JMP Group's (JMP) CEO Joseph Jolson on Q4 2016 Results - Earnings Call Transcript

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JMP Group LLC (NYSE:JMP) Q4 2016 Results Earnings Conference Call February 16, 2017 10:00 AM ET


Andrew Palmer - IR

Joe Jolson - Chairman & CEO

Ray Jackson - CFO

Carter Mack - President


Alex Paris - Barrington Research

Jeffrey Briggs - Singular Research


Welcome to JMP Group's Fourth 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.

Andrew Palmer

Good morning. Here with me today with Joe Jolson, JMP Group's Chairman and Chief Executive Officer; Carter Mack, our President; and Ray Jackson, our CFO.

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.

Joe Jolson

Thanks Andrew. Despite a challenging year, in the U.S. equities business across Wall Street, JMP's 2016 operating earnings of $0.48 per share came pretty close to the consensus analyst estimate of $0.51 per share from last February, due primarily to record results for both our M&A advisory business and our direct principal investments.

Together M&A and private placement fees totaled nearly $33 million from 28 transactions, compared to $12.6 million from 15 transactions in 2015. We met our three-year objective to organically grow this key franchise to record levels even as the volume of sub-billion-dollar U.S. M&A transactions fell by almost 10% in 2016 industrywide.

Adjusted revenues from our direct corporate investments were $18.6 million for the year, a gross return on capital of 43% versus just $2.5 million in the previous year. As a result, net investment income generated by the publicly traded partnership was $0.65 a share, more than covering our cash distributions of $0.39 a share declared for 2016 and enabling us to spend the equivalent of $0.29 per share to repurchase 1.1 million shares while still maintaining a relatively stable adjusted book value that ended the year at $5.76.

In 2016, we also spent potential earnings to invest in our future, continuing our long-standing countercyclical growth strategy. We added research coverage of alternative energy and regional banks. We hired two M&A focused senior bankers. We launched a real estate opportunity fund and we protected JMP Securities employee base was shrunk by only 8% last year, despite a drop of nearly 40% in our capital markets revenues for the year.

We believe that these decisions position us very well for future growth and success when the business cycle turns more favorable. I'll Ray Jackson, our CFO highlight some key financial items before I give you some color on the year as well as the outlook for next year. Ray?

Ray Jackson

Thanks Joe. Adjusted net revenues, which exclude certain non-cash items and noncontrolling interests were $35.5 million up from $29.7 million for the fourth quarter of 2015. For the year, adjusted net revenues were $130.2 million down slightly from $132.6 million for 2015.

Operating net income was $2.8 million or $0.13 per share for the quarter, up from $1 million or $0.04 per share a year earlier. 2016 operating EPS was $0.48 as Joe mentioned, compared to $0.55 for 2015. On the expense front, our adjusted compensation ratio excluding hedge fund incentive fees was 69.7% for the quarter and 69.3% for the year.

On the same basis, our adjusted non-compensation ratio was 21.1% for the quarter and 22.5% for the year. Our adjusted operating margin, which is pretax operating earnings over adjusted net revenues was 6.3% for 2016 versus 9.7% for 2015. From a balance sheet perspective, our recourse debt to total capital ratio was 43% at December 31, shareholder's equity all of which was tangible was $119.4 million with adjusted book value per share, which adds back accumulated non-cash depreciation and amortization expense related to commercial real estate investments ending the year at $5.76 as Joe already stated.

We've already announced monthly cash distributions of $0.03 a share for the first quarter 2017, which gives $0.09 per share in total, unchanged from the fourth quarter of 2016 and earlier this week our Board of Directors authorized the repurchase of up to a million of our share through the yearend. Joe?

Joe Jolson

Thanks Ray. I want to add some color regarding last year's results and then spend a few minutes discussing our future. As I mentioned earlier and Ray mentioned again, our annual operating EPS came pretty close to the consensus analyst estimate of $0.51 a share established in early 2016. Now this was despite a number of challenging factors throughout the year.

First, we faced a much worse than expected capital markets environment with US ECM fees paid in our four industry verticals falling by 47% from 2015. Second, short-term interest rates increased nearly 1%, which hurt the net interest margin on our CLO's due to LIBOR floors at a similar level on our loans.

Third, our hedge funds, which in many years provide us with a strong return on the capital we invest in them had one of the worst years ever, producing only a marginal profit for us. On the other hand, mostly offsetting these headwinds was a breakout year for M&A advisory business and record gains for our direct corporate investments.

In the face of a disappointing year for ECM business across Wall Street, we determined to keep our key industry franchises intact and opted to invest in growth. Our countercyclical growth strategy as well in previous downturns although like before the tactic has a short-term impact on our earnings with higher expense ratios costing us upwards of $0.10 per share last year.

JMP Securities was still profitable however, contributing $0.05 a share of operating EPS, but produced a meager 2.4% operating margin. Drilling down a bit further, our capital markets revenues defined as the sum of our underwriting fees and our net brokerage revenues were $46.2 million down nearly 40% from $76.1 million in 2015 and were even below the $46.8 million we produced in 2008. In short it was a very tough year.

Nevertheless, we continue to support our institutional equities platform through the addition of two well-regarded senior research analysts, Joe Osha initiated coverage of alternative energy space and recently Emlen Harmon initiated coverage of regional banks, expanding our financial services research into an area important to our institutional customers.

There are only a few remaining independent investment banks in the U.S. with established research platforms and competitive equity capital markets businesses. JMP Securities is one of them and we believe that we are well-positioned to benefit when the capital markets revert to more normalized levels over time. I'm reminded that from 1997 through 2001, 31 of the top 50 U.S. investment banks were required for large premiums based primarily on the franchise value of their ECM businesses.

While many things have changed since then and most of them were negative for the industry, it's worth noting that we enjoyed record profits driven by our ECM activity just a short two years ago. While it's always hard to predict the future, it's easy to define the past. Our decision to start aggressively growing our M&A business in 2013 when our ECM business was hot, turned out to be a big winner.

Our strategic advisory revenues totaled $28.6 million, an increase of 169% from the $10.6 million in 2015. Our 2016 M&A revenues were well diversified across our industry groups with 40% in healthcare, 24% in technology, 20% in financial services and 16% in real estate. We were also able to raise our average fee per M&A transaction from slightly under $1 million in 2015 to $1.4 million for 2016.

While we benefited from a couple of large M&A fees last year, our strategy to grow our M&A franchise has relied on two factors. First, a steady increase in the minimum transaction fee that we are willing to accept per engagement and second, a focus on winning larger M&A mandates. We saw both initiatives reflected in our 2016 results.

We are cautiously optimistic about our M&A business entering 2017 as we have a large backlog of engagements and increased focus on the M&A product among all of our senior bankers and a more visible profile with respect to our strategic advisory capabilities among our clients.

Our asset management platform Harvest Capital strategies, JMP asset management, JMP credit advisors and HCAP Advisor earned a fully taxed $0.07 per share in 2016, which equated to a return on equity of a little over 11%. We faced challenges in our hedge fund business in the last few years as cost to operate have increased due to heightened regulation and a mediocre performance of our industry focus fund strategies led to investor redemptions and ultimately to fund closures.

HCAP Advisors also had a tough year last year despite the public company Harvest Capital Credit reporting record results as a result of the three-year claw back in incentive fees, which kicked in for the first time due to some modest below the line investment losses. Thanks mostly to good performance driving higher incentive fees for our flagship hedge fund, Harvest Small-Cap Partners, asset management related fees rose by more than 12% last year to $26.2 million.

Hedge fund client AUM increased little by roughly 1% during the year to a little less than $600 million, even when accounting for the return of $68 million in capital from the closing of two funds. Excluding the funds that closed, our hedge fund AUM would've grown by 14% last year.

At year-end, JMP Credit Advisors managed three CLO's and one total return swap amounting to $1.1 billion. Total client AUM including sponsored funds in which we have an economic interest equaled $3.7 billion at yearend up nearly $1 billion or 35% from a year earlier, which reflected a $969 million portfolio acquisition by Workspace Property Trust in October as well as the sale of RiverBanc in roughly $200 million of AUM in May.

At yearend, 21% of our sponsored AUM was in three hedge funds and 79% was in six private capital strategies. We generated a slight gain of 0.3% for the year on the capital we invest in our hedge funds versus gains of 5.5% and 21.3% for the HFRI Equity Hedge total index and the Russell 2000 Index respectively.

Including our hedge fund investments, CLO securities principle and other investments, our total return on invested capital last year was a very healthy 20.5%. Net corporate income, which is the net investment income less all corporate expenses, contributed 35% to operating EPS up from 30% in 2015, resulting in an ROE last year of 8.2%.

We also benefited from two material principal investment gains last year that drove our record results. The first was the sale of RiverBanc in the second quarter, which contributed a one-time gain of $0.10 per share and operating earnings that with the sale, we also gave up $0.02 to $0.03 per share that RiverBanc would otherwise have earned for our asset management businesses just from ongoing operations.

The second gain resulted from a large portfolio acquisition by Workspace Property Trust, which owns and operates suburban office space in major U.S. metropolitan markets that occurred in in this quarter. The transaction included an equity raise that increased book value per member interest by 30%, resulting in a gain on our investment at book value of $0.07 per share at operating earnings.

Looking to 2017 and beyond, we're focused on four key business initiatives. First, we aim to grow our M&A franchise to more $50 million in annual revenues by 2021 through the addition of experienced M&A-focused bankers and by further leveraging our research footprint with increased calling officers on efforts, I am sorry, on publicly traded small-cap companies.

We'll also consider strategic acquisitions that would accelerate the growth of this business if they are also highly accretive to operating EPS in our estimation. Our strategic advisory platform needs limited working capital to operate and to grow and as such, provides highly appealing returns on the small amount of equity capital needed.

Given our stock trades is just a modest premium to adjusted book value, we're hopeful that the continued growth of this business will not only help drive earnings, but at some point, could also improve the valuation of our stock materially.

Our second objective is to maintain the franchise value of our capital markets business in the face of what could be year three of a severe industrywide downturn. We may have misjudged the duration of this downcycle in the past year as equity prices rallied to new highs without taking the business of capital markets, IPOs, follow-ons, converts and net commission revenues with it. We'll continue to actively manage this area as 2017 unfolds and remain committed to being well positioned when the cycle turns more favorable.

Third, we intend to grow assets under management in our existing funds with excess capacity and to launch JMP Capital One a debt focused strategy that will seek to take advantage of the best investment opportunities originated across the JMP platform, leveraging the expertise and experience of our season private capital team in deal analysis, due diligence, structuring and pricing.

In addition, we will continue to evaluate -- establish strategies and adding them to our platform either through an investment, outsourced services or acquisition. And finally, fourth, we expect to redeploy our large investable cash balance of $1.62 per share at December 31, which has grown significantly in the past year as a result of hedge fund redemptions and the harvesting of successful investments into new opportunities with attractive risk-adjusted returns.

What's on our radar right now currently, is a large commitment to JMP Capital One, that strategy I mentioned, the structuring of one or more new CLO's if conditions warrant, strategic acquisitions and potentially retiring some of our long-term debt, which had a blended rate of roughly 8%.

To finish as always, I want to thank JMP's employees and independent directors for their hard work and dedication. Despite challenging times for capital markets firms, we're pleased to deliver a reasonable operating profit, which more than covered our cash distributions for 2016 and allowed us to continue to invest in our future. I look forward to sharing our first quarter results on our next conference call in late April.

Operator we can take any questions?

Question-and-Answer Session


Thank you. [Operator instructions] Our first question is from Alex Paris of Barrington Research.

Alex Paris

Good morning, all.

Joe Jolson

Hey Alex.

Alex Paris

Just wanted to follow-up on a few comments that you made Joe with regards to 2017. First of all, I note some outperformance versus most of my estimates are in the fourth quarter. The first point that I want to discuss a little further is your initiatives to maintain franchise value and what could be the year three of a downturn in equity capital markets.

Given the outperformance in the fourth quarter, given better performance in the markets, post-election, have you, has that rolled into Q1 or has there been a softening that leads to your comment about what could be your three of a downturn, what does your pipeline look like on the investment banking side, M&A aside, because I am going to come back to M&A?

Joe Jolson

Okay. Yes. I think that we're half way through this quarter and I would say the environment is similar to the last few quarters. I think that the thing that in hindsight a great judge and we'll be judged by that over the next few years whether maintaining our franchise was the right decision. Obviously, there's a short-term cost to that, but usually at least in my 30-plus years of being in this business, there is almost a one-to-one correlation between equity values and stock prices and companies issuing capital, equity capital.

For some reason that correlation broke down last year, particularly in the second half of the year and now into our early 2017. I can't fathom what would have caused that to breakdown longer-term. So, I would think that that will reestablish itself at some point and that's why I was commenting on that, but so far, this year, it's kind of been the similar to the fourth quarter of last year.

In terms of our pipeline, Carter can comment on that further Carter Mack, but it's pretty good for IPOs. Right now, we have the highest backlog particularly in that area of IPOs that we've had maybe ever and I mentioned in my prepared remarks that we've very good backlog on the M&A side. Carter?

Carter Mack

Yes, not a lot more to add to that. We like to see the IPO market open up, the deals that have come so far this year that we've been involved with that have done quite well. One in biotech and a large transaction in real estate, indication homes. We anticipate a lot more IPOs coming to market as they get their year-end numbers audited and get out in the marketplace and we are well-positioned if the IPO market opens up and then as well we see a lot of company starting to plan and look to raise capital and follow-on equity offerings in convertible transaction.

So, we're still optimistic that we're going to see an uptick in equity capital markets activity from the level that we've seen in the second half of last year and on the M&A front, we've got a really large backlog of engagements. We've closed a couple deals already this quarter and feel good about that pipeline. We'll see how things play out.

Alex Paris

Got it, and then just a follow-on that, at the M&A advisory business. Congratulations, it's been a great growth area for you. It's provided some countercyclical help while new issues might be down, and that goal is exciting. How do you think we get there? You did what, $28 million, $28.6 million in advisory revenue this year, and $50 million by 2021, is it -- do you envision a straight line, probably not or what should we expect there in 2017? You think you'll see growth in 2017 in M&A advisory?

Joe Jolson

Given how, this is Joe, given the big jump over 2015, we would probably be hoping to get to the $25 million to $30 million range. It could be higher than that but that would be kind of plus or minus 10%. As you know M&A revenue is a little lumpy and we had a couple of above average fees last year that in the first quarter that helped us for the full year and maybe got us a little bit above the normalized trendline.

But the underlying growth of that business is being generated by adding more M&A focused season bankers. So, we added two last year and one was at the very end of year. And so, they didn't have any revenues last year. Hopefully we're optimistic that this year they will both be contributors to that business from a revenue and earnings point of view.

And so, this year we're hoping to find another one, two or three focused M&A bankers and so it's kind of blocking and tackling. It's difficult to recruit these guys because unlike other areas of the business if you have a successful M&A banker, they're typically walking away from an engagement pipeline from wherever they currently are. Carter?

Carter Mack

Yes, I just had two things to that. As Joe said, it does take a while for an M&A banker to get up to speed on the platform and to start generating revenues. It's kind of if you're really laid out it's kind of a 12 to 18-month period. So, we expect some of the folks we've hired to start really being productive in 2017, but it's also a change in focus internally with all the senior bankers we have, which is the bar has been set on what kind of M&A revenues we expect out of senior bankers. There's a lot of focus on the product internally.

And then number two, when you start getting M&A deals done in subsectors, it leads to more M&A business. So, it's definitely getting exclusive transactions done, gets a lot of momentum in your business. People want to hire you for the next deal that in that industry space, if you have a successful outcome.

So, those are two things that I think have contributed and like I said, it is hard to drive a straight line in this business because it's affected by so many factors and you can get a big fee and it's very lumpy as most of the M&A focused firms will tell you, but we feel good about our ability to get to that $50 million in revenues and hopefully even before 2021.

Joe Jolson

I think that the one thing I'd also point out on that is that we're including in the numbers at least in the summary section, private places, which isn’t a big area for us just to make it comparable to what M&A boutiques report as their revenues, which include similar transactions. Many cases they're much bigger in that area then we are, but $33 million of revenues from those sources is organically it would have been like we acquired a business that added that would've probably cost our shareholders $50 million or $60 million in cash or stock to get there.

So, we feel really good about the progress that we've made there and it's been all on the same capital base for our shareholders. So, we're hopeful at some point investors might view our stock differently since that's the business that doesn't need capital and whatever it's worth is worth something above fair book value.

Alex Paris

Without a doubt, I notice the broker-dealer tend to be valued on a multiple or a discount to book, while the advisory firms tend to be valued on A, earnings or B, in revenue in much higher multiple levels, too.

Joe Jolson


Alex Paris

I guess the last question I have is, you kind of give a breakdown of your M&A advisory by vertical healthcare, tech, financial real estate. Did you give one for your capital raising, your investment banking side, both on what you've been doing and what you can see in terms of the pipeline?

Joe Jolson

I didn't, but I think maybe Ray or Andrew is looking for those numbers right now in our stat book that we have for the quarter. So, do you have it in there.

Alex Paris

Exact numbers, which verticals kind of led the way and which verticals are leading the way in terms of your pipeline?

Joe Jolson

I think that -- well let me just back up a second, a year ago I would have to go back and look at the conference call transcript, but maybe even before that, we were talking about two potential areas of our business that might provide difficult headwinds going forward for earnings.

One was short rates going up because in our CLO business, that's levered ten to one in the structure, the return on equity was being boosted for a period of years just by the fact that short rates were essentially zero and all those loans are variable rate, but they also have floors around the 1% level. So essentially as the year went along in full impact in Q4, absorbed an increase in short rates to 1% it hurt our earnings.

The second area that we talked about was the significant amount of ECM revenues we were generating in life sciences, which at one point I think in 2014 for the first half of last year was probably 70% of all investment banking revenues, which was great that we were in it and we're a good market share in it, but also at some point, we felt that that was obviously going to normalize and could be a headwind.

So, I think at this point -- did we find the number.

Carter Mack

So overall for investment banking, healthcare was 48%, financial services was 20%, technology was 18% and real estate was 14%. So, healthcare came down significantly as a percentage because of significant downturn, especially in healthcare equity capital markets, but don't forget we also did a lot of M&A and healthcare services so well pronounced if you look at the capital markets. So, if you looked at capital markets revenues, they would be much better distributed across all those industries.

Joe Jolson

Obviously, healthcare is a sector for us, but for us it includes healthcare services on the M&A side and we had a good year last year in healthcare services on the M&A side and so just roughly speaking, of that percent that Carter gave healthcare was of total investment banking, I would say 10 to 15 percentage points of that was M&A and healthcare. So, if that helps you look at it that way.

So, healthcare for us when you just look at how many senior research analysts we have, how many senior investment bankers, in other words, the effort to generate revenues there, should be around 40% of our mix in a normal year. It's never normal year, but obviously 70% plus was punching way above its weight class and if you exclude the healthcare services M&A, last year was probably 25% and I think that that's below its weight class. So, it's gone from a risk factor 18 months ago, to an opportunity factor I think going forward.

Carter Mack

Yes, I agree with that.

Alex Paris

Well, that's very helpful. I appreciate the color, guys. Good luck on 2017 and here's hoping that it's not year three of a downturn.

Joe Jolson

I know your guy’s business room for that. So, let's fingers crossed.

Alex Paris

All right. Thank you.

Joe Jolson

Thanks Alex.


Our next question is from Jeffrey Briggs with Singular Research.

Jeffrey Briggs

Hi guys, hope you're doing well. Couple of -- sort of bigger picture questions here for you. The first one has to do with, given some of the talk politically about overhauling, the corporate tax system and all that sort of stuff, obviously, we don't really know which form that will take, but given some of the potential changes that could be there, how might that affect the PTP structure as well as the regular fully tax side of the business, respectively?

Joe Jolson

Yes, we're obviously monitoring anything that could happen there and will react appropriately to changes right, but the area where the PTP structure benefits us is an investment income and potentially in carried interest longer term, but historically you know that including last year, we haven't really had any benefit on carried interest from the PTP structure going forward.

Maybe we will if some of these newer funds we started have big games down the road but historically it hasn't helped us. So, if they change for instance, the rules for the tax rate on carried interest right, which is something that they’ve talked about for a number of years and we don't need to debate whether that's a good thing or not, let's just say they change that, that would affect the tax impact of carried interest to our investors.

At the PTP level it wouldn't affect the earnings of our company that we report. Okay just the tax nature of those earnings pass through right. So, I think that, but it may diminish the value of being in that structure right, but it wouldn't affect the earnings.

The big benefit to us has been in net investment income, which before the conversion was fully taxed at the corporate tax rate and for us is not doubly taxed any more. It's allowed us to have higher earnings than we'd otherwise have as well as to have a higher dividend to shareholders in part to pay for their burden of taxes, but also you even net of that higher dividend.

And if they change the capital gains tax rate relative to corporate taxes, we'll have to take a look at whether that structure make sense anymore. I guess it would depend on the magnitude of those changes. I don't know that they're even talking about that. I think they're talking about lowering personal tax rates, but also lowering the capital gains tax rates. We'll see what happens.

So, when we got shareholder approval to convert, we also got approval to convert back if things change. So, we don't need to go back to shareholders for another vote. We have the flexibility.

Jeffrey Briggs

Okay. Thanks. That's helpful. And I am going to circle back to another question from before, talking just about the long downturn and the equity capital markets, not just your business, but the whole industry. And you mentioned how over time, you expect that business is going to follow the market that, as markets go up, people are going to be selling more equity, because they'll get more value for it and things of that nature.

The question is, do you think part of that breakdown of that relationship has to do with just interest rates and record bond issuance and things of that nature, because generally as the equity markets go up, interest rates may go up along with that.

So, it changes the equation of it's more valuable sell to the equity because markets are up, but then interest rates are going up as well. So, it's less attractive to sell it back. But, debt has stayed, the cost of debt has saved very low for a lot of companies for a very long time. So, do you see that as part of the equation of that…

Joe Jolson

I don't really. I think it has been part of the equation for like five years right that that has been very inexpensive and companies have issued debt because of that. I don't think it's something that changed in the last 6 to 12 months. If anything, short, interest rates are higher, but I do think like getting back to your tax question, we haven't had, as an industry, we haven't had any real brakes in a decade and we'll see what happens going forward.

But if they change the deductibility of interest expense for corporations in terms of lowering the overall tax rate to corporations maybe limiting it to some amount that you can deduct, that's a game changer for companies going to the equity markets and paying off debt. I think longer-term on a secular basis, we've been in this pretty much declining interest rate environment really I mean since the early 80s and I think regardless of how much rates go up with fiscal policy changes and things like that if they address the favoritism of the debt markets for companies taxes and I don't know that they will, some people have talked about it, but that would be huge for an equity capital markets platforms, especially given how depressed the business has been.

I don't know if that's going to happen, no one's really looking at that in our stock or other people's stocks, but there are very few companies left that are independent that have good equity capital markets businesses and I would substantially increase the value of those franchises if it happened, who knows.

Jeffrey Briggs

Yes, that's a good point about the interest rate -- I guess we will just have to see. Okay. Thank you, guys.

Joe Jolson

Thanks Jeff.


And there are no additional questions. I would like to turn the conference back to our presenters for any closing remarks.

Jeffrey Briggs

Yes, thank you guys for all your interest in JMP and I look forward to updating you as this year unfolds.


Thank you, ladies and gentlemen. This does conclude today's conference call. You may now disconnect your lines.

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