JMP Group Inc. (NYSE:JMP)
Q2 2016 Earnings Conference Call
July 28, 2016 10:00 A.M. ET
Andrew Palmer - Head of Investor Relations
Joe Jolson - Chairman and Chief Executive Officer
Carter Mack - President
Ray Jackson - Chief Financial Officer
Mark Lehman - President, JMP Securities
Chris Howe - Barrington Research Associates, Inc.
Jeffrey Briggs - Singular Research
Chris McCampbell - Hilltop Securities
Welcome to JMP Group's Second 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.
Good morning. On the line with me today are Joe Jolson, JMP Group's Chairman and Chief Executive Officer; and Ray Jackson, the company's Chief Financial Officer. We’re joined by Carter Mack, President of JMP Group; and Mark Lehman, President of JMP Securities.
Before we begin, please note that some of this morning's comments may contain forward-looking statements about future events that are out of our control. Actual results may differ materially from those indicated or implied. For a discussion of the uncertainties that could affect JMP's future performance, please review the risk factors detailed in our most recent 10-K.
With that, I'll turn things over to our Chairman and CEO, Joe Jolson.
Thanks Andrew. Despite challenging industry conditions, JMP Group produced operating net income of $0.12 a share for the second quarter, in large part due to our principal investment activities. JMP Securities posted a loss of $0.06 per share, including a tax benefit, as equity underwriting revenues fell sharply in a difficult capital markets environment.
As in previous cycles, we're looking for opportunities to grow, focusing in particular on our M&A advisory business, while we await an increase in capital markets activity. While this strategy may hinder our near-term results, if successful, we would expect to substantially increase our market share and earnings power over the next three to five years.
Earning our current cash distributions and protecting our book value continue to be high priorities despite the difficult operating environment. To that end, our diversified business model with more than 85% of our book value invested in our fund strategies and direct investments, has once again proven to be highly valuable, more than compensating for JMP Securities' weak results.
Net corporate income was $0.17 per share driven both by the sale of RiverBanc, a multi-family real estate fund manager in which JMP Group had been a founding investors since 2011, and by good returns on the capital in our corporate credit business.
Before I continue, I'll ask Ray Jackson to discuss a few highlights, and Carter Mack will make some comments about JMP Securities. Ray?
Thanks, Joe. Adjusted net revenues were $28.4 million, down from $38.3 million for the second quarter of 2015. For the first-half, adjusted net revenues were $65 million, compared to $75.9 million for the first half of last year. Operating net income was $2.6 million or $0.12 per share, as Joe said, down from $4.9 million or $0.22 per share for the second quarter of 2015. For the first half, operating net income was $0.22 versus $0.45 for the same period last year.
As a quick aside, I should note that our calculations of adjusted net revenues and operating net income now exclude depreciation and amortization expenses related primarily to our December 2015 investment in Workspace Property Trust. GAAP requires us to record our share of the funds, net income among our principal transaction revenues and that net income reflects significant non-cash property depreciation and amortization of intangible assets. We reverse these depreciation and amortization expenses when we present adjusted net revenues and operating net income as these non-GAAP metrics have always been designed to offer a view of our cash revenues and earnings.
Moving on to expenses, our adjusted compensation ratio was 69.3% versus 74.1% for the first quarter of this year and 63.8% in the second quarter of 2015. Excluding hedge fund incentive fees, since the vast majority of those fees are passed through to investment teams, the ratio declined to 68.4%, compared to 70.7% the quarter before and 63.7% a year ago. On the same basis, our adjusted non-compensation ratio was 27% versus 22.5% for the prior quarter and 20.2% for the second quarter of 2015.
In light of the challenging environment for our investment banking and brokerage businesses, we started off 2016 with a higher compensation accrual rate at JMP Securities than in years past. In the second quarter, we further increased the accrual rate to 70% and incurred an expense of $0.01 per share to retroactively bring the first quarter's accrual to the same level. In fact it will be overstating our second quarter comp ratio by 170 basis points.
Our adjusted operating margin, pre-tax operating earnings over adjusted net revenues, was 4.5% for the second quarter and 5.4% for the first half, compared to 16% and 15.4% respectively in 2015. From a balance sheet perspective, our recourse debt to total capital ratio was 43% at June 30. Shareholders' equity, all of which was tangible was $120.4 million with book value per share ending the quarter at $5.75, which included $0.11 per share of accumulated non-cash depreciation and amortization expense related to our recent commercial real estate investments, as I discussed earlier.
We paid out a total of $0.09 per share in cash distributions for the second quarter, and as already announced, third quarter distribution is of the same amount. During the quarter, we bought back about 270,000 shares, costing us $1.4 million. There are 1.3 million shares still available for purchase under our existing authorization. Carter?
Thanks, Ray. I'm going to give a brief update on JMP Securities results with a focus on our investment banking business. We are now one year into a broad and dramatic downturn in the US equity capital market and JMP Securities' results for the first six months of 2016 suffered as a consequence. Our ECM business has historically been strong win for us. However, the current environment presents considerable challenges.
In the first half, on a year-over-year basis, US IPO volume, as measured by total proceeds, was down 60%. Follow-on equity issuance was down 38% and convertible equity issuance was down 45%. Only 112 IPOs were completed during the 12 months ended in June over the last year; the lowest total we have seen since 2009.
When considering total proceeds, we have to go back to 2003 to find a more difficult year for IPOs. All other metric for the last 12 months would equate to one of the leanest years for IPO activity in the past few decades. This situation has been puzzling given a backdrop of generally rising US equity markets, historically low market volatility, and very good returns for the IPOs that have come to market in 2016.
In fact, the average initial public offering executed this year is up almost 18% since pricing effect that should spur more companies to consider going public. In June and July, we began to see a fall in this environment with an increased level of ECM activity across all four of our industry groups. [indiscernible] co-manager on the highly successful IPO for Twilio in late June, which is one of only a few technology IPOs to come to market so far this year. This is also the first IPO to price above the range in 2016 and it's been the best performing IPO this year with the stock up more than 180% since pricing.
We believe that this transaction may act as a bellwether for other technology companies, particularly in the Cloud and SaaS-based that may be encouraged to launch IPOs in the second half of the year. We also have witnessed an uptick in initial public offerings in life sciences sectors. JMP Securities is involved in two IPOs in the past month in this space and we are seeing very active engagement from institutional investors taking deal-related road-show meetings and have noted a clear desire among them for additional IPO volume.
On the follow-on equity front, we've also seen an uptick in activity in each of our industry groups over the past few months. In life sciences, companies and investors are adjusting to new pricing realities and they are addressing the pent-up need of many companies to raise additional capital. In the last two months, we have been involved in three follow-on and a convertible securities offering in life sciences space and there is more activity on the way.
In both our financial services and our real estate practices, we have faced a very depressed ECM environment for the last three years, but we are starting to see a change and we're involved in five equity follow-ons and preferred stock offerings in these two areas in June and July.
We've also seen increased issuance through aftermarket or ATM equity placement programs. Seven companies in the financial services and real estate industries issued equity off of JMP underwritten ATMs in June and July. We are currently mandated on a number of additional ATM programs by issuers in these industries and view this as a good opportunity to increase ECM revenues in the second half of this year.
The real bright spot for JMP Securities in the first half of 2016 was our M&A advisory business, which have produced record revenues of $16.3 million; the most we've ever generated in any half of any year. This has been the result of a multi-year effort to grow this business organically both through the hiring of experienced M&A focused-bankers in each of our industry groups and through a focus by our existing bankers on the M&A product, particularly in our real estate, financial services and technology areas as ECM activity has been depressed.
We see very good opportunity to continue to grow organically in M&A advisory and are targeting M&A revenues that comprise 50% of overall investment banking revenues over the next three to five years. In the second quarter, we hired a Senior M&A banker in our technology group Don More, who is focused on the large opportunity in cyber security. We are also in the process of recruiting a senior M&A banker in the healthcare space and hope to make the hiring announcement in the next few months.
While many of our peers are looking to downsize or to scale back hiring efforts and the bulge bracket banks continue to announce layoffs of senior bankers, we think that the current backdrop presents us with an excellent opportunity to recruit productive bankers with relationships and expertise who can leverage the JMP Securities platform.
After producing $12 million of M&A revenues for the first quarter, we had $4.3 million for the second quarter, but we are off to a nice start to the third quarter with three transactions closing so far in July. We continue to build on the robust pipeline of advisory engagements and are on track to have a record year in M&A.
Back to you Joe.
Thanks, Carter. The depth and duration of the current downturn are unknown at this juncture, but in our experience, down cycles have lasted anywhere from six months to a few years. While the current environment is negatively impacting our results, in particular for JMP Securities and further returns on the capital invested in our hedge funds, it also presents us with an opportunity to grow our business in a more productive manner.
In previous downturns, we've been able to take advantage of market dislocation by adding senior producers to our investment bank, entering new asset classes in our asset management business and finding investments that have led to extraordinary returns for our shareholders. I want to be clear that we are currently pursuing the same countercyclical organic growth strategy, which will have a short-term cost since hiring producers precedes incremental revenues, but which could meaningfully increase our market share and earnings power, if successful, over the next three to five years.
JMP's diversified business model allowed us to generate cash earnings during past downturns such as in 2001-2002, as well as in 2008-2009, while still directing some potential earnings towards accelerating our organic growth. Over the past 12 months, our operating earnings have declined by more than 50% from record levels; but we've still been profitable in each quarter due to stable earnings in our asset management businesses and to strong principal investment results.
For the second quarter, income from these areas covered 100% of our corporate cost in strategic growth initiatives and still contributed $0.18 to our operating earnings, allowing us to more than cover our $0.09 cash distribution, fund our $0.06 in share repurchases, and continue to invest in organic growth initiatives.
Specifically, we're presently focused on three growth opportunities. First, as Carter mentioned, we want to continue to grow our M&A advisory business by attracting experienced, industry-focused investment bankers to our platform. We had a record first half M&A revenues of $16.3 million, an amount that was 50% more than the entire year of 2015. And given our current pipeline, we think we're well positioned to have our best year ever this year in M&A.
We aren't riding an industry wave here, rather the growth has been driven by a multi-year focus on adding experienced M&A specialists and a renewed commitment from our existing investment bankers to focus more on the M&A advisory product. We continue to believe that the returns on the compensation dollars we invest to grow this business will be extraordinary over the next three to five years.
Second, we are looking to enter one or two new industry verticals to add to our current mix of healthcare, technology, financial services, and real estate in the next 12 months to 18 months. Any new verticals that we enter must have characteristics similar to the current ones. That is, they must be composed of growth companies with an institutional investor base, and an ongoing need for these companies to raise new capital.
Third, we are looking to launch two new Opportunity Fund Strategies in the next six months to 12 months that will leverage the successful JMP franchises in real estate and corporate credit. We have already redeployed some senior JMP employees to focus on these efforts in 2016 and we hope to have some positive news to report in the next few quarters. Organic growth is expensive in the short term, but provides, by far, the highest return on our capital in the long term, if successful.
We've always done our best to balance the cost of organic growth with an acceptable level of profitability, currently defined by us as covering our cash distributions to shareholders with operating earnings. Besides the specific initiatives mentioned earlier, we're continuing our efforts to build relationships with successful companies in our existing industry verticals, as well as their institutional investors with a three year to five year objective of increasing our market share by more than 50%. Down cycles can also present excellent opportunities for us to invest our capital.
In addition to an unused $30 million line of credit, we currently have more than $40 million of dry powder in cash and in our hedge funds that could be redeployed into higher return investments. We continue to spend time sourcing and evaluating investment opportunities that could be meaningfully accretive to our net investment income and potentially to our cash distributions to shareholders.
For the second quarter, we distributed $0.09 a share in cash to shareholders, a payout ratio of 75% on our operating earnings, above the top end of the 50% to 70% range we have set as a longer-term objective. We earn roughly $0.21 per share as a publicly traded partnership for the quarter however, with our cash distributions representing just 43% of that amount.
In addition, we spent another $0.06; as I mentioned earlier, to repurchase stock and those two combined bring the total payout ratio at the PTP level to about 71%. Given that our stock has been trading below book value and at times well below book value, since the start of the year, we have been much more aggressive in buying back our shares.
To finish, I want to thank JMP's employees and Independent Directors for their tireless efforts in a difficult environment. Despite strong industry headwinds, we have delivered a reasonable operating profit in both of the first two quarters of 2016; we've covered our cash distributions with operating earnings; we've protected our net asset value despite absorbing $0.11 a share in non-cash depreciation expenses year-to-date from our recent commercial real estate investments and have added selective [indiscernible] to our platform for growth. We look forward to updating you on our progress in late October with our third quarter earnings call.
Victoria, we'll open up to any questions. Thank you.
[Operator Instructions] Your first question comes from the line of Alex Paris with Barrington Research.
Good morning. This is Chris Howe sitting in for Alex Paris.
Hi. Just had two questions for you. Assuming stabilization of markets over the second half, would you provide any color, maybe how you're viewing your pipeline for deal activity this fall?
I'll let Carter give you some details to that, but I think that if you just look historically, we've historically have done somewhere between $10 million and $15 million a quarter in the equity capital market side versus couple of million last quarter. That give you just some perspective, Carter why don't you…
I was trying to give a little bit of view into what we're seeing currently through July with some of the stuff I talked about in my remarks. We are seeing, like I said, a fall in that ECM environment. It's not getting back to really robust levels, but we're on more deals, we're seeing a steady stream of follow-ons come to market. We just priced a book-run follow on in the life sciences space this morning.
We expect to see some more IPO activity, especially after Labor Day when people get back into the markets, but it's hard to have a very good crystal ball. If the market is cooperate, if things stay relatively stable, I think you'll see a lot more equity follow-on activity come to market in those deals, you don't have a very good idea of a pipeline there, companies decide they want to finance and then it happens pretty quickly. So, we feel better about the ECM environment and somewhat optimistic that the second half of the year will be better, a lot better than the first.
Chris, well just looking at the numbers, might be helpful in the first half of the year. We did roughly $7 million or $8 million of ECM revenue for the whole first half of the year, I think, and so that's at a run rate of like $15 million. And at the peak, on a calendar year basis not four quarters at the peak, we did $55 million of ECM revenues.
So you're talking about a $40 million drop off of $55 million. I mean that's extreme by any historical measure, including 2008, 2009. So, we don't know when it's going to recover. It seems to have some of the ingredients to pick up a lot in the second half of the year. The good news is we've been profitable each quarter while that's happened and the efforts that we spent that have hurt earnings a little bit in the last few years to build an M&A business, to improve it, they're starting to drive business there.
So, I think we're pretty excited about that and the value to our shareholders that will bring over time if we continue to be successful there. So, I mean the cyclical part of our business is just hard for us to predict like it is for you.
And if I'm correct, the comps should get a little easier as we head into the second half based upon last year's…
Yes, I think I mentioned that we're now one year into this downturn and really in July of 2015, is when we saw a real slowdown in ECM activity. And so, yes.
So, we had a pretty good third quarter in ECM side because of the couple of larger deals, but in any case, yes, the comps will get increasingly easier.
And then, if I may, the brokerage revenues were down 9.4%, 9.3% after being flat to slightly up in Q1 following down mid-single digits in the full year 2015. If you could provide some color on what led to that?
Mark Lehman is here, I'll let him comment on that.
Yes. As you know, volumes have not been terrific even though the markets are at new highs. And through July, that's not been any different. And I think we're doing all we can and trying to maintain market share, but overall, volumes post the volatility that we saw for some of the second quarter has not been great. We're hoping obviously with reporting season coming up and some of the new highs and some of the new action on the capital market side, that will increase, but it has been a challenging environment for us.
I think you'll see that through the second quarter for most of the Street and we continue to work really, really hard in that business and hopefully with an increase in capital markets that will also increase our activity on the secondary business.
Yes. I mean my only add comment to that is that we are trying to grow that business. We've selectively, like I said, one of the growth initiatives for us in the next year is to enter one to two new industry verticals, which is a big commitment to try to grow that business. We hired analysts to spearhead one of those verticals that we hope to enter in the second quarter and we're hoping that he launches coverage and we're active in a new area, maybe in the next few months.
Hopefully by the time our next call, we can talk about that in more detail, but I think that that's an investment in that business to continue to grow it. So it's just been a very difficult business for us, for anyone, it seems like to grow organically in the last few years, but we're still focused on that and we're hopeful that we will be able to do that.
Well thank you for the color and thank you for taking my questions.
No problem. Thank you.
Your next question comes from the line of Jeffrey Briggs with Singular Research.
Hi, how is going guys.
I think, if we were sitting here a year ago and we are talking about these kind of numbers for ECM revenue, I would assume things have looked a lot worse than they do. But I know it's good to see in both the first quarter and second quarter, some of those diversification type strategies pan off with just a lot of M&A revenue in Q1, and then with the revenue that came from that RiverBanc sale in Q2. So, that's definitely a testament to what you guys have been building over the past couple of years. So, that's really good to see.
I was about to ask you about, some of the different verticals you're looking at going into, I know you talked about things that have a lot of institutional interest and things that have a tendency to need to keep raising money, but it sounds like you're in a hold off, I'm taking about this until the next quarter or so.
So, another thing I was thinking about was, on the asset management side, in the Harvest Capital Strategies franchise, what are you seeing in terms of - on the investor side, people adding more to their holdings in your funds. How much room do you have to raise more money, if there is appetite for it?
And actually where do you see that going over the next and 6 to 12 months in terms of any of the capacity, and what you have. It sounds like you're going to add a couple of new strategies down the line. And then, also just what you're seeing from your investors? Are they looking to stand tight or are they looking to downsize or make this an investment?
Okay. So let me, if I forgot something, ask a follow-up. Just in terms of the industry verticals that we're looking at, I think even though we don't want to talk about it that we've launched specifically, we have talked in the past about two areas, two to three areas that made sense given they use of our products, raising equity capital, and M&A.
And that would be the energy space is one area, diversified industrials is another area and potentially consumer products. So, I think it's safe to assume that that we're looking to get into at least one of those three areas that we've talked about publicly before and maybe in a little creative way than that.
And then, in terms of asset management, we're always looking to raise more [indiscernible]. Obviously there's a significant amount of earnings leverage for raising more AUM in the same strategies that we currently have, most of our funds are sub-scale and so, the marginal revenue dollar adds very large contribution margin relative to our current profit margin in asset management.
So the only fund that's been closed for a long time now and has returned capital in our mix is our small cap fund. So everything else is trying to raise money and some of these funds are private equity funds and they're not like a hedge fund where they could raise money every quarter. Their growth will come after they deploy their money and then look to launch a follow-up fund.
So that will be more chunkier kind of growth. So as our mix has shifted to two-thirds private equity credit type of strategies over time, the growth will come chunkier there. But specifically on the two funds we're looking at, a real estate opportunity fund, we're not looking at that to be significant this year, but we're hoping to have a first close of around $20 million this quarter.
In the credit fund, a similar kind of first close maybe by year-end and then grow from there. I think that we made some seed investments for the real estate fund that we think are highly attractive. And to get that off the ground. We haven't yet made any seed investments for the credit fund, but we might be considering some of those as the year goes along. So anyway, hopefully that helps you on those two funds.
Within our hedge fund universe, our agricultural focus fund is kind of a unique strategy. He is kind of at a level at about $150 million under management where he is having conversations with a lot of larger allocators and investors. And so we'll see what happens with that over the next year. I mean, he's got a lot of [indiscernible].
So, our current hedge funds that are opened to raising more capital, his strategy is very scalable in a lot of conversations. I don't have anything positive to report today there. But hopefully by year-end, there will be some good news in terms of growing that. Hopefully that helps you.
Now, just so everyone is aware, selling - we didn't instigate the sale of RiverBanc. This quarter, we owned a little over 20% of it as a founder and was purchased by New York Mortgage. They announced it in May when they reported their first quarter results and that was very profitable strategy for us. So the good news was that it was a great return and was good earnings this quarter, but it's going to take a little while to replace the lost earnings going forward, there were a couple cents a share per year from that. So I have to rebuild some other things to grow to make up for that.
So, I think that was a couple hundred million of our assets under management that was in the April 1 slide that will drop on the July 1 slide. Anyway, hopefully that helps you Jeff.
Yes, thanks. It’s helpful.
Your next question comes from the line of Chris McCampbell with Hilltop Securities.
Good Moring. Mr. Jolson, I understand your optimism for the business long-term, I think it's fair to say you've had a strong appetite for JMP common stock. Are there any limitations on how high your ownership can be?
You mean like legal limitations or personal limitations?
I don’t know.
No, I think just so you frame it positively or negatively. I'm obviously a long-term investor and until we went public 9.5 years ago, most people at our company would have loved buy more shares of our company at book value, let alone today it's selling at a big discount to book value with the traded stock as opposed to being a private company.
I think that RiverBanc, in the quarter, the net gain before comp and taxes was around $5 million-plus and we had $200,000 invested in it. And it just points out that, we have a lot of hidden value that isn't in our book value. We haven't made any acquisitions. So, we've organically grown everything and expensed everything to grow it.
So, we have a very conservatively stated book value with lots of franchise value, I think, in some of these businesses. So, yes the blackouts over with tomorrow morning, if someone wants to sell me shares down here, I'll be there to meet him the invisible hand markets. So, I have an appetite to own a lot more at these kind of price levels as long as they're showing out they're willing to sell it to me.
And by the way, our Company has an active buyback program as well. Earlier this year, given where the stock was selling, we lowered our cash dividend a little bit in exchange for increasing our Board authorization to buy back even more stock, just in reaction to where the stock was trading. So, we have about another $1.3 million authorized and we're in the market today, I'm sure in a 10b-5 plan. Hopefully that helps you.
It does, I appreciate it. Thank you so much.
Okay, and it looks like there are currently no further questions in queue. I'll turn it back to the presenters for any closing remarks.
Yes. Thanks Victoria. Thank you for your interest in our company. We appreciate it and we hope to report positive progress in a couple of months. Thank you.
Again, thank you for your participation. This concludes today's call. You may now disconnect.
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