recover.
We also implemented a selective reduction in headcount at JMP Securities in the quarter, decreasing staff by 14 people or 7% of the total, at JMP Securities. In light of the depressed ECM fee environment we started off 2016 with a higher compensation accrual rate then we had in years past, despite what ended up being a pretty good quarter on a revenue basis at JMP Securities. Factoring in all these items JMP Securities contributed $0.07 per share of operating earnings at an adjusted operating margin of about 10% and an annualized return on equity of 40%, which I think is pretty impressive given the state of the general capital markets environment.
Our asset management platforms Harvest Capital Strategies, HCAP Advisors and JMP Credit Advisors contributed $0.02 of operating EPS for the quarter. That equated to an annualized return on equity of approximately 15%. Some of that is seasonal with the inflows and outflows of our equity account in that business. Asset management related fee revenues jumped 82% year-over-year to $8.9 million, primarily due to an increase in incentive fees at Harvest Small Cap Partners. Recall however that the vast majority of these incentive fees are pass-through to the investment team; the top line change had a positive impact on our bottom line but only modestly. In addition, we are absorbing start-up costs so far this year in launching our Real Estate Opportunity Fund strategy and we’re optimistic that we will have a first close to report in the next three months to six months.
Total client AUM, including sponsored funds from which we earn fees equaled $2.7 million at March 31st, up $263 million or 11% from a year earlier. Hedge Fund Client AUM, including sponsored funds ended the quarter at $860 million, down just $50 million from a year earlier. However in the past 12 months, as we mentioned in previous calls, we voluntarily return $97 million of capital through the closing of Harvest Opportunity Partners II and the liquidation of JMP Masters Fund. Our Small Cap Fund Strategy also returned $78 million in profits to investors nine months ago.
Excluding those amounts Hedge Fund Client AUM including sponsored funds would have been up about 14% year-over-year. JMP Credit Advisors currently manages $1.1 billion in three CLOs and one total return swap. At quarter end 32% of our sponsored AUM was in hedge funds and 68% was in private capital strategies.
We lost 0.8% for the quarter on the capital invested in our hedge funds managed by Harvest Capital Strategies, compared to declines of 1.7% and 1.5% for the HFRI Equity Hedge Fund Index and Russell 2000 indices, respectively.
Now in per share amounts year-over-year that negative return cost us year-over-year about $0.06 a share after tax. We earned 4.7% on the capital invested in our CLO and TRS managed by JMP Credit Advisors which was lower than the 5.6% earned a year ago due to an increase of roughly 35 basis points in three months LIBOR to 62 basis points by the end of March as well as unrealized mark-to-market losses in TRS for the quarter. Considering our hedge funds CLO Securities and principal investments together our total return on invested capital in the quarter was 2.6% and that compares to a decline of 2.5% for the HFRI Fund-of-Funds Composite Index resulting in a contribution after all corporate cost of roughly $0.01 a share of operating EPS and a very modest annualized return on equity of about 1%.
In the first quarter, as we have discussed we distributed $0.12 per share in cash distributions to shareholders, a payout ratio of over 100% of our operating EPS. In addition to that given where our stock was selling we stepped up our buyback activities and repurchased roughly another $0.12 a share in stock in the open market. Obviously the two together were considerably more than a 100% of our earnings for the quarter. Longer term we continued to target distributions of 50% to 70% in cash dividends on our operating EPS, given where stock is trading at a 10% plus material discount to tangible book value.
As I mentioned we increased our emphasis on share buybacks in the first quarter. So in light of these factors our Board of Directors a couple of days ago elected to trim our cash distribution for the second quarter from $0.12 to $0.09. At the same time we also increased our share buyback authorization to a 1.5 million shares, which roughly equates to 7% of the outstanding shares. So we can continue what we started in the first quarter in terms of buyback activities.
In the first quarter we earned $0.08 a share on a GAAP basis and paid out $0.12 a share in distributions. Our book value per share increased $0.02 however thanks in part to this buyback activity. As always I want to finish by thanking JMP’s employees and Independent Directors for their contributions to our success. Because of their hard work we were able to exceed expectations in the first quarter amid difficult industry conditions.
I look forward to updating all of you on our progress during our next call in mid-summer. Operator we can now take any questions that might be there. Thank you.
[Operator Instructions] Your first question comes from the line of Alex Paris with Barrington Research.
Hi, good morning. This is Chris Howe sitting in for Alex Paris.
Joseph A. Jolson
Hey Chris. How are you?
I'm good. Just had a question on the Strategic Advisory Business, wondering if you can provide some additional color on the success you had in the quarter, regarding the increased traction and what you might be seeing thus far in the second quarter for this business?
Joseph A. Jolson
Sure. It’s very lumpy business, so you can see in our press release that the revenue per deal was very high. So that tells you that we closed some decent sized deals. I think our pipeline in terms of number of deals is continuing to grow. We have a few decent sized revenue opportunities, and that pipeline maybe back-end weighted to the third or fourth quarter of this year. We'll see if we can close those, in that timeframe. The typical average fee in that business for us is maybe $1 million to a $1.5 million for the typical buy plan. So the number of deals continues to grow. But because the lumpiness is in the first quarter unlikely to continue to positively help us in the next quarter to that we have a shot by the late third quarter or fourth quarter, some bigger deals. Hopefully that helps you a little bit there.
We have, I would say, of the 20 plus senior investment banking calling officers, roughly half of those people have significant experience and background historically in the M&A side and we want to continue to grow that. So we're actively looking to hire other bankers in targeted spaces where we think we have a good opportunity. So we added another banker there to those ranks, that will start shortly we think. And we’re continuing in this down cycle to look to recruit more.
Thank you for the color. That was very helpful.
Joseph A. Jolson
Your next question comes from the line of Jeffrey Briggs with Singular Research.
Good morning, guys.
Joseph A. Jolson
So first question is along the lines of the strategic advisory as well. So you obviously, as you mentioned from a [indiscernible] got along with M&A activity and that, isn't always predictable kind of like the equity capital markets business. In terms of I guess industry breakdown, the places where you guys really have a key [ph], like the Healthcare, the Biotech, and things like that and also the real estate gains a little bit, the technology companies, do you that being similar, sort of a similar breakdown to where you guys come out in terms of equity capital market. So do you see it being fairly weighted to Healthcare, Biotech things like that, or are there people that are sort of working that part of the business, do they have a little different breakdown over the capital raising side.
Joseph A. Jolson
Yeah, I mean it is a good question. I think that the – most of our equity capital markets business historically, at least the last few years has been in the life sciences area and as that industry is sold off from where – where some of stocks were trading, I think that, that's an opportunity for us in looking at raising, because these companies typically need more capital within a year or two. So that business has shifted a little in this environment to non-traditional ways of raising capital and structured finance. So I think you will see more of that. We didn’t see much of that this quarter, but I think we will see some increase there later this year.
We also have M&A activity there as well. It's typically the larger kind of former companies, or larger kind of roll-ups of life sciences companies are buying the smaller companies. So we think that will increase as well. But you didn’t really see that in the first quarter, okay. Now the way we grew healthcare we also include healthcare services, and for us that's really an M&A business, since we don’t really traffic a lot in the public side of those companies either through our research coverage per se although we have some of the healthcare reads type of thing. But it is mostly an M&A business for us and there was a one large transaction that closed in the first quarter there.
Historically, financial services has been more equity capital oriented and that part of our business, given that most of the companies in the mortgage REIT space, BDCs and the like have been selling at significant discounts to book value, they really haven't been raising capital in the last few years. So that's been very depressed and we have a number of senior bankers in that space that have kind of refocused their efforts more in the M&A side. And we had a couple of fees closed in the first quarter there, and you know that takes a year or so to build up a pipeline and then start closing deals. And we are optimistic that, that will continue going forward just because they have refocused in their efforts there.
On the real estate side similarly it's been more of a balance business, but raising equity has been depressed in this environment. And we would expect more M&A fees there in the back-half of the year. On the tech side for us, it's really driven historically by M&A, although we get into these periods where you have a hot tech tape and there is IPOs and secondary's and that’s kind of been depressed for over a year, the equity markets for tech stocks. And so we have a number of M&A bankers in that area with a pipeline and we would be optimistic that they didn’t really close anything material, I think in the first quarter. So but I think we’ll see more of those closing as we go through the year.
Hopefully that helps you. So it's more balanced, I guess is the conclusion versus the over weighting in life sciences, but recognizing that when we give our industry groups we include the healthcare services in healthcare, which may cause that to look higher than it otherwise would just for life sciences.
Right. And then sort of follow-up, in terms of margins and how much cost variance you guys have in generating that revenue, is the strategic advisory M&A, is that similar cost structure that to the capital markets revenue, or as you change that weighting does that change your margins a little bit?
Joseph A. Jolson
You know what all else being equal, it's higher margin because there is no really no non-comp cost related to it. I mean we typically accrue the same comp ratio across the revenues at securities, and we don’t include any investment income that securities might have in those revenues for comp accruals. So it’s really just based on fee revenues. So but you know there’s no non-comp cost attached to that. So whatever the comp ratio is, the net of that typically drops to pretax. So it has a better effect on earnings per share, everything else being equal.
I think that I mentioned in my prepared remarks that we started the year at higher accrual rate at securities given our experience last year. I mean we’ve been public a while, but private before that. We’re not typically surprised that the end of the year was a shortfall like we were last year in the bonus pool. So we wanted to get – make sure that that doesn’t happen again. And so we started the year out a lot more conservatively on the accrual, just realizing that this equity capital markets environment may be like this for a while. And I think that, that cost us year-over-year a couple of cents a share in the quarter, that we would have otherwise earned, I think. Because the $18 million plus of investment banking revenues was actually a pretty solid quarter for us compared to last two or three or four or five years.
So in hindsight we’ll see – or in foresight we’ll see whether we have the ability to bring that in later in the year. But hopefully we do because revenues will end up being a lot better than expected.
I think the other kind of year-over-year change in the results, it’s securities related to the non-comp side, and spent some time analyzing that, and it was like a penny or two a share and some of it was related to the timing of conference expenses and T&E expenses, and so maybe half of it was related to that and the other half was kind of related to just higher rent cost and depreciation expense for the new space. So that’s kind of the breakout of that.
Okay, thanks. I guess just one real quick thing on the comp ratio. So the quarter-over-quarter number what we’re looking at is, actually if you look at last year’s number that was probably a little lower because it was all just down in the fourth quarter right, so really you’re just accruing at a higher rate. So when you are looking at sort of the year-over-year, it’s high [ph] but it really should been higher last year right?
Joseph A. Jolson
Yeah, if you look at that ratio was 71% last year, which was much higher than we would have normally had…
Yeah, but the first quarter was lower than that for you.
Joseph A. Jolson
Yeah, it was but if we would have been smart enough to accrue in that same 71% ratio in the first quarter of last year, instead of the more normal 65% that we had accrued at, I mean year-over-year that’s a lot more than that $0.02. That $0.02 that I gave you is just 68% versus 65%. So you can add another $0.02 on that top of that for a year-over-year comparison.
I would now like to turn the call back over to Joe Jolson, Chairman and CEO for closing comments.
A - Joseph A. Jolson
Yeah, I appreciate everyone’s interest in -- we’re off to a good start this year actually, especially in light of the environment and we’re pretty fired up around here. We had some exciting things happening in the asset management space hopefully, as the year goes along as well, and look forward to updating everyone in a few months on our second quarter. Thank you.
Ladies and gentlemen, this does conclude today’s conference call. You may now disconnect.
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