Financial regulations were tightened in the aftermath of the financial crisis. The intent of these new regulations was to reign in the large Wall Street banks, but there were unintended consequences. Increased regulatory costs and complex new rules discouraged many smaller companies from going public or raising additional capital. Investment banks focusing on the microcap sector such as JMP Group LLC (NYSE:JMP) suffered along with their potential clients.
JMP stock has languished since the financial crisis along with peers such as Cowen Group, Inc. (NASDAQ:COWN) and FBR & Co. (NASDAQ:FBRC). Despite the historical bull market, all three of these diversified microcap investment banks are currently trading below their 12/31/2009 closing prices. Valuation multiples have slipped. JMP is currently trading at just 1.2X book value as compared to 1.7X at the end of 2009.
Why should we be optimistic now after such a long period of gloom? President Trump has already issued an executive order to start rolling back burdensome financial regulations. We are seeing early signs of increased microcap investment banking activity. National Holdings Corp. (NASDAQ:NHLD) stock surged 24% on 2/15/2017 after reporting strong earnings, including a 59% spike in investment banking revenues. The combination of a broad bull market rally and regulatory relief has created favorable conditions for microcap investment banking to rebound in 2017.
JMP appears especially well positioned to take advantage of the expected recovery. Despite weak investment banking results, 2016 earnings were solid due to a good performance from the company's investments and other areas of their diversified platform. Staffing levels have been maintained during the downturn, and market share has increased. Here are the top 10 reasons to consider JMP.
1. Distributions fully covered in 2016
JMP is a partnership, so investors will receive a K-1 and distributions are taxed accordingly. Net investment income was 65 cents per share for 2016. The current monthly dividend is now 3 cents per share. Dividend coverage is therefore: 65 cents/36 cents = 1.8X.
2. 47% insider ownership
As per the company's 4/22/2016 proxy statement (see page #25), Directors and Executive Officers owned 47% of the common stock. This recent Seeking Alpha article by respected author Superinvestor Bulletin highlighted insider buying at JMP.
3. Aggressive share buyback program
The company has also been actively repurchasing shares. Share buybacks accounted for an unusually aggressive 45% of 2016 net investment income. Buybacks continued in Q4 despite the stock's rally. As per page #1 of the Q4 2016 earnings report:
"...net investment income generated by the publicly traded partnership was $0.65 per share, more than covering the cash distributions of $0.39 per share declared for 2016 and enabling us to spend the equivalent of $0.29 per share to repurchase 1.1 million shares, while maintaining a stable adjusted book value of $5.56 per share at year-end."
4. Good balance sheet
At first glance, JMP appears to be a highly leveraged company, but this is misleading. Recourse debt accounts for only 43% of shareholders' equity. It's important to distinguish between recourse and non-recourse debt. JMP Credit Advisors is a unit of JMP that manages $1.1 billion of assets through three collateralized loan obligations, or CLOs. Due to complex GAAP accounting rules, this CLO-related debt appears on JMP's consolidated balance sheet even though it is backed only by the assets of each individual CLO.
5. Strength at Harvest Capital
JMP manages Harvest Capital Credit Corp. (NASDAQ:HCAP). HCAP is a business development corporation that is focused on making loans to middle market companies. HCAP has rallied strongly over the last year and is now trading above net asset value. An equity capital raise is possible for HCAP and would generate additional fee income for JMP. JMP currently owns 713k HCAP shares (see page #3 of the 4/27/2016 HCAP proxy statement) and receives dividends on those shares as well as management fees.
6. Increasing market share
JMP is well positioned to take advantage of improving microcap investment banking conditions in 2017. They have been growing market share during the downturn. Chairman and CEO Joe Jolson highlights this on page #1 of the Q4 2016 earnings conference call:
"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 industry wide."
7. JMP is a takeover target
It takes time to build client relationships and a stable of well-respected analysts. After a long downturn, fewer companies are focused on microcap investment banking. Companies such as JMP may become takeover targets if the sector heats up. Just a few days ago, close peer FBRC soared on a buyout offer. CEO Joe Jolson highlights the buyout value of his company on the Q4 2016 earnings conference call (see page #2):
"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 acquired for large premiums based primarily on the franchise value of their ECM businesses."
8. Growing backlog
As per the Q4 2016 earnings conference call (see page #3), management is optimistic for improved results in 2017. Their optimism is based on the increasing number of clients that they are discussing potential deals with:
"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."
9. Management is pounding the table
Management optimism is certainly no guarantee of success, but it doesn't hurt. Carter D. Mack is the President of JMP Group which is the investment banking unit of JMP. He makes the bullish case in this 2/12/2017 Institutional Investor article titled "Why Initial Public Offerings Will Rebound In 2017."
10. A 50% capital gain is possible in 2017
JMP's current valuation of 1.2X book value is very low compared to higher historical valuations such as 1.7X book value for 12/13/2009. Even 1.7X book value is far short of typical past bull market valuations for diversified investment banks. A 50% capital gain in 2017 is possible assuming a 10% increase in book value due to higher cyclical earnings and a return to a more normalized valuation of 1.7X book value.
What are the major risks?
Like other financial stocks, JMP is vulnerable to a broad market selloff, economic slowdown or loss in investor confidence. The JMP Credit Advisors unit manages and invests in CLOs that are sensitive to changes in interest rates. Investment banking revenues are concentrated in the technology, financial services, healthcare and real estate sectors. Weakness in any of those specific sectors would hurt investment banking results. JMP is a microcap that typically trades about 25K shares daily. Limit orders and patience are recommended when trading.
JMP is poised for stronger results in 2017 as microcap investment banking benefits from reduced regulations and favorable market conditions. Management appears confident in a rebound as illustrated by insider buying, aggressive share buybacks, maintenance of staffing levels and recent statements. JMP offers a well covered modest dividend and the potential for a 50% capital gain based on stronger 2017 earnings and a return to a more normalized valuation multiple. The CEO has highlighted JMP's prospects as a takeover target at the right price, and I believe that will be the eventual outcome.
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Disclosure: I am/we are long JMP, COWN, NHLD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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