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cohn20201002
Author Name, ProPublica
2021-10
cohn20201002_10k.htm
Table of Contents UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) ☒ ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2020 OR ☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from to Commission file number: 001-32026 COHEN & COMPANY INC. (Exact name of registrant as specified in its charter) Maryland 16-1685692 (State or Other Jurisdiction of Incorporation or Organization) (I.R.S. Employer Identification No.) Cira Centre 2929 Arch Street, Suite 1703 Philadelphia, Pennsylvania 19104 (Address of principal executive offices) (Zip Code) Registrant’s telephone number, including area code: (215) 701-9555 Securities registered pursuant to Section 12(b) of the Act: Title of class Trading Symbol(s) Name of each exchange on which registered Common Stock, par value $0.01 per share COHN NYSE AMERICAN STOCK EXCHANGE Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ☐ No ☒ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ☐ No ☒ Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐ Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files. Yes ☒ No ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer”, “smaller reporting company”, and “emerging growth company” in Rule 12b-2 of the Exchange Act. Large accelerated filer ☐ Accelerated filer ☐ Non-accelerated filer ☐ Smaller Reporting Company ☒ Emerging Growth Company ☐ If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐ Indicate by check mark whether the registrant has filed a report on and attestation to its management's assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. Yes ☐ No ☒ Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ☐ No ☒ As of June 30, 2020, the aggregate market value of the Common Stock held by non-affiliates of the Registrant was approximately $7.6 million. As of March 3, 2021, there were 1,329,007 shares of Common Stock of Cohen & Company Inc. outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Proxy Statement for the Registrant’s 2020 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K. Table of Contents
Forward Looking Statements
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995, Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act. Forward-looking statements discuss matters that are not historical facts. Because they discuss future events or conditions, forward-looking statements may include words such as “anticipate,” “believe,” “estimate,” “intend,” “could,” “should,” “would,” “may,” “seek,” “plan,” “might,” “will,” “expect,” “predict,” “project,” “forecast,” “potential,” “continue,” negatives thereof or similar expressions. Forward-looking statements speak only as of the date they are made, are based on various underlying assumptions and current expectations about the future and are not guarantees. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, level of activity, performance or achievement to be materially different from the results of operations or plans expressed or implied by such forward-looking statements.
These forward-looking statements are found at various places throughout this Annual Report on Form 10-K and include information concerning possible or assumed future results of our operations, including statements about the following subjects:
• integration of operations; • business strategies; • growth opportunities; • competitive position; • market outlook; • expected financial position; • expected results of operations; • future cash flows; • financing plans; • plans and objectives of management; • tax treatment of the business combinations; • the special purpose acquisition companies (SPACs) of which we are a sponsor including, INSU Acquisition III, a blank check company that will seek to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization or similar business combination with one or more businesses; • our investments in both SPACs and SPAC sponsor entities through our SPAC funds and SPAC Series Funds • our role as asset manager in our SPAC franchise • fair value of assets; and • any other statements regarding future growth, future cash needs, future operations, business plans and future financial results, and any other statements that are not historical facts.
These forward-looking statements represent our intentions, plans, expectations, assumptions and beliefs about future events and are subject to risks, uncertainties, and other factors. Many of those factors are outside of our control and could cause actual results to differ materially from the results expressed or implied by those forward-looking statements. In light of these risks, uncertainties and assumptions, the events described in the forward-looking statements might not occur or might occur to a different extent or at a different time than we have described. You should consider the areas of risk and uncertainty described above and discussed under “Item 1A — Risk Factors.” Actual results may differ materially as a result of various factors, some of which are outside our control, including the following:
• a decline in general economic conditions or the global financial markets; • continuation of the COVID-19 pandemic or future outbreaks of COVID-19, the timing and effectiveness of vaccine distribution, and uncertainty surrounding the length and severity of future impacts on the global economy and on our business, liquidity, results of operations and financial condition; • risks and liabilities due to our investments in the equity interests of SPACs and SPAC sponsor entities including the risk of increased regulation applicable to SPACs, risks regarding litigation in connection with the SPACs in which we invest and those which we sponsor, uncertainty of whether the SPACs in which we invest and those we sponsor will consummate a business combination, adverse impacts of COVID-19 on our SPAC franchise, significant competition for business combination opportunities in the SPAC industry, write-downs or write-offs with respect to the securities which we hold subsequent to the consummation of a initial business combination by the SPACs in which we invest and those which we sponsor, and the target of a SPAC being an early-stage and financially unstable company; • losses caused by financial or other problems experienced by third parties; • losses due to unidentified or unanticipated risks; • losses (whether realized or unrealized) on our principal investments; • a lack of liquidity, i.e., ready access to funds for use in our businesses, including the availability of securities financing from our clearing agency and the Fixed Income Clearing Corporation the (“FICC”); or the availability of financing at prohibitive rates; • the ability to attract and retain personnel; • the ability to meet regulatory capital requirements administered by federal agencies; • an inability to generate incremental income from acquired, newly established, or expanded businesses; • unanticipated market closures due to inclement weather or other disasters; • the volume of trading in securities including collateralized securities transactions; • the liquidity in capital markets; • the creditworthiness of our correspondents, trading counterparties, and banking and margin customers; • changing interest rates and their impacts on U.S. residential mortgage volumes;
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• competitive conditions in each of our business segments; • the availability of borrowings under credit lines, credit agreements, warehouse agreements, and our credit facilities; • our continued membership in the FICC; • the potential misconduct or errors by our employees or by entities with whom we conduct business; and • the potential for litigation and other regulatory liability.
You are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date of this Annual Report on Form 10-K. All subsequent written and oral forward-looking statements concerning other matters addressed in this Annual Report on Form 10-K and attributable to us or any person acting on our behalf are expressly qualified in their entirety by the cautionary statements contained or referred to in this Annual Report on Form 10-K. Except to the extent required by law, we undertake no obligation to update or revise any forward-looking statements, whether as a result of new information, future events, a change in events, conditions, circumstances or assumptions underlying such statements, or otherwise.
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Certain Terms Used in this Annual Report on Form 10-K
In this Annual Report on Form 10-K, unless otherwise noted or as the context otherwise requires, the “Company,” “we,” “us,” and “our” refer to Cohen & Company Inc. (formerly Institutional Financial Markets, Inc.), a Maryland corporation and its subsidiaries on a consolidated basis; and “Cohen & Company, LLC” (formerly IFMI, LLC) or the “Operating LLC” refer to the main operating subsidiary of the Company.
“Cohen Brothers” refers to the pre-merger Cohen Brothers, LLC and its subsidiaries; “AFN” refers to the pre-merger Alesco Financial Inc. and its subsidiaries; “AFN Merger” refers to the December 16, 2009 closing of the merger of AFN, Alesco Financial Holdings, LLC, a wholly owned subsidiary of AFN, with and into Cohen Brothers, which resulted in Cohen Brothers becoming a majority owned subsidiary of the Company.
“JVB Holdings” refers to JVB Financial Holdings, L.P., a wholly owned subsidiary of the Operating LLC; “JVB” refers to J.V.B. Financial Group, LLC, a wholly owned broker dealer subsidiary of JVB Holdings; “CCFL” refers to Cohen & Company Financial Limited (formerly known as EuroDekania Management LTD), a wholly owned subsidiary of the Operating LLC formerly regulated by the Financial Conduct Authority (formerly known as the Financial Services Authority) in the United Kingdom (the “FCA”); “CCFEL” refers to Cohen & Company Financial (Europe) Limited, a wholly owned subsidiary of the Operating LLC regulated by the Central Bank of Ireland ( the “CBI”); and “EuroDekania” refers to EuroDekania (Cayman) Ltd., a Cayman Islands exempted company that was externally managed by CCFL.
“Securities Act” refers to the Securities Act of 1933, as amended; and “Exchange Act” refers to the Securities Exchange Act of 1934, as amended.
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PART I
ITEM 1. BUSINESS.
INFORMATION REGARDING COHEN & COMPANY INC.
Overview
We are a financial services company specializing in the fixed income markets and, more recently, in special purpose acquisition company ("SPAC") 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. Our business segments are Capital Markets, Asset Management, and Principal Investing. Our Capital Markets business segment consists of fixed income sales, trading, and matched book repo financing as well as new issue placements in corporate and securitized products and advisory services, operating primarily through our subsidiaries, JVB in the United States (the “U.S.”) and CCFEL in Europe. Our Asset Management business segment manages assets through investment vehicles, such as collateralized debt obligations (“CDOs”), managed accounts, joint ventures, and investment funds (collectively, “Investment Vehicles”). As of December 31, 2020, we had approximately $2.8 billion of assets under management (“AUM”) in primarily fixed income assets in a variety of asset classes including U.S. and European bank and insurance trust preferred securities (“TruPS”), debt issued by small and medium sized European, U.S., and Bermuda insurance and reinsurance companies, and equity interests of SPACs and their sponsor entities. A substantial portion of our AUM, 74.3%, was in CDOs we manage, which were all securitized prior to 2008. The remaining portion of our AUM is from a diversified mix of other Investment Vehicles most of which were more recently formed. Our Principal Investing business segment is comprised primarily of investments we hold related to our SPAC franchise and investments that we have made for the purpose of earning an investment return rather than investments made to support our trading, matched book repo, or other capital markets business activity.
In June 2018, in response to the uncertainty surrounding Brexit, we created a new subsidiary, CCFEL (f/k/a Cohen & Company Financial (Ireland) Limited) in Ireland, for the purpose of seeking to become regulated to perform asset management and capital markets activities in Ireland and the European Union. In April 2019, CCFEL received authorization from the CBI under the European Union (Markets in Financial Instruments) Regulations 2017 to provide Financial Instruments. The services for which CCFEL received authorization include the receipt and transmission of orders in relation to Financial Instruments, the execution of orders on behalf of clients, portfolio management, investment advice and investment research, and financial analysis. In addition, CCFEL applied for approval of a French branch, which approval was granted by the CBI and the branch was authorized by the French regulators in April 2019. Following authorization of the French Branch of CCFEL, various contracts originally entered into by CCFL were novated to the French Branch of CCFEL. The novation of contracts was completed on July 1, 2019.
Capital Markets
Our Capital Markets business segment consists primarily of fixed income sales, trading, and matched book repo financing as well as new issue placements in corporate and securitized products and advisory services and is operated through our subsidiaries, JVB in the U.S. and CCFEL in Europe.
Our Capital Markets business segment consists of JVB as our sole operating U.S. broker-dealer and our European broker-dealer CCFEL, which is regulated by the CBI. JVB operates under our JVB Holdings subsidiary and is a member of the Financial Industry Regulatory Authority (“FINRA”) and the Securities Industry Protection Corporation (“SIPC”). We also operated our European Capital Markets business through our subsidiary CCFL, in the United Kingdom, which up until 2020 was regulated by the Financial Conduct Authority ("FCA") in the United Kingdom. In 2020, CCFL ceased being regulated by the FCA, completed the transfer of any remaining ongoing business to CCFEL, and is currently in the process of being dissolved.
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 and loans, asset-backed securities (“ABS”), mortgage backed securities (“MBS”), commercial mortgage-backed securities (“CMBS”), residential mortgage-backed securities (“RMBS”), CDOs, collateralized loan obligations (“CLOs”), collateralized bond obligations (“CBOs”), collateralized mortgage obligations (“CMOs”), municipal securities, to-be-announced securities (“TBAs”) and other forward agency MBS contracts, Small Business Administration loans (“SBA loans”), U.S. government bonds, U.S. government agency securities, brokered deposits and certificates of deposit (“CDs”) for small banks, and hybrid capital of financial institutions including TruPS, whole loans, and other structured financial instruments.
In 2012, we established a trading desk for “to-be-announced” securities, or TBAs, as part of our mortgage group. TBAs are forward mortgage-backed securities whose collateral remains unknown until just prior to the trade settlement. The forward collateral types are exclusively issued by U.S. government agencies, such as the Federal National Mortgage Association (“Fannie Mae”), the Federal Home Loan Mortgage Corporation (“Freddie Mac”), and the Government National Mortgage Association (“Ginnie Mae”). One objective of our mortgage group is to provide capital markets execution services to small and middle market institutional mortgage originators that hedge their mortgage pipelines. In addition to providing credit for MBS trading lines and execution services, our mortgage group offers trading of specified pools and financing for qualified originators. Our mortgage group offers a range of solutions for institutional clients seeking to enhance their mortgage pipeline execution and overall portfolio profitability. In addition, our mortgage group acts as an intermediary between borrowers and lenders of short-term funds and provides funding for various inventory positions using repurchase agreements.
We have grown our matched book repo business, under which JVB enters into repurchase and reverse repurchase agreements. In general, JVB lends money to a counterparty after obtaining collateral securities from that counterparty via a reverse repurchase agreement. JVB also borrows money from another counterparty using those same collateral securities via a repurchase agreement. JVB seeks to earn net interest income on these transactions. Currently, we categorize our matched book repo business into two major groups: gestation repo and general collateral funding (“GCF”) repo.
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● Gestation Repo: For several years, JVB has operated a matched book gestation repo program. Gestation repo involves entering into repurchase and reverse repurchase agreements where the underlying collateral security represents a pool of newly issued mortgage loans. The borrowers (the reverse repurchase agreement counterparties) are generally mortgage originators. The lenders (the repurchase agreement counterparties) are a diverse group of counterparties comprised of banks, insurance companies, and other financial institutions.
● GCF Repo: In October 2017, JVB was approved as a full netting member of the Fixed Income Clearing Corporation’s (“FICC”) Government Securities Division. As a member of the FICC, JVB has access to the FICC’s GCF repo service, which provides netting and settlement services for repurchase transactions where the underlying security is general collateral (primarily U.S. Treasuries and U.S. Agency securities). The FICC’s GCF repo service provides us with many benefits including more flexible and lower cost of financing, increased liquidity, increased efficiency in trade execution, and guaranteed settlement. The borrowers (the reverse repurchase agreement counterparties) are a diverse group of financial institutions including hedge funds, registered investment funds, real estate investment trusts (“REITs”), and other similar counterparties. The lenders (the repurchase agreement counterparties) are the FICC and several other large financial institutions. As a condition to our membership, we maintain an aggregate $25 million credit facility with Byline Bank. See notes 11 and 20 to our consolidated financial statements included in this Annual Report on Form 10-K. The FICC reserves the right to terminate our membership if we fail to comply with this condition. Without access to the FICC’s GCF repo service, any expansion of our matched book repo business will be limited.
We have been in the Capital Markets business since our inception. Our Capital Markets business segment has transformed over time in response to market opportunities and the needs of our clients. The initial focus was on sales and trading of listed equities of small financial companies with a particular emphasis on bank stocks. Early on, a market opportunity arose for participation in a particular segment of the debt market, the securitization of TruPS. We began assisting small banks in the issuance of TruPS through CDOs. These Investment Vehicles were structured and underwritten by large investment banks while our broker-dealer typically participated as a co-placement agent or selling group member. We also participated in the secondary market trading between institutional clients of the securities issued by these CDOs.
In early 2008, our management team made the strategic decision to restructure our Capital Markets business model from exclusively focusing on TruPS and structured credit products to a more traditional fixed income broker-dealer platform with more diversified revenue streams primarily from trading activity. In the ensuing years, we hired many sales and trading professionals with expertise in areas that complement our core competency in structured credit. In 2011, our acquisitions of JVB and the PrinceRidge Group (“PrinceRidge”) further expanded our Capital Markets platform. As a result of these acquisitions, offset by subsequent downsizings and mergers, our Capital Markets staffing increased from six sales and trading professionals at the beginning of 2008, to over 230 professionals in mid-2011, and decreased to 53 professionals as of December 31, 2020. We continue to explore opportunities to add complementary distribution channels, hire experienced talent, expand our presence across asset classes, and bolster the service capabilities of our Capital Markets business segment.
Our Capital Markets business segment generates revenue through the following activities: (1) trading activities, which include execution and brokerage services, matched book repo, riskless trading activities as well as gains and losses (unrealized and realized), and income and expense earned on securities classified as trading, and (2) new issue and advisory revenue comprised of (a) origination fees for newly created financial instruments originated by us, (b) revenue from advisory services, and (c) new issue revenue associated with arranging and placing the issuance of newly created financial instruments. Our Capital Markets business segment has offices in Boca Raton (Florida), Cold Spring Harbor (New York), Dublin (Ireland), Hunt Valley (Maryland), New York City (New York), Paris (France), and Philadelphia (Pennsylvania).
Trades in our Capital Markets business segment can be either “riskless” or risk based. “Riskless trades” are transacted with a customer order in hand, resulting in limited risk to us. “Risk-based trades” involve us owning the securities and thus placing our capital at risk. Such risk-based trading activity may include the use of leverage. In recent years, we began to utilize more leverage in our Capital Markets business segment. We believe that the prudent use of capital to facilitate client orders increases trading volume and profitability. Any gains or losses on trading securities that we have classified as investments-trading are recorded in our Capital Markets business segment, whereas any gains or losses on securities that we classified as other investments, at fair value are recorded in our Principal Investing business segment.
During the first quarter of 2014, we stopped providing investment banking and advisory services in the U.S. as a result of the loss of certain of JVB’s former employees. At the beginning of 2021, we have hired several investment banking professionals within JVB, who are seeking to generate new issue placement and advisory business in the financial technology (commonly referred to as "fintech") and SPAC spaces, further expanding our SPAC capabilities, which are more fully described below. Currently, JVB’s primary source of new issue revenue is from originating assets into our U.S. insurance investment funds and CCFEL’s primary source of new issue revenue is from originating assets into the PriDe funds as more fully described below.
Asset Management
Our Asset Management business segment manages assets within a variety of Investment Vehicles. We earn management fees for our ongoing asset management services provided to these Investment Vehicles, which may include fees both senior and subordinate to the securities issued by the Investment Vehicles. Management fees are based on the value of the AUM or the investment performance of the vehicle, or both. As of December 31, 2020, we had $2.8 billion in AUM, of which 74.3% was in CDOs we manage. AUM equals the sum of: (1) the gross assets included in the CDOs that we have sponsored and/or manage; plus (2) the net asset value (“NAV”) or gross assets of the Other Investment Vehicles we manage based on whichever measurement serves as the basis for the calculation of our management fees. Our calculation of AUM may differ from the calculations of other asset managers and, as a result, this measure may not be comparable to similar measures presented by other asset managers. This definition of AUM is not necessarily identical to any definition of AUM that may be used in our management agreements.
Currently, a substantial portion of our AUM is in CDOs that we manage. 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 secured by the assets. In the event of a default, the lender will have recourse only to the assets securing the loan. We have originated assets for, served as co-placement agent for, and continue to manage this type of Investment Vehicle, which is generally structured as a trust or other special purpose vehicle. In addition, we invested in some of the debt and equity securities initially issued by certain CDOs, gains and losses of which are recorded in our Principal Investing business segment.
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These structures can hold different types of securities. Historically, we focused on the following asset classes: (1) U.S. and European bank and insurance TruPS and subordinated debt; (2) U.S. ABS, such as MBS and commercial real estate loans; (3) U.S. and European corporate loans; and (4) U.S. obligations of non-profit entities. As of December 31, 2020, our only remaining CDOs under management were backed by U.S. and European bank and insurance TruPS and subordinated debt.
The credit crisis starting in 2008 caused available liquidity, particularly through CDOs and other types of securitizations, to decline precipitously. Our ability to accumulate assets for securitization effectively ended with the market disruption. We securitized $14.8 billion of assets in 16 trusts during 2006, $17.8 billion of assets in 16 trusts during 2007, $400 million of assets in one trust during 2008, and zero assets in zero trusts since 2009.
We generate asset management revenue for our services as an asset manager. Many of our sponsored CDOs, particularly those where the assets are bank TruPS and ABS, have experienced asset deferrals, defaults, and rating agency downgrades that reduce our management fees. In addition, many of the CDOs we manage have experienced high enough levels of deferrals, defaults, and downgrades to reduce our ongoing subordinated management fees to zero. In a typical structure, any failure of a covenant coverage test redirects cash flow to pay down the senior debt until compliance is restored. If compliance is eventually restored, the entity will resume paying subordinated management fees to us, including those that were accrued but remained unpaid during the period of non-compliance.
As of December 31, 2020, we had two subsidiaries that act as collateral managers and investment advisors to the CDOs that we manage. These entities are registered investment advisors under the Investment Advisers Act of 1940 (the “Investment Advisers Act”).
Subsidiary Product Line Asset Class Cohen & Company Financial Management, LLC (“CCFM”) Alesco Bank and insurance TruPS, subordinated debt of primarily U.S. companies Dekania Capital Management, LLC (“DCM”) Dekania Europe Bank and insurance TruPS, subordinated debt of primarily European companies
The table below shows changes in our AUM by product line for the last five years.
ASSETS UNDER MANAGEMENT (Dollars in Millions)
As of December 31, 2020 2019 2018 2017 2016 Alesco (1) (2) $ 1,890 $ 2,044 $ 2,112 $ 2,469 $ 2,614 Dekania Europe (3) (4) 167 153 171 402 495 Munda (3) (5) - - 103 246 330 Total CDO AUM 2,057 2,197 2,386 3,117 3,439 Other Investment Vehicles 712 560 466 375 229 Total AUM $ 2,769 $ 2,757 $ 2,852 $ 3,492 $ 3,668
(1) During 2014, we entered into a sub-advisory agreement to employ Mead Park Advisors, LLC to render advice and assistance with respect to collateral management services for the Alesco portfolios. On March 30, 2017, the sub-advisory agreement with Mead Park Advisors, LLC was terminated, and we entered into a sub-advisory agreement with another unrelated third-party provider effective March 30, 2017. (2) During 2018, the Alesco II CDO liquidated after a successful auction. (3) Dekania Europe and Munda portfolios are denominated in Euros. For purposes of the table above they have been converted to U.S. dollars at the prevailing exchange rates at the points in time presented. (4) During 2018, the Dekania Europe I CDO liquidated after a successful auction. (5) During 2019, the Munda CLO was liquidated.
A description of our CDO product lines that were under management as of December 31, 2020 is set forth below.
Alesco and Dekania. As of December 31, 2020, we managed eight Alesco deals and two Dekania Europe deals, which were initially securitized during 2003 to 2007. CCFM manages our Alesco platform. During 2018, one of the Alesco deals was liquidated after a successful auction. DCM manages our Dekania Europe platform. During 2014, we entered into a sub-advisory agreement to employ Mead Park Advisors, LLC to render advice and assistance with respect to collateral management services to the Alesco portfolios. On March 30, 2017, the sub-advisory agreement with Mead Park Advisors, LLC was terminated, and we entered into a sub-advisory agreement with another unrelated third-party provider effective March 30, 2017.
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In general, our Alesco and Dekania Europe deals have the following terms. We receive senior and subordinate management fees, and there is a potential for incentive fees on certain deals if equity internal rates of return are greater than 15%. We can be removed as manager without cause if 66.7% of the rated note holders voting separately by class and 66.7% of the equity holders vote to remove us, or if 75% of the most senior note holders vote to remove us when certain over-collateralization ratios fall below 100%. We can be removed as manager for cause if a majority of the controlling class of note holders or a majority of equity holders vote to remove us. “Cause” includes unremedied violations of the collateral management agreement or indenture, defaults attributable to certain actions of the manager, misrepresentations or fraud, criminal activity, bankruptcy, insolvency or dissolution. There was a non-call period for the equity holders, which ranged from three to six years. Once this non-call period expires, a majority of the equity holders can trigger an optional redemption as long as the liquidation of the collateral generates sufficient proceeds to pay all principal and accrued interest on the rated notes and all expenses. In ten years after the closing, an auction call will be triggered if the rated notes have not been redeemed in full. In an auction call redemption, an appointee will conduct an auction of the collateral, which will only be executed if the highest bid results in sufficient proceeds to pay all principal and accrued interest on the rated notes and all expenses. If the auction is not successfully completed, all residual interest that would normally be distributed to equity holders will be sequentially applied to reduce the principal of the rated notes. Any failure of an over-collateralization coverage test redirects interest to paying down notes until compliance is restored. The securities mature up to 30 years from closing. An event of default will occur if certain over-collateralization ratios drop below 100%. While an event of default exists, a majority of the senior note holders can declare the principal and accrued and unpaid interest immediately due and payable. All of the Alesco and Dekania Europe CDOs that we manage have reached their auction call redemption features, which means the portfolio of collateral for each CDO is subject to an auction on either a quarterly or bi-annual basis. If an auction is successful, the management contract related to such CDO will be terminated in connection with the liquidation of the CDO and we will lose the related management fees.
We have received a Notice of Termination of the Collateral Management Agreement for Alesco Preferred Funding IX, without cause.
Munda. CCFL acted as lead and junior investment manager to the Munda CLO, a limited liability company incorporated under the laws of the Netherlands. In September 2012, CCFL assumed the lead investment management role from a large European bank. Munda CLO was comprised of broadly syndicated corporate loans primarily of European companies. Munda CLO was initially securitized in December 2007. In connection with the Mundo CLO, we received senior and subordinate management fees, and there was no potential to earn incentive fees. In July 2019, the Mundo CLO was liquidated. In February 2020, we received a final fee and we will no longer receive management fees in connection with this CLO.
A description of our other Investment Vehicles that were under management as of December 31, 2020 is set forth below.
PriDe Funds. In July 2014, we, initially through CCFL and now through CCFEL, became the investment advisor of a newly created French investment fund with total commitments of €238 million, and an initial investment period of two years (which was later extended by two years) and a maturity date of July 2026 (which was later extended until July 2028). In January 2017, the second vintage funds in the series of these funds closed with total commitments of €203.5 million, and an initial investment period of three years (which was recently extended by one year) and a maturity date of January 2032. In July 2020, the third vintage funds in the series of these funds closed with total commitments of €375.5 million, and an initial investment period of three years and a maturity date of July 2033. This series of funds is referred to in this Annual Report on Form 10-K as the “PriDe Funds.” The PriDe Funds earn investment returns by investing in a diversified portfolio of debt securities issued by small and medium sized European insurance companies that have limited access to capital markets. CCFEL earns investment advisor regular fees and investment advisor performance fees depending on the level of returns achieved. We have not made an investment, nor do we expect to make any investment, in the PriDe Funds. AUM of the PriDe Funds was $555.0 million at December 31, 2020. In late 2017, we hired an industry veteran to oversee the development of the Company’s U.S. Insurance Asset Management Platform as a complement to our existing focus on insurance related investments.
U.S. Insurance JV. In May 2018, we committed to invest up to $3.0 million in a newly formed joint venture (the “U.S. Insurance JV”) with an outside investor who committed to invest approximately $63.0 million of equity in the U.S. Insurance JV. The U.S. Insurance JV was formed for the purposes of investing in debt issued by small and medium sized U.S. and Bermuda insurance and reinsurance companies and is managed by DCM. We are required to invest 4.5% of the total equity of the U.S. Insurance JV with an absolute limit of $3.0 million. The U.S. Insurance JV has a $250 million credit agreement for leverage to grow its assets. As of December 31, 2020, the equity of the U.S. Insurance JV was $32.4 million, and we had invested $1.4 million into the U.S. Insurance JV of the $3.0 million commitment. In addition, the insurance company debt that will be funded by the U.S. Insurance JV may be originated by us and there may be origination fees earned in connection with such transactions. We will also earn management fees as manager of the U.S. Insurance JV. We are entitled to a quarterly base management fee, an annual incentive fee (if certain return hurdles are met), and an additional incentive fee upon the liquidation of the portfolio (if certain return hurdles are met).
SPAC Funds. In 2018, we invested in and became the investment manager and general partner of a newly formed Delaware limited partnership and the investment manager for a Cayman Islands exempted company that are feeder funds into a separate Cayman Islands exempted company that serves as the primary investment vehicle (the “SPAC Funds”). The SPAC Funds were created for the purpose of investing primarily in the equity interests of SPACs and, in certain circumstances, SPAC sponsor entities including SPACs sponsored by us, our affiliates, and third parties. As of December 31, 2020, we had invested $0.6 million in the SPAC Funds. CCFM is the manager of the SPAC Funds and is entitled to a quarterly base management fee based on a percentage of the NAV of the SPAC Funds and an annual incentive allocation based on the actual returns earned by the SPAC Funds. As of December 31, 2020, the NAV of the SPAC Funds was $53.2 million.
SPAC Series Funds. As a complement to the SPAC Funds, we established and became the managing member and investment manager to two newly formed umbrella limited liability companies (the “SPAC Series Funds”) that issue a separate series for each investment portfolio, which typically consists of investments in the sponsor entities of individual SPACs. The investing activity of the SPAC Series Funds includes purchasing interests in the placement units of certain SPAC sponsor entities that, in addition to placement units, entitle the SPAC Series Funds to certain amounts of founder shares, for a nominal price. The number of founders shares allocated to the SPAC Series Funds are not finally determined until the related business combination (if any) is completed by the applicable SPAC. The amount of founders shares allocable to each SPAC Series Fund is subject to change for two main reasons. First, if a business combination is not completed by the applicable SPAC within the allowed time frame, the SPAC Series Funds will forfeit all the founders shares allocated to them for that particular SPAC. Second, even if a business combination by the applicable SPAC is completed, the economic terms of the combination are subject to negotiation between the target company and that SPAC. In many cases, the total amount of founders shares to which the sponsor entities are entitled will be reduced as part of these negotiations. In these cases, any allocation to the SPAC Series Funds will also be reduced. Although we do not charge a management fee for most of the SPAC Series Funds, nor do we earn a performance fee from most of the SPAC Series Funds, we and certain of our employees receive a portion of the allocations of founders shares, for a nominal price, from the SPAC sponsor entities in which the SPAC Series Funds invest. As of December 31, 2020, the SPAC Series Funds had issued limited liability company interests representing investments in nine SPAC sponsor entities, totaling net asset carrying value of $24.1 million. As of December 31, 2020, in our capacity as the asset manager of the SPAC Series Funds, we have received a current allocation of a total 1.7 million founder shares, for a nominal price, from five different SPAC sponsor entities.
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Managed Accounts. We provide investment management services to a number of separately managed accounts. Part of our European CDO team has transitioned to providing investment management or advisory services primarily to European family offices, high net worth individuals, and asset managers. The investment focus is on CDO and CLO notes and debt instruments where the investment managers have relevant expertise. For these services, we are paid gross annual base management or advisory fees of approximately 1.5% plus a gross annual performance fee of 20% of cash-on-cash returns in excess of an 8% hurdle. There is also an early redemption fee if any of the clients were to terminate their arrangement within the first five years of the relationship. AUM of these European managed accounts was $31.5 million as of December 31, 2020.
In addition, we have historically received revenue shares from certain asset management businesses that we initially sponsored or owned, and subsequently sold or spun-off. A description of our only remaining asset management revenue share as of December 31, 2020 is set forth below.
Infrastructure Finance Business. On March 12, 2012, we entered into an agreement with unrelated third parties whereby we agreed to assist in the establishment of an international infrastructure finance business (“IIFC”). As consideration for our assistance in establishing IIFC, we receive 8.0% of certain revenues of the manager of IIFC. The IIFC revenue share arrangement expires when we have earned a cumulative $20 million in revenue share payments or with the dissolution of IIFC’s management company. Also, in any particular year, the revenue share earned by us cannot exceed $2.0 million. In 2020, we earned $0.5 million from the IIFC revenue share. From inception through 2020, we have earned $3.2 million. In addition, in March 2012, we issued 50,000 restricted units of the Common Stock to the managing member of IIFC, which vest 1/3 when we receive $6.0 million of cumulative revenue share payments, 1/3 when we receive $12.0 million of cumulative revenue share payments, and 1/3 when we receive $18.0 million of cumulative revenue share payments. In certain circumstances, we retain the right to deliver fixed amounts of cash to the managing member of IIFC as opposed to vested shares of Common Stock. On March 12, 2022, any remaining unvested restricted units expire. See note 22 to our consolidated financial statements included in this Annual Report on Form 10-K.
Principal Investing
Our Principal Investing business segment has historically been comprised of investments in the Investment Vehicles we manage, as well as investments in certain other structured products, and the related gains and losses that they generate. In 2014, we refocused our Principal Investing portfolio on products that we do not manage for the purpose of earning an investment return. More recently, capitalizing on our SPAC expertise, we have become active in multiple aspects of the SPAC market, including as a sponsor, asset manager, and investor, and as a result we hold various investments related to our SPAC franchise. A description of our Principal Investments as of December 31, 2020 is set forth below.
A SPAC is a shell corporation formed for the sole purpose of raising investment capital through an initial public offering (“IPO”), which is then used to acquire or merge with one or more unspecified businesses to be identified after the IPO. SPACs are formed and sponsored by experienced business executives who are confident that their reputation and experience will help them identify a profitable company to acquire or with which to merge. The sponsors of the applicable SPAC generally provide the starting capital for that SPAC and such sponsors stand to benefit from a sizeable stake in the post business combination acquired or merged company (assuming a business combination is consummated by the SPAC which they sponsor). The capital raised in the SPAC's IPO is placed in an interest-bearing trust account and cannot be disbursed except to complete a business combination or to return the money to investors (if the SPAC does not complete a business combination within the required time period and must be liquidated.) A SPAC generally has approximately two years to complete a deal. In return for the capital invested by investors in the SPAC IPO, investors typically receive units in the SPAC, with each unit often comprising a share of common stock and a warrant (or fraction thereof) to purchase more stock at a later date. The purchase price per unit of the securities is typically $10.00. After a SPAC's IPO, the pre-IPO units of the SPAC become separable into shares of common stock and warrants. The purpose of the warrant is to provide investors with additional compensation for investing in the SPAC. The warrants generally become exercisable either 30 days after the completion of a business combination or twelve months after the IPO. The fair market value of the target company must be at least 80% (but generally much more) of the SPAC’s trust assets. Upon successful completion of a business combination, the sponsors will profit from their stake in the post-business combination acquired or merged company, while the investors receive an equity interest according to their respective investment amounts The founders of the SPAC generally purchase founder shares at the initiation of the SPAC, paying nominal consideration for the number of shares that, based on recent transactions, results in or around a 20% to 25% ownership stake in the outstanding shares after the completion of the IPO.
Since 2018, we have sponsored three SPACs. Our first sponsored SPAC, Insurance Acquisition Corp., completed its $150.7 million IPO in March 2019, entered into a merger agreement in June 2020, and completed its business combination in October 2020 with Shift Technologies, Inc. (“Shift”), a car-buying e-commerce platform. When the merger closed on October 13, 2020, Insurance Acquisition Corp. changed its name to "Shift Technologies, Inc." and, on October 15, 2020, its trading symbol on the NASDAQ Capital Market (“NASDAQ”) changed from "INSU" to "SFT." Our second sponsored SPAC, INSU Acquisition Corp. II (NASDAQ: INAQ), completed its $250 million IPO in September 2020 and entered into a merger agreement in November 2020 with Metromile, Inc., a digital insurance platform and pay-by-mile auto insurer ("MetroMile"), which closed on February 9, 2021. When the merger closed, INSU Acquisition Corp. II changed its name to Metromile, Inc and on February 10, 2021, its trading symbol on the NASDAQ changed from "INAQ" to "MILE". Our third sponsored SPAC, INSU Acquisition Corp. III (NASDAQ: IIIIU), completed its $218 million IPO in December 2020 and is currently seeking to effect a merger, capital stock exchange, asset acquisition, stock purchase, reorganization, or similar business combination with one or more businesses that provides insurance or insurance related services but is not required to complete a business combination with an insurance business. See note 4 to our consolidated financial statements included in this Annual Report on Form 10-K.
Subject to changes in the overall SPAC market which are evolving rapidly, we anticipate continuing to grow our SPAC franchise and capitalizing on opportunities in the space. In addition to our sponsored SPACs, we receive founders shares and purchase placement units and IPO units in various SPACs sponsored by third parties and affiliates, through our SPAC Funds, our SPAC Series Funds, and our Principal Investing portfolio. The amount of founders shares allocated to us are not finally determined until the related business combination is completed. The amount of founders shares allocable to us are subject to change for two main reasons. First, if a business combination is not completed by the applicable SPAC within the allowed time frame, we will forfeit all the founders shares allocated to us for that particular SPAC. Second, even if a business combination is completed by the applicable SPAC, the economic terms of the combination are subject to negotiation between the target company and that SPAC. In many cases, the total amount of founders shares to which the sponsor entities are entitled to will be reduced as part of these negotiations. In these cases, any allocation of founders shares to the us will also be reduced.
As of December 31, 2020, our Principal Investing portfolio was valued at $58.5 million and included investments in Shift (valued at $36.4 million), non-sponsored SPAC equity (valued at $10.6 million), International Money Express, Inc. (NASDAQ: IMXI) (valued at $4.3 million), the U.S. Insurance JV (valued at $1.6 million), the SPAC Funds (valued at $0.8 million), and other securities (valued at $4.9 million). The investment in Shift is held by our consolidated sponsor entities, which are owned approximately 48.3% by non-controlling interests.
A description of our Principal Investments as of December 31, 2020 is set forth below.
Shift Technologies, Inc. As of December 31, 2020, our investment in Shift public equity was valued at $36.4 million and is held by our consolidated sponsor entities, which are owned approximately 48.3% by non-controlling interests. Our investment in Shift is the result of our sponsorship of Insurance Acquisition Corp. Certain of the shares are subject to restrictions on transfer until threshold trading prices are met. We engaged a third-party valuation firm to value this investment. See notes 3 and 9 to our consolidated financial statements included in this Annual Report on Form 10-K.
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Investments in Non-Sponsored SPAC Equity. In December 2017, we began investing in SPAC equity positions of SPACs that were not sponsored by us. As of December 31, 2020, our five equity positions in these publicly traded SPACs were valued at $10.6 million (three of these equity positions valued at an aggregate $7.8 million are in SPACs sponsored by related parties – see notes 4 and 31 to our consolidated financial statements included in this Annual Report on Form 10-K). All five of these publicly traded SPACs have completed an IPO but have not yet consummated a business combination, and only one has signed a merger agreement with a potential business combination target. We expect to continue to invest additional capital in non-sponsored SPAC equity as opportunities arise.
International Money Express, Inc. As of December 31, 2020, our investment in the public equity of International Money Express, Inc. ("IMXI"), an unrelated publicly traded company, was valued at $4.3 million. We acquired most of our investment in IMXI in December 2019 through a securities purchase agreement with Daniel G. Cohen, chairman of the board and president and chief executive of European operations, and the DGC Family Fintech Trust, a trust established by Mr. Cohen (the "DGC Trust") whereby we issued units of membership interests in the Operating LLC (the “LLC Units”) and Series F Preferred Stock, and we received IMXI shares as consideration for the issuance of the LLC Units and Series F Preferred Stock. Certain of the shares are subject to restrictions on transfer until threshold trading prices are met. We engaged a third-party valuation firm to value this investment. See note 21 to our consolidated financial statements included in this Annual Report on Form 10-K.
Investment in the U.S. Insurance JV. During 2018, we co-established and committed to invest up to $3.0 million in the U.S. Insurance JV. As of December 31, 2020, we had invested $1.4 million of this commitment, with $1.6 million remaining to be invested. In June 2019, we received a $0.6 million distribution related to a security redemption. As of December 31, 2020, our investment in the U.S. Insurance JV was valued at $1.6 million and the NAV of the U.S. Insurance JV was $33.6 million.
Investment in the SPAC Funds. In August 2018, we established and invested $0.6 million in the SPAC Funds. As of December 31, 2020, our investment in the SPAC Funds was valued at $0.8 million and the NAV of the SPAC Funds was $53.2 million.
Investments in Other Securities. We have invested in various original issuance securities that we have originated and certain other securities that we have not originated. As of December 31, 2020, our investments in these other securities were valued at $4.6 million, which included public equity, corporate bonds, and real estate loans.
Employees
As of December 31, 2020, we employed a total of 87 full time professionals and support staff. This number includes 53 employees of our JVB subsidiary, 14 employees of our U.S. Asset Management business segment, 6 employees of our European Asset Management business segment, 11 employees of our U.S. support services group, and 3 employees of our European support services group. We consider our employee relations to be good and believe that our compensation and employee benefits are competitive with those offered by other financial services firms that we compete with for personnel. None of our employees is subject to any collective bargaining agreements. Our core asset is our professionals, their intellectual capital, and their dedication to providing the highest quality services to our clients. Prior to joining us, members of our management team held positions with other leading financial services firms, accounting firms, law firms, investment firms, or other public companies. Lester R. Brafman, Daniel G. Cohen, and Joseph W. Pooler, Jr. are our executive operating officers, and biographical information relating to each of these officers is incorporated by reference in “Part III — Item 10 — Directors, Executive Officers and Corporate Governance” to the Company’s Proxy Statement, to be filed in connection with the Company’s 2021 Annual Meeting of Stockholders.
Competition
All areas of our business are intensely competitive, and we expect them to remain so. We believe that the principal factors affecting competition in our business include economic environment, quality and price of our products and services, client relationships, reputation, market focus, and the ability of our professionals.
Our competitors are other public and private asset managers, investment banks, brokerage firms, merchant banks, and financial advisory firms. We compete globally and on a regional, product and niche basis. Many of our competitors have substantially greater capital and resources than we do and offer a broader range of financial products and services. Certain of these competitors continue to raise additional amounts of capital to pursue business strategies that may be similar to ours. Some of these competitors may also have access to liquidity sources that are not available to us, which may pose challenges for us with respect to investment opportunities. In addition, some of these competitors may have higher risk tolerances or make different risk assessments than we do, allowing them to consider a wider variety of investments and establish broader business relationships.
In recent years, there has been substantial consolidation and convergence among companies in the financial services industry, including among many of our former competitors. In particular, a number of large commercial banks have established or acquired broker-dealers or have merged with other financial institutions. Many of these firms have the ability to offer a wider range of products than we offer, including loans, deposit taking, and insurance. Many of these firms also have investment banking services, which may enhance their competitive position. They also have the ability to support investment banking and securities products with commercial banking and other financial services revenue in an effort to gain market share, which could result in pricing pressure in our business. This trend toward consolidation and convergence has significantly increased the capital base and geographic reach of our competitors.
Competition is intense for the recruitment and retention of experienced and qualified professionals. The success of our business and our ability to continue to compete effectively will depend significantly upon our continued ability to retain and motivate our existing professionals and attract new professionals. See “Item 1A — Risk Factors."
Regulation
Certain of our subsidiaries, in the ordinary course of their business, are subject to extensive regulation by government and self-regulatory organizations both in the U.S. and abroad. As a matter of public policy, these regulatory bodies are responsible for safeguarding the integrity of the securities and other financial markets. The regulations promulgated by these regulatory bodies are designed primarily to protect the interests of the investing public generally and thus cannot be expected to protect or further the interests of our company or our stockholders and may have the effect of limiting or curtailing our activities, including activities that might be profitable.
As of December 31, 2020, our regulated subsidiaries include: JVB, a registered broker-dealer regulated by FINRA and subject to oversight by the U.S. Securities and Exchange Commission (the “SEC”); CCFEL, an Irish company regulated by the CBI; and CCFM and DCM, each of which is a registered investment adviser regulated by the SEC under the Investment Advisers Act. Since our inception, our businesses have been operated within a legal and regulatory framework that is constantly developing and changing, requiring us to be able to monitor and comply with a broad range of legal and regulatory developments that affect our activities.
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Certain of our businesses are also subject to compliance with laws and regulations of U.S. federal and state governments, foreign governments, their respective agencies and/or various self-regulatory organizations or exchanges relating to, among other things, the privacy of client information and any failure to comply with these regulations could expose us to liability and/or reputational damage. Additional legislation, changes in rules promulgated by financial authorities and self-regulatory organizations or changes in the interpretation or enforcement of existing laws and rules, either in the U.S. or abroad, may directly affect our mode of operation and profitability.
The U.S. and foreign government agencies and self-regulatory organizations, as well as state securities commissions in the U.S., are empowered to conduct periodic examinations and initiate administrative proceedings that can result in censure, fine, the issuance of cease-and-desist orders, and/or the suspension or expulsion of a broker-dealer or its directors, officers, or employees. See “Item 1A — Risk Factors” beginning on page 17.
U.S. Regulation . As of December 31, 2020, JVB was registered as a broker-dealer with the SEC and was a member of and regulated by FINRA. JVB is subject to the regulations of FINRA and industry standards of practice that cover many aspects of its business, including initial licensing requirements, sales and trading practices, relationships with customers (including the handling of cash and margin accounts), capital structure, capital requirements, record-keeping and reporting procedures, experience and training requirements for certain employees, and supervision of the conduct of affiliated persons, including directors, officers, and employees. FINRA has the power to expel, fine, and otherwise discipline member firms and their employees for violations of these rules and regulations. JVB is also registered as a broker-dealer in certain states, requiring us to comply with the laws, rules, and regulations of each state in which JVB is registered. Each state may revoke the registration to conduct a securities business in that state and may fine or otherwise discipline broker-dealers and their employees for failure to comply with such state’s laws, rules, and regulations.
The SEC, FINRA, and various other regulatory agencies within and outside of the U.S. have stringent rules and regulations with respect to the maintenance of specific levels of net capital by regulated entities. Generally, a broker-dealer’s net capital is net worth plus qualified subordinated debt less deductions for certain types of assets. The net capital rule under the Exchange Act requires that at least a minimum part of a broker-dealer’s assets be maintained in a relatively liquid form. The SEC and FINRA impose rules that require notification when net capital falls below certain predefined criteria. These rules also dictate the ratio of debt to equity in the regulatory capital composition of a broker-dealer and constrain the ability of a broker-dealer to expand its business under certain circumstances. If a firm fails to maintain the required net capital, it may be subject to suspension or revocation of registration by the applicable regulatory agency, and suspension or expulsion by these regulators could ultimately lead to a firm’s liquidation. Additionally, the net capital rule under the Exchange Act and certain FINRA rules impose requirements that may have the effect of prohibiting a broker-dealer from distributing or withdrawing capital and requiring prior notice to the SEC and FINRA for certain capital withdrawals.
If these net capital rules are changed or expanded, or if there is an unusually large charge against our net capital, our operations that require the intensive use of capital would be limited. A large operating loss or charge against our net capital could adversely affect our ability to expand or even maintain current levels of business, which could have a material adverse effect on our business and financial condition.
Our investment adviser subsidiaries, CCFM and DCM, are registered with the SEC as investment advisers and are subject to the rules and regulations of the Investment Advisers Act. The Investment Advisers Act imposes numerous obligations on registered investment advisers including record-keeping, operational and marketing requirements, disclosure obligations, limitations on principal transactions between an adviser and its affiliates and advisory clients, and prohibitions on fraudulent activities. The SEC is authorized to institute proceedings and impose sanctions for violations of the Investment Advisers Act, ranging from fines and censure to termination of an investment adviser’s registration. Investment advisers are also subject to certain state securities laws and regulations.
We are also subject to the U.S.A PATRIOT Act of 2001 (the “Patriot Act”), which imposes obligations regarding the prevention and detection of money-laundering activities, including the establishment of customer due diligence, customer verification, and other compliance policies and procedures. These regulations require certain disclosures by, and restrict the activities of, broker-dealers, among others. Failure to comply with these new requirements may result in monetary, regulatory and, in the case of the Patriot Act, criminal penalties.
In July 2010, the federal government passed the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructures and intensifies regulation in the financial services industry, with provisions that include, among other things, the creation of a new systemic risk oversight body (i.e., the Financial Stability Oversight Council), expansion of the authority of existing regulators, increased regulation of and restrictions on OTC derivatives markets and transactions, broadening of the reporting and regulation of executive compensation, expansion of the standards for market participants in dealing with clients and customers, and regulation of fiduciary duties owed by municipal advisors or conduit borrowers of municipal securities. In addition, Section 619 of the Dodd-Frank Act (known as the “Volker Rule”) and section 716 of the Dodd-Frank Act (known as the “swaps push-out rule”) limit proprietary trading of certain securities and swaps by certain banking entities. Although we are not a banking entity and are not otherwise subject to these rules, some of our clients and many of our counterparties are banks or entities affiliated with banks and will be subject to these restrictions. These sections of the Dodd-Frank Act and the regulations that are adopted to implement them could negatively affect the swaps and securities markets by reducing their depth and liquidity and thereby affect pricing in these markets. Further, the Dodd-Frank Act as a whole and the intensified regulatory environment will likely alter certain business practices and change the competitive landscape of the financial services industry, which may have an adverse effect on our business, financial condition, and results of operations. To date, we have adapted successfully to the applicable legislative and regulatory requirements of Dodd-Frank.
Irish Regulation . Our Irish subsidiary, Cohen & Company Financial (Europe) Limited (“CCFEL”), is authorized and regulated by the Central Bank of Ireland (“CBI”). CCFEL has CBI permission to carry on the following activities: (1) receiving/transmitting orders; (2) executing client orders; (3) portfolio management; (4) investment advice; and (5) research and financial analysis. An overview of key aspects of Ireland’s regulatory regime, which apply to CCFEL, is set out below.
Ongoing regulatory obligations. As a CBI regulated entity, CCFEL is subject to the CBI’s ongoing regulatory obligations, which cover the following wide-ranging aspects of its business.
The CBI’s sets conditions that all Irish authorized firms, including CCFEL, must satisfy in order to become and remain authorized by the CBI. These relate to the firm’s ability to act in the best interests of consumers, ensuring the firm is financially sound and safely managed with sufficient financial resources, that the firm is governed and controlled appropriately, with clear and embedded risk appetites, which drive an appropriate culture within them and have frameworks in place to ensure failed or failing providers go through orderly resolution.
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CCFEL is expected to comply with the CBI’s regulatory frameworks. The frameworks govern the way in which a regulated firm conducts business and include obligations to conduct business with integrity, due skill, care and diligence, to take reasonable care to organize and control its affairs responsibly and effectively, with adequate risk management systems, to maintain adequate financial resources, to have appropriate regard for customers’ interests, to ensure adequate and appropriate communication with clients, to observe proper standards of market conduct and to ensure appropriate dialogue with regulators (both in Ireland and overseas).
The CBI’s requires a regulated firm to take reasonable care to organize and control its affairs responsibly effectively, with adequate risk management systems. Consequently, the CBI imposes overarching responsibilities on the directors and senior management of a regulated firm. The CBI ultimately expects the senior management of a regulated firm to take responsibility for determining what processes and internal organization are appropriate to its business. Key requirements in this context include the need to have adequate systems and controls in relation to: (1) senior management arrangements and general organizational requirements; (2) compliance, internal audit, and financial crime prevention; (3) outsourcing; (4) record keeping; (5) risk management; and (6) managing conflicts of interest.
CCFEL has CBI permission to deal only with eligible counterparties and professional clients in relation to the regulated activities it conducts. The level with which CCFEL must comply is dependent on the categorization of its clients, which should be considered in the context of the regulated activity being performed. These rules include requirements relating to the type and level of information that must be provided to clients before business is conducted with or for them, the regulation of financial promotions, procedures for entering into client agreements, obligations relating to the suitability and appropriateness of investments, and rules about managing investments and reporting to clients.
Reporting. All authorized firms in Ireland are required to report to the CBI on a periodic basis. CCFEL’s reporting requirements are based on its scope of permissions. The CBI will use the information submitted by CCFEL to monitor it on an ongoing basis. There are also high-level reporting obligations, whereby CCFEL is required to deal with the CBI and other regulators in an open and co-operative way and to disclose to regulators appropriately anything relating to it of which the regulators would reasonably expect notice.
CBI’s enforcement powers. The CBI has a wide range of disciplinary and enforcement tools that it can use should a regulated firm fail to comply with its regulatory obligations. It uses a wide range of tools to take action against regulated entities and/or individuals which fall short of our expected standards of behavior including:
● Administrative sanctions (under Part IIIC of the Central Bank Act 1942 , and separately under Securities and Markets Regulations )
● Fitness and Probity investigations
● Refusals and revocation of authorizations
● Cancellation and refusal of registrations
● Summary criminal prosecution
● Supervisory Warning
● Imposition of a condition
● Issuance of a direction
● Reports to other agencies (including Gardaí, Revenue Commissioners, The Competition and Consumer Protection Commission).
Financial Resources . As part of the firm regulatory requirements under the CBI it must maintain adequate financial resources. Under CBI rules, the required level of capital depends on CCFEL’s regulatory permissions, calculated in accordance with the relevant CBI rules. A firm’s categorization is loosely based on the type of regulated activities that it conducts, as this in turn determines the level of risk to which a firm is considered exposed. CCFEL is classified as a MIFID Investment firm. In broad terms, this means that it would be subject to a base capital requirement of the higher of (1) €50,000; or (2) the higher of ¼ of its annual fixed expenses or the sum of its credit risk plus its market risk.
Anti-money Laundering Requirements . An Irish financial institution is subject to additional client acceptance requirements, which stem from anti-money laundering legislation that requires a firm to identify its clients before conducting business with or for them and to retain appropriate documentary evidence of this process.
Relevant money laundering legislation in Ireland is derived from EU Directives. Legislation also includes the Ireland’s Criminal Justice (Money Laundering and Terrorist Financing) Act 2010 (as amended) (“CJA 2010”). While Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) preventative measures are dealt with together by the Act, it is important to note that a distinction exists in the nature of the two offences.
● For money laundering to occur, the funds involved must be the proceeds of criminal conduct.
● For terrorist financing to occur, the source of funds is irrelevant, i.e. the funds can be from a legitimate or illegitimate source.
For a CBI regulated firm such as CCFEL, there are additional obligations contained in the CBI’s rules.
As a CBI regulated entity, CCFEL is required to ensure that it has adequate systems and controls to enable it to identify, assess, monitor, and manage financial crime risk. CCFEL must also ensure that these systems and controls are comprehensive and proportionate to the nature, scale, and complexity of its activities.
In addition to potential regulatory sanctions for CCFEL from the CBI, individuals, meanwhile, may be subject to:
● A caution or reprimand
● Disqualification from managing a regulated firm for a specified period, and / or
● A fine of up to €1 million.
Under the Fitness and Probity regime, the CBI also has the power to suspend individuals or prohibit them from working in regulated financial services.
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Fitness and Probity . The Fitness and Probity Regime applies to persons in senior positions, known as Controlled Functions (CFs) and Pre-Approval Controlled Functions (PCFs), within Regulated Financial Service Providers (RFSPs). The CBI expects all persons to which the Fitness and Probity Standards apply, to comply with these standards at all times:
● Competent and capable;
● Honest, ethical and to act with integrity; and
● Financially sound.
CCFEL is required to ensure that it assesses and monitors the ongoing competence of its control staff and their fitness and probity.
Changes in Existing Laws and Rules . Additional legislation and regulations, changes in rules promulgated by the government regulatory bodies, or changes in the interpretation or enforcement of laws and regulations may directly affect the manner of our operation, our net capital requirements, or our profitability. In addition, any expansion of our activities into new areas may subject us to additional regulatory requirements that could adversely affect our business, reputation, and results of operations.
Available Information
Our internet website address is www.cohenandcompany.com . We make available through our website, free of charge, our Annual Reports on Form 10-K, our Quarterly Reports on Form 10-Q, our Current Reports on Form 8-K, and any amendments to those reports that we file or furnish pursuant to Section 13(a) or 15(d) of the Exchange Act as soon as reasonably practicable after we electronically file such information with, or furnish such information to, the SEC.
Our filings can also be obtained for free on the SEC’s Internet site at
http://www.sec.gov . The reference to our website address does not constitute incorporation by reference of the information contained on our website in this filing or in other filings with the SEC, and the information contained on our website is not part of this filing.
13 Table of Contents
ITEM 1A. RISK FACTORS.
You should carefully consider the risks and uncertainties described below and elsewhere in this Annual Report on Form 10-K. If any of these risks actually occur, our business, financial condition, liquidity and results of operations could be adversely affected. The risks and uncertainties described below constitute all of the material risks of the Company of which we are currently aware; however, the risks and uncertainties described below may not be the only risks the Company will face. Additional risks and uncertainties of which we are presently unaware, or that we do not currently deem to be material, may become important factors that affect us and could materially and adversely affect our business, financial condition, results of operations and the trading price of our securities. Investing in the Company’s securities involves risk and the following risk factors, together with the other information contained in this report and the other reports and documents filed by us with the SEC, including Forms ADV filed by CCFM and DCM, should be considered carefully.
Summary of Risk Factors
The following summary highlights some of the principal risks that could adversely affect our business, financial condition or results of operations. This summary is not complete and the risks summarized below are not the only risks we face.
Risks Related to Our Business and Our Industry :
● Difficult market conditions have adversely affected our business and may continue to do so.
● Economic slowdown, market volatility, a recession and increasing interest rates may impair investments and operating results.
● We may experience write downs of financial instruments and other losses due to the volatile and illiquid market conditions.
● We have incurred losses for certain periods covered by this report and in the recent past and may incur losses in the future.
● Continued difficulties in our Capital Markets segment due to intense competition has resulted in significant strain on our administrative, operational and financial resources and these difficulties may continue in the future.
● The incurrence of additional debt could adversely effect on our financial condition and results of operation.
● Our gestation repo business serves a narrow market and is likely subject to highly volatile demand.
● Our mortgage group’s revenue is highly dependent on the U.S. housing market, generally.
● Our matched book repo financing is facilitated through JVB which is subject to various broker-dealer regulations.
● We may not be successful in achieving our strategic goals with respect to our matched book repo business.
● Our Capital Markets segment depends significantly on a limited group of customers.
● Failure to retain senior management and qualified personnel may result in our not being able to execute our business strategy.
● Payment of severance could strain our cash flow.
● If additional cash is not available, our business and financial performance will be significantly harmed.
● Failure to obtain or maintain adequate capital and funding would adversely affect the growth and results of our operations.
● The lack of liquidity in certain investments may adversely affect our business, financial condition and results of operations.
● If we are unable to manage the risks of international operations effectively, our business could be adversely affected.
● The securities settlement process exposes us to risks that may adversely affect our business.
● We are exposed to the risk that third parties that are indebted to us will not perform their obligations.
● We are exposed to various risks related to margin requirements under repurchase agreements and securities financing arrangements and are highly dependent on our clearing relationships.
● We have market risk exposure from unmatched principal transactions entered into by our brokerage desks.
● Pricing and other competitive pressures may impair the revenues and profitability of our brokerage business.
● Increase in capital commitments in our trading business increases the potential for significant losses.
● Our principal trading and investments expose us to risk of loss.
● Our principal investments are subject to various risks and expose us to a significant risk of capital loss.
● Transition away from LIBOR may adversely affect our business.
● Historical returns of our funds and managed accounts may not be indicative of their future results.
● There is increasing regulatory supervision of alternative asset management companies.
● Asset management clients generally may redeem their investments, which could reduce our asset management fee revenues.
● The investment management business is intensely competitive, which could have a material adverse impact on our business.
● Poor performance of our investment funds’ and separately managed accounts’ investments could result in a decline in our asset management revenue and earnings and investors terminating our management agreements.
● If the investments we have made on behalf of our CDOs perform poorly, we will suffer a decline in our asset management revenue and earnings and the investors in our CDOs may seek to terminate our management agreements.
● Our investments in SPAC Sponsor Entities are speculative, subject to total loss, and illiquid prior to business combination.
● Our investments in post-business combination SPACs are carried at fair value but are subject to sale restrictions which could result in significant losses to our business.
● Our strategic relationship with Fintech Masala, LLC could result in conflicts of interest and a termination of such relationship could result in losses to our business.
● Our management may allocate some portion of their time to the business of the SPAC, which may create conflicts of interest.
● Any agreement to indemnify a SPAC against certain claims could negatively affect our financial results.
● We may make future loans to SPACs which may not be repaid.
● If our risk management systems for our businesses are ineffective, we may be exposed to material unanticipated losses.
● Failures in our information and communications systems could significantly disrupt our business.
● We may not be able to keep pace with continuing changes in technology.
● Failure to protect client data or prevent breaches of our information systems could expose us to liability/reputational damage.
● We are largely dependent on Pershing LLC to provide clearing services and margin financing and Bank of New York to provide settlement and clearing services in connection with our matched book repo business.
● Our substantial level of indebtedness could adversely affect our financial health and ability to compete.
● Changes in accounting interpretations or assumptions could adversely impact our financial statements.
● Any change of our investment strategy, hedging strategy, asset allocation and operational policies may result in riskier investments and adversely affect the market value of our Common Stock.
● Maintenance of our Investment Company Act exemption imposes limits on our operations.
● The soundness of other financial institutions and intermediaries affects us.
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● We operate in a highly regulated industry and may face increasing restrictions on, and examination of, the conduct of our operations.
● Substantial legal liability or significant regulatory action could materially affect our business.
● Highly competitive markets could have a material adverse effect on our business.
● Employee misconduct or error could harm our business.
Risks Related to Our Organizational Structure and Ownership of Our Common Stock :
● We are dependent on distributions from the Operating LLC as a holding company.
● Daniel G. Cohen’s significant ownership interests in the Operating LLC and other entities could create conflicts of interest.
● As a “controlled company,” our other stockholders may lose certain corporate governance protections.
● Redemptions of our outstanding LLC Units may cause substantial dilution to our existing stockholders.
● We may not fully realize our deferred tax asset.
● The Maryland General Corporation Law and our charter and bylaws may prevent potentially beneficial takeover attempts.
Risks Related to General and Global Factors :
● The COVID-19 pandemic has caused severe disruptions in the U.S. and global economy and is expected to continue to impact our business, financial condition and results of operations.
● Repurchases of our Common Stock could adversely affect our business.
● Future sales of our Common Stock could lower the price of our Common Stock and harm our future securities offerings.
● Our stockholders’ percentage ownership in the Company may be diluted in the future.
● If we fail to control our costs effectively, our business could be disrupted and adversely affected.
● We may need to offer new investment strategies and products in order to continue to generate revenue.
● Our failure to deal appropriately with conflicts of interest could damage our reputation and adversely affect our business.
● Insurance may be inadequate to cover risks facing the Company.
● We depend on third-party software licenses and the loss of key licenses could adversely affect our brokerage services.
● Failure to maintain effective internal control over financial reporting and disclosure controls could harm our business.
● The market price of our Common Stock may be volatile and may be affected by market conditions beyond our control.
● Our Common Stock may be delisted, which may have a material adverse effect on the liquidity and our Common Stock value.
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Risks Related to Our Business and Our Industry
Difficult market conditions have adversely affected our business in many ways and may continue to adversely affect our business in a manner which could materially reduce our revenues.
Our business has been and may continue to be materially affected by conditions in the global financial markets and economic conditions. The financial markets continue to be volatile and continue to present many challenges such as the level and volatility of interest rates, investor sentiment, the availability and cost of credit, the status of the U.S. mortgage and real estate markets, consumer confidence, unemployment and geopolitical issues.
A prolonged economic slowdown, volatility in the markets, a recession, and increasing interest rates could impair our investments and harm our operating results.
Our investments are, and will continue to be, susceptible to economic slowdowns, recessions and rising interest rates, which may lead to financial losses in our investments and a decrease in revenues, net income and asset values. These events may reduce the value of our investments, reduce the number of attractive investment opportunities available to us and harm our operating results, which, in turn, may adversely affect our cash flow from operations.
Our ability to raise capital in the long-term or short-term debt capital markets or the equity markets, or to access secured lending markets, has been and could continue to be adversely affected by conditions in the U.S. and international markets and the economy. Global market and economic conditions have been, and continue to be, disrupted and volatile. In particular, the cost and availability of funding have been and may continue to be adversely affected by illiquid credit markets and wider credit spreads and volatility of interest rates (including overnight repo). As a result of concern about the stability of the markets generally and the strength of counterparties specifically, many lenders and institutional investors have reduced and, in some cases, ceased to provide funding to borrowers. Continued turbulence in the U.S. and international markets and economy may adversely affect our liquidity and financial condition and the willingness of certain counterparties to do business with us.
In addition, global macroeconomic conditions and U.S. financial markets remain vulnerable to the potential risks posed by exogenous shocks, which could include, among other things, political and financial uncertainty in the U.S. and the European Union (the “EU”), continued spread of the global novel coronavirus (“COVID-19”) pandemic, renewed concern about China’s economy, complications involving terrorism and armed conflicts around the world, or other challenges to global trade or travel. More generally, because our business is closely correlated to the macroeconomic outlook, a significant deterioration in that outlook or an exogenous shock would likely have an immediate negative impact on our overall results of operations.
We may experience write downs of financial instruments and other losses related to the volatile and illiquid market conditions.
The credit markets in the U.S. experienced significant disruption and volatility from mid-2007 through early 2009, and challenging conditions have continued since that time. Although financial markets have become more stable and have generally improved since 2009, there remains a certain degree of uncertainty about a global economic recovery. Available liquidity also declined precipitously during the credit crisis and remains significantly depressed. The disruption in these markets generally, and in the U.S. and European markets in particular, impacted and may continue to impact our business. Furthermore, the asset management revenues we derive from CDOs are based on the outstanding performing principal balance of those investments. Therefore, as adverse market conditions result in defaults within these CDOs, our management fees have declined and may continue to decline. We have exposure to these markets and products, and if market conditions continue to worsen, the fair value of our investments and our management fees could further deteriorate. In addition, market volatility, illiquid market conditions and disruptions in the global credit markets have made it extremely difficult to value certain of our securities. Subsequent valuations, in light of factors then prevailing, may result in significant changes in the values of these securities, and when such securities are sold, it may be at a price materially lower than the current fair value. Any of these factors could require us to take further write downs in the fair value of our investment portfolio or cause our management fees to decline, which may have an adverse effect on our results of operations in future periods.
We have incurred losses for certain periods covered by this report and in the recent past and may incur losses in the future.
The Company recorded net losses of $4.0 million and $3.6 million for the years ended December 31, 2018 and December 31, 2019, respectively. We may incur additional losses in future periods. If we are unable to finance future losses, those losses may have a significant effect on our liquidity as well as our ability to operate our business.
In addition, the Company has incurred and may continue to incur significant expenses in connection with initiating new business activities or in connection with any expansion or reorganization of our businesses. We may also engage in strategic acquisitions and investments for which we may incur significant expenses. Accordingly, we may need to increase our revenue at a rate greater than our expenses in order to achieve and maintain our profitability. If our revenue does not increase sufficiently, or even if our revenue does increase but we are unable to manage our expenses, we will not achieve and maintain profitability in future periods.
We have experienced difficulties in our Capital Markets segment over the past several years due to intense competition in our industry, which has resulted in significant strain on our administrative, operational and financial resources. These difficulties may continue in the future.
The financial services industry and all of our businesses are intensely competitive, and we expect them to remain so. We compete with commercial banks, brokerage firms, insurance companies, sponsors of mutual funds, hedge funds and other companies offering financial services in the U.S., globally, and through the internet. We compete on the basis of several factors, including transaction execution, capital or access to capital, products and services, innovation, reputation, risk appetite and price. Over time, certain sectors of the financial services industry have become more concentrated as institutions involved in a broad range of financial services have been acquired by or merged into other firms or have declared bankruptcy. These developments could result in our competitors gaining greater capital and other resources such as a broader range of products and services and geographic diversity. We have experienced and may continue to experience pricing pressures in our Capital Markets segment as a result of these factors and as some of our competitors may seek to increase market share by reducing prices.
Both margins and volumes in certain products and markets within the fixed income brokerage business have decreased materially as competition has increased and general market activity has declined. Further, we expect that competition will increase over time, resulting in continued margin pressure. These challenges have materially adversely affected our Capital Markets segment’s results of operations and may continue to do so.
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We intend to focus on improving the performance of our Capital Markets segment, which could place additional demands on our resources and increase our expenses. Improving the performance of our Capital Markets segment will depend on, among other things, our ability to successfully identify groups and individuals to join our firm and our ability to successfully grow our existing business lines and platforms and opportunistically expand into other complementary business areas. It may take more than a year for us to determine whether we have successfully integrated new individuals, lines of business and capabilities into our operations. During that time, we may incur significant expenses and expend significant time and resources toward training, integration and business development. If we are unable to hire and retain senior management or other qualified personnel, such as salespeople and traders, we will not be able to grow our business and our financial results may be materially and adversely affected.
There can be no assurance that we will be able to successfully improve the operations of our Capital Markets segment, and any failure to do so could have a material adverse effect on our ability to generate revenue and control expenses.
The incurrence of additional debt to finance our matched book repo business could have a material adverse effect on our financial condition and results of operation.
The Company has been a full netting member of the FICC’s Government Securities Division since October 2017. As a member of the FICC, the Company has access to the FICC’s GCF repo service that provides netting and settlement services for repurchase transactions where the underlying security is general collateral (primarily U.S. Treasuries and U.S. Agency securities). The Company began entering into matched book GCF repo transactions in November 2017. The borrowers (the reverse repurchase agreement counterparties) are a diverse group of financial institutions including hedge funds, registered investment funds, REITs, and other similar counterparties. The lender (the repurchase agreement counterparty) is primarily the FICC itself. In connection with our matched book repo business, we have incurred additional debt and expect to incur additional debt in the future. Our level of debt and the limitations imposed upon us by our debt agreements could have a material adverse effect on our financial condition and results of operations.
Our matched book repo financing is facilitated through JVB which is subject to various broker-dealer regulations. JVB’s failure to comply with these regulations and its ability to facilitate attractive matched book repo financing and to conduct its business with third parties could adversely affect our funding costs, “haircuts” and/or counterparty exposure.
We operate a matched book repo business under which JVB enters into repurchase and reverse repurchase agreements. JVB’s ability to access repo funding and to raise funds through the GCF repo service offered by the FICC requires that it continuously meet the regulatory and membership requirements of FINRA and the FICC, which may change over time. If JVB fails to meet these requirements and is unable to access such funding, we would be required to find alternative funding, which we may be unable to do and our funding costs, “haircuts” and/or counterparty exposure could increase. This could make our matched book repo business uneconomical and/or could have a material adverse effect on our financial condition and results of operations.
Our matched book repo business remains a relatively new business strategy for us that continues to require significant resources and management attention, and we may not be successful in achieving our strategic goals.
There is no assurance that we will be able to continue to operate our matched book repo business effectively or to operate it profitably over the long term, or that our matched book repo business will result in improved operating results. Furthermore, the matched book repo industry is intensely competitive, and we compete with existing players in this sector, many of whom are established and have significant resources and existing customer relationships. Moreover, we may not be able to consistently ascertain and allocate the appropriate financial and human resources necessary to continue to grow this business area. We have invested and may continue to invest considerable capital in developing our matched book repo business but fail to achieve satisfactory financial return. In light of these risks and uncertainties, there can be no assurance that we will realize a profit from this business line or that continuing to divert our management’s attention to this business line will not have a negative impact on our other existing businesses or new business initiatives, any of which may have a material adverse effect on our financial condition and results of operations.
Our gestation repo business serves a narrow market and is likely subject to highly volatile demand.
In addition to our GCF matched repo business, we also operate a matched gestation repo program. Gestation repo involves entering into repo and reverse repo where the underlying collateral security represents a pool of newly issued mortgages. Our reverse repo counterparties are mortgage originators. This type of financing would only be of interest to mortgage originators. Therefore, demand for gestation repo financing is much narrower than our GCF repo business and volumes will therefore be more volatile.
Mortgage and U.S. Housing Market-Related Risks
In recent years, our mortgage group has become an increasingly important component of our Capital Markets segment and the 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 U.S. Origination activity is highly sensitive to interest rates, the U.S. job market, housing starts, sale activity of existing housing stock, as well as the general health of the U.S. economy. In addition, any new regulation that impacts U.S. government agency mortgage backed security issuance activity, residential mortgage underwriting standards, or otherwise impacts mortgage originators will impact our business. We have no control over these external factors and there is no effective way for us to hedge against these risks. Our mortgage group’s volumes and profitability will be highly impacted by these external factors.
Our Capital Markets segment depends significantly on a limited group of customers.
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