Cohen & Co Inc.: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of the consolidated financial condition and results of operations of Cohen & Company Inc. and its majority owned subsidiaries (collectively, “we,” “us,” “our,” or the “Company”) should be read in conjunction with the unaudited consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto appearing in the Company’s Annual Report on Form 10-K for the year ended December 31, 2022.

“Management’s Discussion and Analysis of Financial Condition and Results of Operations” is based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and related disclosures of contingent assets and liabilities. On a regular basis, we evaluate these estimates, including fair value of financial instruments. These estimates are based on historical experience and on various other assumptions that are believed to be reasonable under the circumstances. Actual results may differ from these estimates.

All amounts in this disclosure are in thousands (except share, unit, per share, and per unit data) except where otherwise noted.

Overview

We are a financial services company specializing in an expanding range of capital markets and asset management services. We are organized into three business segments: Capital Markets, Asset Management, and Principal Investing.

• Capital Markets: Our Capital Markets business segment consists primarily of fixed income sales, trading, gestation repo financing, new issue placements in corporate and securitized products, and advisory services. 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, ABS, MBS, RMBS, CDOs, CLOs, CBOs, CMOs, municipal securities, TBAs and other forward agency MBS contracts, U.S. government bonds, U.S. government agency securities, brokered deposits and CDs for small banks, and hybrid capital of financial institutions including TruPS, whole loans, and other structured financial instruments. We carry out our capital markets activities primarily through our subsidiaries: JVB in the United States and CCFESA in Europe. A division of JVB, Cohen & Company Capital Markets ("CCM") is our full-service boutique investment bank, which focuses on M&A, capital markets, and SPAC advisory services.
• Asset Management: Our Asset Management business segment manages assets within CDOs, managed accounts, joint ventures, and investment funds (collectively, “Investment Vehicles”). 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 backed by the assets. In the event of default, the lenders will have recourse only to the assets securing the loan. Our Asset Management business segment includes our fee-based asset management operations, which include on-going base and incentive management fees. As of September 30, 2023, we had approximately $2.0 billion in assets under management (“AUM”) of which 49% was in CDOs. A significant portion of our asset management revenue is earned from the management of CDOs. We have not completed a new securitization since 2008. As a result, our asset management revenue has declined from its historical highs as the assets of the CDOs decline due to maturities, repayments, auction call redemptions, liquidations, and defaults. Our ability to complete securitizations in the future will depend upon, among other things, our asset origination capacity and success, our ability to arrange warehouse financing to originate assets, our willingness and capacity to fund required amounts to obtain warehouse financing and securitized financings, and the demand in the markets for such securitizations. The remaining portion of our AUM is from a diversified mix of other Investment Vehicles that were more recently formed.
• Principal Investing: Our Principal Investing business segment is comprised of investments that we hold related to our SPAC franchise and other investments we have made for the purpose of earning an investment return rather than investments to support our Capital Markets business segment activities. These investments are a component of our other investments, at fair value; other investments sold, not yet purchased; and investments in equity method affiliates in our consolidated balance sheet.

We generate our revenue by business segment primarily through the following activities.

Capital Markets:

• Our trading activities, which include execution and brokerage services, riskless trading activities as well as gains and losses (unrealized and realized) and income and expense earned on securities and derivatives classified as trading;
• Revenue earned on our gestation repo financing activities; and
• New issue and advisory revenue comprised primarily of (a) new issue revenue associated with originating, arranging, or placing newly created financial instruments and (b) revenue from advisory services.

Asset Management:

• Asset management fees for our on-going asset management services provided to certain Investment Vehicles, which may include fees both senior and subordinate to the securities issued in the Investment Vehicle; and
• Incentive management fees earned based on the performance of Investment Vehicles.

Principal Investing:

• Gains and losses (unrealized and realized) and income and expense earned on securities classified as other investments, at fair value and other investments sold, not yet purchased; and
• Income and loss earned on equity method investments.

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Business Environment

Our business in general and our Capital Markets business segment in particular do not produce predictable earnings. Our results can vary dramatically from year to year and quarter to quarter. Our business is materially affected by economic conditions in the financial markets, political conditions, broad trends in business and finance, the housing and mortgage markets, changes in volume and price levels of securities transactions, and changes in interest rates, including overnight funding rates, all of which can affect our profitability and are unpredictable and beyond our control. These factors may affect the financial decisions made by investors and companies, including their level of participation in the financial markets and their willingness to participate in corporate transactions. Severe market fluctuations or weak economic conditions could reduce our trading volume and revenues, negatively affect our ability to generate new issue and advisory revenue, and adversely affect our profitability.

As a general rule, our trading business benefits from increased market volatility. Increased volatility usually results in increased activity from our clients and counterparties. However, periods of extreme volatility may at times result in clients reducing their trading volumes, which would negatively impact our results. Also, periods of extreme volatility may result in large fluctuations in securities valuations and we may incur losses on our holdings. Also, our mortgage group’s business benefits when mortgage volumes increase, and may suffer when mortgage volumes decrease. Among other things, mortgage volumes are significantly impacted by changes in interest rates. In addition, as a smaller firm, we are exposed to intense competition. Although we provide financing to our customers, larger firms have a much greater capability to provide their clients with financing, giving them a competitive advantage. We are much more reliant upon our employees’ relationships, networks, and abilities to identify and capitalize on market opportunities. Therefore, our business may be significantly impacted by the addition or loss of key personnel.

We try to address these challenges by (i) focusing our business on clients and asset classes that are underserved by the large firms, (ii) continuing to monitor our fixed costs to enhance operating leverage and limit our losses during periods of low volumes, and (iii) attempting to hire and retain entrepreneurial and effective traders, investment bankers, and salespeople. Our business environment is rapidly changing. New risks and uncertainties emerge continuously and it is not possible for us to predict all the risks we will face. This may negatively impact our operating performance.

A portion of our revenue is generated from net trading activity. We engage in proprietary trading for our own account, provide securities financing for our customers, and execute “riskless” trades with a customer order in hand resulting in limited market risk to us. The inventory of securities held for our own account, as well as held to facilitate customer trades, and our market making activities are sensitive to market movements.

A portion of our revenue is generated from new issue and advisory engagements. The fees charged and volume of these engagements are sensitive to the overall business environment. We provide origination services in Europe through our subsidiary CCFESA, and new issue and advisory services in the U.S. through our subsidiary JVB. A division of JVB, CCM is our full-service boutique investment bank, which focuses on M&A, capital markets, and SPAC advisory services. Currently, our primary source of new issue and advisory revenue is from investment banking and advisory services through CCM, as well as from originating assets for our U.S. and European insurance asset management business including our U.S. Insurance JV and CREO JV.

A portion of our revenue is generated from management fees. Our ability to charge management fees and the amount of those fees is dependent upon the underlying investment performance and stability of the Investment Vehicles. If these types of investments do not provide attractive returns to investors, the demand for such instruments will likely fall, thereby reducing our opportunity to earn new management fees or maintain existing management fees. As of September 30, 2023, 49% of our existing AUM were in CDOs. The creation of CDOs has depended upon a vibrant securitization market. Since 2008, volumes within the securitization market have dropped significantly and have not fully recovered since that time. We have not completed a new securitization since 2008. The remaining portion of our AUM is from a diversified mix of other Investment Vehicles most of which were more recently formed.

A significant portion of our asset management revenue is earned from the management of CDOs. As a result, our asset management revenue has declined from its historical highs as the assets of the CDOs decline due to maturities, repayments, auction call redemptions, liquidations, and defaults. Our ability to complete securitizations in the future will depend upon, among other things, our asset origination capacity and success, our ability to arrange warehouse financing to originate assets, our willingness and capacity to fund required amounts to obtain warehouse financing and securitized financings, and the demand in the markets for such securitizations.

A portion of our revenues is generated from our principal investing activities. Therefore, our revenues are impacted by the overall market supply and demand of these investments as well as the individual performance of each investment. Our principal investments are included within other investments, at fair value; other investments sold, not yet purchased; and investments in equity method affiliates in our consolidated balance sheets. More recently, a significant component of our principal investment revenue has come from SPAC related equity investments, primarily in entities that have been the result of sponsored SPAC business combinations, SFA transactions, or related party sponsored SPAC business combinations. Access to these investments is reliant on a robust SPAC market. Performance of the resulting principal investments can be materially impacted by overall performance of the equity markets. See notes 7 and 9 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

The SPAC Market

In 2018, we began sponsoring a series of SPACs. Each sponsored SPAC either completed or was seeking to complete a business combination with a company involved in the insurance market. In addition, we invest in other SPACs at various stages of their business life cycle. Beginning in 2019, these SPAC activities have become a significant portion of our Principal Investing business segment. In August 2018, we invested in and became the general partner of a newly formed investment fund (the “SPAC Fund”), which was created for the purpose of investing in the equity interests of SPACs and SPAC sponsor entities including SPACs sponsored by us, our affiliates, and third parties. Effective April 1, 2023, all of the investors in the SPAC Fund, other than the GP of the SPAC Fund, redeemed all of their interests in the SPAC Fund. See recent events below for discussion of our consolidation of the SPAC Fund.

As a complement to the SPAC Fund, we established and became manager of two newly formed umbrella limited liability companies (the “SPAC Series Funds”) that issue a separate series of interest for each investment portfolio, which typically consists of investments in the sponsor entities of individual SPACs. Generally, when a SPAC acquires or merges with a privately held target company, the target company winds up owning a majority of the resulting outstanding equity of the SPAC so the transaction is accounted for as a reverse merger. Private companies utilize reverse mergers with SPACs as a method of going public as an alternative to a traditional IPO. All of our business activity related to SPACs is highly sensitive to the volume of activity in the SPAC market. Volumes could be negatively impacted if target companies no longer see SPACs as an attractive alternative thereby reducing the number of suitable potential business combination targets. Also, investor demand for SPACs would be negatively impacted if the stock of SPACs that successfully complete a business combination underperform the market. If volumes of SPAC activity decline, our results of operations will likely be significantly negatively impacted.

Equity prices of SPACs and post business combination SPACs declined significantly during 2022 and 2023. We are exposed to public equity prices of SPACs and post business combination SPACs both through our other investments, at fair value and investments in equity method affiliates. As a result, we recorded significant principal transaction losses and equity method losses during 2022 and the nine months ended September 30, 2023 in certain SPAC related investments. Continued declines in the equity prices of these companies will result in further losses for us.

Margin Pressures in Fixed Income Brokerage Business

Performance in the financial services industry in which we operate is highly correlated to the overall strength of the economy and financial market activity. Overall market conditions are a product of many factors beyond our control and can be unpredictable. These factors may affect the financial decisions made by investors, including their level of participation in the financial markets. In turn, these decisions may affect our business results. With respect to financial market activity, our profitability is sensitive to a variety of factors including the volatility of the equity and fixed income markets, the level and shape of the various yield curves, and the volume and value of trading in securities.

Margins and volumes in certain products and markets within the fixed income brokerage business continue to decrease materially as competition has increased and general market activity has declined. Further, we continue to expect that competition will increase over time, resulting in continued margin pressure.

Our response to this margin compression has included: (i) building a diversified fixed income trading platform, (ii) acquiring or building out new product lines and expanding existing product lines, (iii) building a hedging execution and funding operation to service mortgage originators, (iv) building out CCM, and (v) monitoring our fixed costs. Our cost management initiatives are ongoing. However, there can be no certainty that these efforts will be sufficient. If insufficient, we will likely see a decline in profitability.

U.S. Housing Market

In recent years, our mortgage group has grown in significance to our Capital Markets segment and our 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.

Rising Interest Rates and Inflation

During 2022, the U.S. Federal Reserve began a process of raising the federal funds rate and quantitative tightening to address rising inflation. These actions have the effect of increasing interest rates, which negatively impacts our business in several ways:

1. Rising rates reduce the fair value of the fixed income securities that we hold on our balance sheet.

2. Rising rates create instability in the equity markets, which has reduced equity financing and business combination volumes and negatively impacted CCM.

3. Rising rates reduce the volumes of new issue fixed income instruments, which has negatively impacted our CREO JV.

4. Rising rates significantly reduce mortgage activity. Our mortgage group's profitability is mainly impacted by the volume of mortgage activity in the U.S. (both mortgages for new home purchases as well as refinancing). Furthermore, our mortgage group engages in repo lending to mortgage originators. Reduced mortgage volumes impose financial pressures on mortgage originators and may increase the risk that originators default on their repo obligations to us. See note 10 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

5. Rising rates may ultimately push the U.S. into recession, which may further reduce overall transaction volumes in the financial markets negatively impacting our business generally.

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Recent Events

Consolidation of the SPAC Fund

Prior to March 31, 2023, the general partner of the SPAC Fund (“GP of the SPAC Fund”) had an investment in the SPAC Fund and the potential to earn incentive fees and did not consolidate the SPAC Fund. We own an interest in and consolidate the GP of the SPAC Fund. Effective April 1, 2023, all of the investors in the SPAC Fund, other than the GP of the SPAC Fund, redeemed all of their interests in the SPAC Fund. Therefore, effective April 1, 2023, the GP of the SPAC Fund became the sole owner of the SPAC Fund and began consolidating it. Because we consolidate the GP of the SPAC Fund, we began consolidating the SPAC Fund effective April 1, 2023 as well. The following table represent the assets and liabilities of the SPAC Fund upon consolidation by us:

Included in accounts payable and other liabilities were amounts due to the redeeming investors in the SPAC Fund. As of September 30, 2023, all of the other redemption amounts were paid.

Conversion of the 2017 Convertible Note

On March 10, 2017, the Operating LLC issued to DGC Family Fintech Trust (the “DGC Trust”), a trust established by Daniel G. Cohen, a convertible senior secured promissory note in the aggregate principal amount of $15,000 (the "2017 Convertible Note"). On March 20, 2022, the DGC Trust elected to convert the 2017 Convertible Note into an aggregate of 10,344,827 LLC Units at the conversion rate specified in the 2017 Convertible Note agreement of $1.45 per unit. As a result of such conversion, the 2017 Convertible Note was cancelled in its entirety. These LLC Units have the same conversion and redemption rights as the existing convertible non-controlling interest units. See note 20 to the Company's December 31, 2022 Annual Report filed on Form 10-K.

Pursuant to the DGC Trust’s governing documents, Daniel G. Cohen has the ability to acquire at any time any of the DGC Trust’s assets, including the units of membership interest, by substituting other property of an equivalent value without the approval or consent of any person, including any trustee or beneficiary of the DGC Trust. See notes 16 and 24 to our consolidated financial statements included Item 1 of this Quarterly Report on Form 10-Q.

The 2020 Senior Notes

On January 31, 2020, the Operating LLC entered into a note purchase agreement (the “Original Purchase Agreement”) with the JKD Investor and RN Capital Solutions LLC, a Delaware limited liability company (“RNCS”). The JKD Investor is owned by Jack DiMaio, Jr., the vice chairman of the Company’s board of directors and the Operating LLC’s board of managers, and his spouse. The note purchased by the JKD Investor is herein referred to as the “JKD Note.” Pursuant to the Original Purchase Agreement, JKD Investor and RNCS each purchased a senior promissory note in the principal amount of $2,250 (for an aggregate investment of $4,500). The senior promissory notes bore interest at a fixed rate of 12% per annum and matured on January 31, 2022.

On January 31, 2022, the Operating LLC and JKD Investor entered into a note purchase agreement (the "2022 Purchase Agreement"), pursuant to which, among other things, (i) JKD Investor paid to the Operating LLC an additional $2,250 and (ii) in consideration for such funds, the Operating LLC issued to JKD Investor an Amended and Restated Senior Promissory Note in the aggregate principal amount of $4,500 (the “Amended and Restated Note”), which Amended and Restated Note amended and restated the JKD Note in its entirety. The 2022 Purchase Agreement contains customary representations and warranties on the part of each of JKD Investor and the Operating LLC. We used these proceeds to retire the $2,250 of the 2020 Senior Notes held by RNCS. See notes 16 and 24 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

INSU Acquisition Corp III ("Insurance SPAC III")

The Operating LLC was the manager of Insurance Acquisition Sponsor III, LLC (“IAS III”) and Dioptra Advisors III, LLC (together with IAS III, the “Insurance SPAC III Sponsor Entities”). The Insurance SPAC III Sponsor Entities were sponsors of INSU Acquisition Corp. III ("Insurance SPAC III"). On December 22, 2020, Insurance SPAC III completed the sale of 25,000,000 units (the “Insurance SPAC III Units”) in its initial public offering ("IPO"). Each Insurance SPAC III Unit consisted of one share of Insurance SPAC III's Class A common stock, par value $0.0001 per share (“Insurance SPAC III Common Stock”), and one-third of one Insurance SPAC III warrant (each, an “Insurance SPAC III Warrant”), where each whole Insurance SPAC III Warrant entitled the holder to purchase one share of Insurance SPAC III Common Stock for $11.50 per share. The Insurance SPAC III Units were sold in the IPO at an offering price of $10.00 per unit. If Insurance SPAC III failed to consummate a business combination within the first 24 months following the IPO, its corporate existence would cease except for the purposes of winding up its affairs and liquidating its assets.

The Operating LLC loaned to Insurance SPAC III approximately $71 to cover its IPO expenses, which amount was repaid in full at the closing of the IPO. IAS III and its affiliates, including the Operating LLC, committed to loan Insurance SPAC III up to an additional $1,500 to cover operating and acquisition related expenses following the IPO, of which $960 was borrowed by Insurance SPAC III. See note 24 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. The loans bore no interest, and if the Insurance SPAC III consummated a business combination in the required time period, the loans were to be repaid from the funds held in Insurance SPAC III’s trust account. Pursuant to its governing documents, if Insurance SPAC III did not consummate a business combination in the required time frame, no funds from Insurance SPAC III's trust account could be used to repay the loans.

On November 18, 2022, Insurance SPAC III announced it would not consummate an initial business combination within the required time period and that it intended to dissolve and liquidate, effective as of the close of business on December 22, 2022, and redeem all of the Insurance SPAC III Common Stock and each Insurance SPAC III Warrant that were included in its IPO, at a per-share redemption price of approximately $10.09. As of the close of business on December 22, 2022, the Insurance SPAC III Common Stock and each Insurance SPAC III Warrant were deemed cancelled and represented only the right to receive the redemption amount of $10.09 per share.

In order to provide for the disbursement of funds from the trust account, Insurance SPAC III instructed the trustee of the trust account to take all necessary actions to liquidate the securities held in the trust account. The proceeds of the trust account were held in a non-interest bearing account while awaiting disbursement to the holders of the public shares. Record holders received their pro rata portion of the proceeds of the trust account, less $100 of interest to pay dissolution expenses and net of taxes payable. Insurance SPAC III Sponsor Entities agreed to waive their redemption rights with respect to their outstanding shares of Class B common stock issued prior to the Insurance SPAC III IPO. There will be no redemption rights or liquidating distributions with respect to each Insurance SPAC III Warrant, which expired and were rendered worthless.

As a result of the liquidation of Insurance SPAC III, we recorded an equity method loss of $5,896 for the year ended December 31, 2022, which included a write-off of the amounts advanced to Insurance SPAC III from the Operating LLC as well as amounts invested. Of this loss, $4,808 was allocated to the non-convertible non-controlling interests. Therefore, the net impact to the Operating LLC was a loss of $1,088.

Consolidated Results of Operations

The following section provides a comparative discussion of our consolidated results of operations for the specified periods. The period-to-period comparisons of financial results are not necessarily indicative of future results.

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

The following table sets forth information regarding our consolidated results of operations for the nine months ended September 30, 2023 and 2022.

COHEN & COMPANY INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands)

(Unaudited)

Revenues

Revenues increased by $16,580, or 52%, to $48,517 for the nine months ended September 30, 2023, as compared to $31,937 for the nine months ended September 30, 2022. As discussed in more detail below, the change was comprised of (i) a decrease of $7,248 in net trading revenue; (ii) a decrease of $1,825 in asset management revenue; (iii) a decrease in new issue and advisory of $10,944; and (iv) an increase of $36,597 in principal transactions and other income.

Net trading revenue decreased by $7,248, or 24%, to $23,117 for the nine months ended September 30, 2023, as compared to $30,365 for the nine months ended September 30, 2022. The following table shows the detail by trading group.

(Dollars in Thousands)

Our net trading revenue includes unrealized gains on our trading investments as of the applicable measurement date that may never be realized due to changes in market or other conditions outside of our control. This may adversely affect the ultimate value realized from these investments. In addition, our net trading revenue includes realized gains on certain proprietary trading positions. Our ability to derive trading gains from such trading positions is subject to overall market conditions. Due to volatility and uncertainty in the capital markets, generally, the net trading revenue recognized may not be indicative of future results. Furthermore, from time to time, some of the assets included in the investments-trading line of our consolidated balance sheets represent level 3 valuations within the FASB valuation hierarchy. Level 3 assets are carried at fair value based on estimates derived using internal valuation models and other estimates. See notes 7, 8, and 9 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. The fair value estimates made by us may not be indicative of the final sale price at which we will ultimately sell these assets. We consider our gestation repo business to be subject to significant concentration risk. See note 10 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

A loss of $1,787 and $4,642 related to the FGMC bankruptcy is included above in the mortgage group during the nine months ended September 30, 2023 and 2022, respectively. See note 10 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

Asset Management

Our AUM equals the sum of the NAV or gross assets of the 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 used by 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 the definitions of AUM that may be used in our management agreements.

(1) Other Investment Vehicles include any Investment Vehicle that is not a Company-sponsored CDO.

(2) In some cases, accounts we manage may employ leverage. Further, in some cases, our fees are based on gross assets and in other cases, our fees are based on net assets. Finally, in the case of the SPAC Series Funds, there are no management fees earned. AUM included herein is calculated using either gross or net assets of each managed account or CDO based on whichever serves as the basis for our management fees. In the case where no management fees are earned, the net assets are included.

Asset management fees decreased by $1,825, or 25%, to $5,418 for the nine months ended September 30, 2023, as compared to $7,243 for the nine months ended September 30, 2022, as discussed in more detail below. The following table provides a more detailed comparison of the two periods.

ASSET MANAGEMENT

(Dollars in Thousands)

Asset management fees from CDOs decreased mainly due to paydowns of principal and the successful auction of one of our Alesco CDOs in 2022. Asset management fees from other remained relatively unchanged.

New Issue and Advisory

New issue and advisory revenue decreased by $10,944, or 53%, to $9,542 for the nine months ended September 30, 2023, as compared to $20,486 for the nine months ended September 30, 2022. The following table summarizes new issue revenue by business line.

Our revenue earned from new issue and advisory has been, and we expect will continue to be, volatile. We earn revenue from a limited number of engagements. Therefore, a small change in the number of engagements can result in large fluctuations in the revenue recognized. Further, even if the number of engagements remains consistent, the average revenue per engagement can fluctuate considerably. Finally, our revenue is generally earned when an underlying transaction closes (rather than on a monthly or quarterly basis). Therefore, the timing of underlying transactions increases the volatility of our revenue recognition. In addition, we often incur certain costs related to new issue engagements. These costs are included as a component of either subscriptions, clearing and execution, or professional fees and other, and will generally be recognized in the same period that the related revenue is recognized.

CCM, a division of JVB, is our full-service boutique investment bank, which focuses on M&A, capital markets, and SPAC advisory services. In addition, we generate new issue revenue by originating new assets for the U.S. Insurance JV, CREO JV, and our PriDe funds in Europe.

Principal Transactions and Other Income (Loss)

Principal transactions and other income (loss) increased by $36,597 to $10,440 for the nine months ended September 30, 2023, as compared to ($26,157) for the nine months ended September 30, 2022. The following table summarizes principal transactions and other income by category.

PRINCIPAL TRANSACTIONS & OTHER INCOME

(Dollars in Thousands)

Principal Transactions

In connection with the investments discussed below, see note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q for information regarding how we determine the value of such investments. For several of the investments described below, we also had an investment in the same company that was accounted for under the equity method during the periods presented. See discussion of equity method income / (loss) below.

SFTGQ represents equity positions in Shift Technologies, Inc. (OTC: SFTGQ), a publicly traded company that closed a business combination with Insurance SPAC. As of September 30, 2023, we had total investment in SFTGQ carried at fair value of $270, which was included as a component of other investments, at fair value. In October 2023, SFTGQ declared bankruptcy and was delisted from NASDAQ. We will write-off this investment in October 2023 and incur a principal transactions loss of $270.

LMND represents equity positions in Lemonade, Inc. (NYSE: LMND), a publicly traded company that acquired Metromile, Inc. ("MILE"), which closed a business combination with Insurance SPAC II. As of September 30, 2023, we had total investment in LMND carried at fair value of $128, which was included as a component of other investments, at fair value.

WEJOF represents equity positions of Wejo Group Ltd. (OTC: WEJOF), a publicly traded company that closed a business combination with Virtuoso Acquisition Corp. As of September 30, 2023, we had total investment in WEJOF carried at fair value of $6, which was included as a component of other investments, at fair value.

REE represents equity positions of REE Automotive Ltd. (NASDAQ: REE), a publicly traded company that closed a business combination with 10X Capital Venture Acquisition Corp. As of September 30, 2023, we had a total investment in REE carried at fair value of $112, which was included as a component of other investments, at fair value.

RBT represents equity positions of Rubicon Technologies, Inc. (NYSE: RBT), a publicly traded company that closed a business combination with Founder SPAC. As of September 30, 2023, we had a total investment in RBT carried at fair value of $0.

HLGN represents equity positions of Heliogen, Inc. (NYSE: HLGN), a publicly traded company that closed a business combination with Athena Technology Acquisition Corp. As of September 30, 2023, we had a total investment in HLGN carried at fair value of $56, which was included as a component of other investments, at fair value.

PAYO represents equity positions of Payoneer Global, Inc. (NASDAQ: PAYO), a publicly traded company that closed a business combination with FTAC Olympus Acquisition Corp. As of September 30, 2023, we had a total investment in PAYO carried at fair value of $1,704, which was included as a component of other investments, at fair value.

PWP represents equity positions of Perella Weinberg Partners (NASDAQ: PWP), a publicly traded company that closed a business combination with FTAC IV Acquisition Corp. As of September 30, 2023, we had a total investment in PWP carried at fair value of $219, which was included as a component of other investments, at fair value.

FOXO represents equity positions of FOXO Technologies Inc. (NYSE American: FOXO), a publicly traded company that closed its business combination with Delwinds Insurance Acquisition Corp. As of September 30, 2023, we had a total investment in FOXO carried at fair value of $39, which was included as a component of other investments, at fair value.

ML represents equity positions of MoneyLion Inc. (NYSE: ML), a publicly traded company that closed its business combination with Fusion Acquisition Corp. As of September 30, 2023, we had a total investment in ML carried at fair value of $29, which was included as a component of other investments, at fair value.

BURU represents equity positions of Nuburu, Inc. (NYSE American: BURU), a publicly traded company that closed a business combination with Tailwind Acquisition Corp. As of September 30, 2023, we had a total investment in BURU carried at fair value of $17, which was included as a component of other investments, at fair value.

The SPAC Fund invested in the equity of SPACs. We carried our investment in the SPAC Fund at its reported NAV. Effective April 1, 2023, we began consolidating the SPAC Fund (see note 4 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q). During 2023, the amount shown above represents the change in fair value during the period prior to consolidation.

We have engaged in several transactions known as share forward arrangements ("SFAs"). In a typical SFA transaction, we acquire an interest in a publicly traded company and enter into an offsetting derivative with the same company. Both the interest in the public company and the offsetting derivative are carried at fair value. The amount shown in the table above represents the net change in fair value recorded during the period. The interests we hold in SFA counterparties are included as a component of other investments, at fair value. The derivatives are included as a component of other investments sold, not yet purchased, at fair value. See note 9 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q for more information.

In 2022, we entered into a bridge loan arrangement with an early stage growth company. The principal of the bridge loan was repaid in full during 2023. We earned a gross exit fee, initially valued at $3,040, comprised of a cash component of $1,050 and a share component of $1,990. The cash component was paid in full. The share component remains outstanding and is carried at fair value. During 2023, the share component increased in fair value by $60. During the nine months ended September 30, 2023, the total principal transactions revenue was $3,100. As of September 30, 2023, the share component was carried at its fair value of $2,050 as a component of other investments, at fair value.

The U.S. Insurance JV invests in insurance company debt. We carry our investment in the U.S. Insurance JV at its reported NAV. As of September 30, 2023, we had a total investment in the U.S. Insurance JV carried at fair value of $3,073, which was included as a component of other investments, at fair value.

The CREO JV invests in commercial real estate debt. We carry our investment in the CREO JV at its reported NAV. As of September 30, 2023, we had a total investment in the CREO JV carried at fair value of $5,835, which was included as a component of other investments, at fair value.

Stoa USA Inc. / FlipOS was a private company in which we owned common equity. During the three months ended September 30, 2023, Stoa USA Inc. / FlipOS announced that it had ceased operations. We wrote-off our investment during the three months ended September 30, 2023, and recorded a principal transactions loss. We have no remaining investment in Stoa USA Inc. / FlipOS as of September 30, 2023.

Other principal investments consist of realized and unrealized gains and losses from other investments reported at fair value.

Other Income (Loss)

Other income / (loss) is comprised of an ongoing revenue share arrangement as well as other miscellaneous operating income items. The revenue share arrangement noted in the table above entitles us to a percentage of revenue earned by IIFC. The IIFC revenue share arrangement expires at the earlier of (i) the dissolution of IIFC or (ii) when we have earned a cumulative $20,000 in revenue share payments. To date, we have earned $5,297. In any particular year, the IIFC revenue share earned by us cannot exceed $2,000.

Operating Expenses

Operating expenses decreased by $4,024, or 7%, to $53,105 for the nine months ended September 30, 2023, as compared to $57,129 for the nine months ended September 30, 2022. As discussed in more detail below, the change was comprised of (i) a decrease of $5,563 in compensation and benefits; (ii) an increase of $110 in business development, occupancy, and equipment; (iii) an increase of $852 in subscriptions, clearing, and execution; (iv) an increase of $558 in professional fee and other operating; and (v) an increase of $19 in depreciation and amortization.

Compensation and Benefits

Compensation and benefits decreased by $5,563, or 13%, to $35,757 for the nine months ended September 30, 2023, as compared to $41,320 for the nine months ended September 30, 2022.

COMPENSATION AND BENEFITS

(Dollars in Thousands)

Cash compensation and benefits in the table above was primarily comprised of salary, incentive compensation, severance, employer portion of payroll taxes, and benefits. Cash compensation and benefits decreased by $5,573 to $32,482 for the nine months ended September 30, 2023, as compared to $38,055 for the nine months ended September 30, 2022. The decrease was due to a decrease in incentive compensation related to revenue. Our total headcount decreased from 122 at September 30, 2022 to 114 at September, 2023.

Equity-based compensation increased by $10 to $3,275 for the nine months ended September 30, 2023, as compared to $3,265 for the nine months ended September 30, 2022.

Business Development, Occupancy, and Equipment

Business development, occupancy, and equipment increased by $110 to $3,887 for the nine months ended September 30, 2023, as compared to $3,777 for the nine months ended September 30, 2022. This increase was comprised of an increase in occupancy and equipment of $233, partially offset by a decrease in business development of $123.

Subscriptions, Clearing, and Execution

Subscriptions, clearing, and execution increased by $852 to $6,877 for the nine months ended September 30, 2023, as compared to $6,025 for the nine months ended September 30, 2022. This increase was comprised of an increase in subscriptions and dues of $408 and an increase in clearing and execution of $444.

Professional Fee and Other Operating Expenses

Professional fee and other operating expenses increased by $558 to $6,151 for the nine months ended September 30, 2023, as compared to $5,593 for the nine months ended September 30, 2022. This increase was comprised of an increase in professional fees of $388 and an increase in other operating expense of $170.

Depreciation and Amortization

Depreciation and amortization increased by $19 to $433 for the nine months ended September 30, 2023, as compared to $414 for the nine months ended September 30, 2022.

Non-Operating Income and Expense

Interest Expense, net

Interest expense, net increased by $1,104 to $4,907 for the nine months ended September 30, 2023, as compared to $3,803 for the nine months ended September 30, 2022.

INTEREST EXPENSE

(Dollars in Thousands)

See notes 15 and 16 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

Income / (Loss) from Equity Method Affiliates

Income / (loss) from equity method affiliates increased by $12,922 to ($1,608) for the nine months ended September 30, 2023, as compared to ($14,530) for the nine months ended September 30, 2022. See note 11 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

SPAC Sponsor Entities includes both indirect and direct investments in SPAC Sponsor Entities. Several of these SPAC Sponsor Entities are invested in SPACs that have completed their business combinations. Those SPAC Sponsor Entities hold restricted and unrestricted equity interests in the public post-merger entities. We account for our investments in SPAC Sponsor Entities under the equity method of accounting. If the SPAC Sponsor Entity distributes SPAC shares to us, we account for those SPAC shares as a component of other investments, at fair value. The following table shows the equity method income / (loss) included in SPAC Sponsor Entities and Other above broken out by the ultimate public company investee. For several of the investments described below, we also had an investment in the same company accounted for at fair value as a component of other investments, at fair value during the periods presented. See discussion of principal transactions above.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of HLGN was $0. However, we held HLGN shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of WEJOF was $0. However, we held WEJOF shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of DRTS was $0. However, we held DRTS shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of FOXO was $0. However, we held FOXO shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

The remaining investments in SPAC Sponsor Entities and Other represent investments in sponsor entities that have not yet completed a business combination and other equity method investments. See note 11 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q

Income Tax Expense / (Benefit)

Income tax expense / (benefit) increased by $1,845 to $5,379 for the nine months ended September 30, 2023, as compared to $3,534 for the nine months ended September 30, 2022.

Of the $5,379 of income tax expense recognized during the nine months ended September 30, 2023, $5,199 represented deferred income tax expense recorded as a result of an increase in the valuation allowance recorded against our carryforward assets (net operating loss, "NOL," and net capital loss, "NCL"). Currently, we expect to have federal NOL carryforwards of $98,035, federal NCL carryforwards of $59,729, as well as significant state NOL carryforwards in several states and cities where we do business, as of December 31, 2023. According to ASC 740 Income Taxes, we should record an offsetting valuation allowance against these deferred tax assets in an amount such that the net asset recognized represents amounts that we believe are more likely than not to be realized. In making this determination, we must estimate the future amounts of taxable income we will generate in each taxing jurisdiction. We then must consider the remaining statutory time period available for each carryforward asset, as well as other statutory limitations on usage such as annual limits and income type limits (capital vs. ordinary). Due to significant losses incurred recently as well as the overall market conditions that we face generally, in the nine months ended September 30, 2023, we revised downward the amount of carryforward assets we believe will be realizable in the future above a more likely than not standard. Accordingly, we increased the valuation allowances that we had recorded in the nine months ended September 30, 2023, resulting in additional deferred tax expense.

Our provision for income taxes fluctuates due to several factors mostly attributable to our legal structure, which are summarized as follows.

Cohen & Company Inc. is treated as a C corporation for United States federal income tax purposes. A U.S. C corporation is subject to a federal tax rate of 21%. The Company's effective tax rate is significantly different than this rate for the following reasons:

1. Cohen & Company Inc. consolidates the Operating LLC but only owns a minority economic interest in the Operating LLC. For the nine months ended September 30, 2023, Cohen & Company Inc. owned 27.37% of the economic interests of the Operating LLC (on average) and was allocated the same percentage of income/(loss) generated by the Operating LLC. To the extent Cohen & Company Inc. incurs tax obligations on this amount, the related tax expense is recognized in these consolidated financial statements. The remaining 72.63% that was allocated to the non-controlling members of the Operating LLC is subject to taxation on the members' tax returns.

2. The Operating LLC itself consolidates certain pass-through entities. Therefore, the income/(loss) of these entities is included in the Company's consolidated results, but no tax expense/(benefit) related to the unowned portions is included.

3. There are state, local, and foreign taxes to which the Operating LLC or its subsidiaries are subject to, which are included in the effective tax rate.

4. We also have valuation allowances applied against our NOL and NCL carryforward deferred tax assets as well as our tax over book basis in the Operating LLC. Valuation allowances are applied to deferred tax assets when management determines that the assets may not be fully realized. This determination requires significant judgement and is primarily based on management's expectations regarding the generation of future taxable income. ASC 740 indicates that all available evidence should be considered when assessing the need for and the appropriate level of a valuation allowance. All available evidence includes historical information supplemented by all currently available information about future periods.

Net Income / (Loss) Attributable to the Non-Convertible Non-Controlling Interest

Net income / (loss) attributable to the non-convertible non-controlling interest for the nine months ended September 30, 2023 and 2022 was comprised of the non-controlling interest related to member interests in consolidated subsidiaries of the Operating LLC, other than interests held by us therein, for the relevant periods. These interests are not convertible into Common Stock.

SUMMARY CALCULATION OF NON-CONVERTIBLE NON-CONTROLLING INTEREST

For the Nine Months Ended September 30, 2023

Insurance SPAC III Sponsor Entities are the sponsor entities formed by us for Insurance SPAC III. SPAC PIPE Entities are entities that invest in private investment in public equity ("PIPEs") of post business combination SPACs. Other SPAC Sponsor Investor represents an entity that we consolidate, but do not wholly own, that invests in other SPAC sponsor entities. The GP of the SPAC Fund is consolidated by us, but we do not wholly own it.

Net Income / (Loss) Attributable to the Convertible Non-Controlling Interest

Net income / (loss) attributable to the convertible non-controlling interest for the nine months ended September 30, 2023 and 2022 was comprised of the non-controlling interest related to member interests in the Operating LLC, other than interests held by us therein, for the relevant periods. These interests are convertible into Common Stock. See note 21 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2022.

SUMMARY CALCULATION OF CONVERTIBLE NON-CONTROLLING INTEREST

For the Nine Months Ended September 30, 2023

SUMMARY CALCULATION OF NON-CONTROLLING INTEREST

For the Nine Months Ended September 30, 2022

(1) Non-controlling interest is recorded on a quarterly basis. Because earnings are recognized unevenly throughout the year and the non-controlling interest percentage may change during the period, the average effective non-controlling interest percentage may not equal the percentage at the end of any period or the simple average of the beginning and ending percentages.

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

The following table sets forth information regarding our consolidated results of operations for the three months ended September 30, 2023 and 2022.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands)

(Unaudited)

Revenues

Revenues decreased by $6,344, or 27%, to $17,121 for the three months ended September 30, 2023, as compared to $23,465 for the three months ended September 30, 2022. As discussed in more detail below, the change was comprised of (i) a decrease of $475 in net trading revenue, (ii) a decrease of $1,668 in asset management revenue, (iii) a decrease of $5,988 in new issue and advisory revenue, and (iv) an increase of $1,787 in principal transactions and other income.

Net trading revenue decreased by $475, or 6%, to $7,491 for the three months ended September 30, 2023, as compared to $7,966 for the three months ended September 30, 2022. The following table shows the detail by trading group.

(Dollars in Thousands)

Our net trading revenue includes unrealized gains on our trading investments as of the applicable measurement date that may never be realized due to changes in market or other conditions not under our control. This may adversely affect the ultimate value realized from these investments. In addition, our net trading revenue also includes realized gains on certain proprietary trading positions. Our ability to derive trading gains from such trading positions is subject to overall market conditions. Due to volatility and uncertainty in the capital markets, the net trading revenue recognized may not be indicative of future results. Furthermore, from time to time, some of the assets included in the investments-trading line of our consolidated balance sheets represent level 3 valuations within the FASB valuation hierarchy. Level 3 assets are carried at fair value based on estimates derived using internal valuation models and other estimates. See notes 7, 8, and 9 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q. The fair value estimates made by us may not be indicative of the final sale price at which these assets may be sold. We consider our gestation repo business to be subject to significant concentration risk. See note 10 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

A loss of $60 and $4,642 related to the FGMC bankruptcy was included above in the mortgage group during the three months ended September 30, 2023 and 2022, respectively. See note 10 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

Asset Management

Our AUM equals the sum of the NAV or gross assets of the 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 used by 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 the definitions of AUM that may be used in our management agreements.

(1) Other Investment Vehicles include any Investment Vehicle that is not a Company-sponsored CDO.

(2) In some cases, accounts we manage may employ leverage. Further, in some cases, our fees are based on gross assets and in other cases, our fees are based on net assets. Finally, in the case of the SPAC Series Funds there are no management fees earned. AUM included herein is calculated using either gross or net assets of each managed account or CDO based on whichever serves as the basis for our management fees. In the case where no management fees are earned, the net assets are included.

Asset management fees decreased by $1,668, or 48%, to $1,788 for the three months ended September 30, 2023, as compared to $3,456 for the three months ended September 30, 2022, as discussed in more detail below. The following table provides a more detailed comparison of the two periods.

ASSET MANAGEMENT

(Dollars in Thousands)

Asset management fees from CDOs decreased mainly due to paydowns of principal and the successful auction of one of our Alesco CDOs in 2022. Asset management fees from other remained relatively unchanged.

New Issue and Advisory

New issue and advisory revenue decreased by $5,988 to $7,247 for the three months ended September 30, 2023, as compared to $13,235 for the three months ended September 30, 2022. The following table summarizes new issue and advisory revenue by business line.

Our revenue earned from new issue and advisory has been, and we expect will continue to be, volatile. We earn revenue from a limited number of engagements. Therefore, a small change in the number of engagements can result in large fluctuations in the revenue recognized. Further, even if the number of engagements remains consistent, the average revenue per engagement can fluctuate considerably. Finally, our revenue is generally earned when an underlying transaction closes (rather than on a monthly or quarterly basis). Therefore, the timing of underlying transactions increases the volatility of our revenue recognition. In addition, we often incur certain costs related to new issue engagements. These costs are included as a component of either subscriptions, clearing and execution, or professional fees and other, and will generally be recognized in the same period that the related revenue is recognized.

CCM, a division of JVB, is our full-service boutique investment bank, which focuses on M&A, capital markets, and SPAC advisory services. In addition, we generate new issue revenue by originating new assets for the U.S. Insurance JV, CREO JV, and our PriDe funds in Europe.

Principal Transactions and Other Income (Loss)

Principal transactions and other income (loss) increased by $1,787 to $595 for the three months ended September 30, 2023, as compared to ($1,192) for the three months ended September 30, 2022. The following table summarizes principal transactions and other income by category.

PRINCIPAL TRANSACTIONS & OTHER INCOME

(Dollars in Thousands)

Principal Transactions

In connection with the investments discussed below, see note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q for information regarding how we determine the value of such investments. For several of the investments described below, we also had an investment in the same company that was accounted for under the equity method during the periods presented. See discussion of equity method income / (loss) below.

LMND represents equity positions in Lemonade, Inc. (NYSE: LMND), a publicly traded company that acquired Metromile, Inc. ("MILE"), which closed a business combination with Insurance SPAC II. As of September 30, 2023, we had total investment in LMND carried at fair value of $128, which was included as a component of other investments, at fair value.

REE represents equity positions of REE Automotive Ltd. (NASDAQ: REE), a publicly traded company that closed a business combination with 10X Capital Venture Acquisition Corp. As of September 30, 2023, we had a total investment in REE carried at fair value of $112, which was included as a component of other investments, at fair value.

RBT represents equity positions of Rubicon Technologies, Inc. (NYSE: RBT), a publicly traded company that closed a business combination with Founder SPAC. As of September 30, 2023, we had a total investment in RBT carried at fair value of $0.

PAYO represents equity positions of Payoneer Global, Inc. (NASDAQ: PAYO), a publicly traded company that closed a business combination with FTAC Olympus Acquisition Corp. As of September 30, 2023, we had a total investment in PAYO carried at fair value of $1,704, which was included as a component of other investments, at fair value.

FOXO represents equity positions of FOXO Technologies Inc. (NYSE American: FOXO), a publicly traded company that closed its business combination with Delwinds Insurance Acquisition Corp. As of September 30, 2023, we had a total investment in FOXO carried at fair value of $39, which was included as a component of other investments, at fair value.

The SPAC Fund invested in the equity of SPACs. We carried our investment in the SPAC Fund at its reported NAV. Effective April 1, 2023, we began consolidating the SPAC Fund (see note 4 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q).

We have engaged in several transactions known as share forward arrangements ("SFAs"). In a typical SFA transaction, we acquire an interest in a publicly traded company and enter into an offsetting derivative with the same company. Both the interest in the public company and the offsetting derivative are carried at fair value. The amount shown in the table above represents the net change in fair value recorded during the period. The interests we hold in SFA counterparties are included as a component of other investments, at fair value. The derivatives are included as a component of other investments sold, not yet purchased, at fair value. See note 9 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q for more information.

In 2022, we entered into a bridge loan arrangement with an early stage growth company. The principal of the bridge loan was repaid in full during 2023. We earned a gross exit fee, initially valued at $3,040, comprised of a cash component of $1,050 and a share component of $1,990. The cash component was paid in full. The share component remains outstanding and is carried at fair value. During the three months ended September 30, 2023, the share component increased in fair value by $60. As of September 30, 2023, the share component was carried at its fair value of $2,050 as a component of other investments, at fair value.

The U.S. Insurance JV invests in insurance company debt. We carry our investment in the U.S. Insurance JV at its reported NAV. As of September 30, 2023, we had a total investment in the U.S. Insurance JV carried at fair value of $3,073, which was included as a component of other investments, at fair value.

The CREO JV invests in commercial real estate debt. We carry our investment in the CREO JV at its reported NAV. As of September 30, 2023, we had a total investment in the CREO JV carried at fair value of $5,834, which was included as a component of other investments, at fair value.

Stoa USA Inc. / FlipOS was a private company in which we owned common equity. During the three months ended September 30, 2023, Stoa USA Inc. / FlipOS announced that it had ceased operations and declared bankruptcy. We wrote-off our investment during the three months ended September 30, 2023, and recorded a principal transactions loss. We have no remaining investment in Stoa USA Inc. / FlipOS as of September 30, 2023.

Other principal investments consist of realized and unrealized gains and losses from other investments reported at fair value.

Other Income (Loss)

Other income / (loss) is comprised of an ongoing revenue share arrangement as well as other miscellaneous operating income items. The revenue share arrangement noted in the table above entitles us to a percentage of revenue earned by IIFC. The IIFC revenue share arrangement expires at the earlier of (i) the dissolution of IIFC or (ii) when we have earned a cumulative $20,000 in revenue share payments. To date, we have earned $5,297. In any particular year, the IIFC revenue share earned by us cannot exceed $2,000.

Operating Expenses

Operating expenses increased by $608, or 3%, to $21,225 for the three months ended September 30, 2023, as compared to $20,617 for the three months ended September 30, 2022. As discussed in more detail below, the change was comprised of (i) a decrease of $8 in compensation and benefits; (ii) an increase of $34 in business development, occupancy, and equipment; (iii) an increase of $297 in subscriptions, clearing, and execution; (iv) an increase of $284 in professional fee and other operating; and (v) an increase of $1 in depreciation and amortization.

Compensation and Benefits

Compensation and benefits decreased by $8, or 0%, to $15,219 for the three months ended September 30, 2023, as compared to $15,227 for the three months ended September 30, 2022.

COMPENSATION AND BENEFITS

(Dollars in Thousands)

Cash compensation and benefits in the table above was primarily comprised of salary, incentive compensation, severance, employer portion of payroll taxes, and benefits. Cash compensation and benefits remained relatively unchanged Our total headcount decreased from 122 at September 30, 2022 to 114 at September 30, 2023. Equity-based compensation remained relatively unchanged.

Business Development, Occupancy, and Equipment

Business development, occupancy, and equipment increased by $34, or 3%, to $1,268 for the three months ended September 30, 2023, as compared to $1,234 for the three months ended September 30, 2022. This increase was comprised of an increase in occupancy and equipment of $105, partially offset by a decrease in business development of $71.

Subscriptions, Clearing, and Execution

Subscriptions, clearing, and execution increased by $297, or 14%, to $2,409 for the three months ended September 30, 2023, as compared to $2,112 for the three months ended September 30, 2022. This increase was due to an increase of $149 in subscriptions and an increase of $148 in clearing and execution.

Professional Fee and Other Operating Expenses

Professional fee and other operating expenses increased by $284, or 15%, to $2,189 for the three months ended September 30, 2023, as compared to $1,905 for the three months ended September 30, 2022. This increase was comprised of an increase in professional fees of $128 and an increase in other operating expense of $156.

Depreciation and Amortization

Depreciation and amortization increased by $1, or 1%, to $140 for the three months ended September 30, 2023, as compared to $139 for the three months ended September 30, 2022.

Non-Operating Income and Expense

Interest Expense, net

Interest expense, net increased by $339 to $1,685 for the three months ended September 30, 2023, as compared to $1,346 for the three months ended September 30, 2022.

INTEREST EXPENSE

(Dollars in Thousands)

See notes 15 and 16 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

Income / (Loss) from Equity Method Affiliates

Income / (loss) from equity method affiliates decreased by $1,320 to ($702) for the three months ended September 30, 2023, as compared to $618 for the three months ended September 30, 2022. See note 11 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

SPAC sponsor entities and other includes both indirect and direct investments in SPAC sponsor entities. Several of these SPAC sponsor entities are invested in SPACs that have completed their business combinations. Those SPAC sponsor entities hold restricted and unrestricted equity interests in the public post-merger entities. We account for our investments in SPAC sponsor entities under the equity method of accounting. If a SPAC sponsor entity distributes SPAC shares to us, we account for those SPAC shares as a component of other investments, at fair value. The following table shows the equity method income / (loss) included in SPAC sponsor entities and other above broken out by the ultimate public company investee. For several of the investments described below, we also had an investment in the same company accounted for at fair value as a component of other investments, at fair value during the periods presented. See discussion of principal transactions above.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of FOXO was $0. However, we held FOXO shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

As of September 30, 2023, our equity method investment in the sponsor entity of the predecessor SPAC of DRTS was $0. However, we held DRTS shares as a component of other investments, at fair value as of September 30, 2023. See Principal Transactions above and note 8 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

The remaining investments in SPAC Sponsor Entities and Other represent investments in SPAC sponsor entities that have not yet completed a business combination and other equity method investments. See note 11 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q

Income Tax Expense / (Benefit)

Income tax expense / (benefit) increased by $2,516 to ($755) for the three months ended September 30, 2023, as compared to $1,761 for the three months ended September 30, 2022.

Our provision for income taxes fluctuates due to several factors mostly attributable to our legal structure, which are summarized as follows.

Cohen & Company Inc. is treated as a C corporation for United States federal income tax purposes. A U.S. C corporation is subject to a federal tax rate of 21%. The Company's effective tax rate is significantly different than this rate for the following reasons:

1. Cohen & Company Inc. consolidates the Operating LLC but only owns a minority economic interest in the Operating LLC. For the three months ended September 30, 2023, Cohen & Company Inc. owned 27.49% of the economic interests of the Operating LLC (on average) and was allocated the same percentage of income/(loss) generated by the Operating LLC. To the extent Cohen & Company Inc. incurs tax obligations on this amount, the related tax expense is recognized in these consolidated financial statements. The remaining 72.51% that was allocated to the non-controlling members of the Operating LLC is subject to taxation on such members' tax returns.

2. The Operating LLC itself consolidates certain pass-through entities. Therefore, the income/(loss) of these entities is included in the Company's consolidated results, but no tax expense/(benefit) related to the unowned portions is included.

3. There are state, local, and foreign taxes to which the Operating LLC or its subsidiaries are subject to, which are included in the effective tax rate.

4. We also have valuation allowances applied against our NOL and NCL carryforward deferred tax assets as well as our tax over book basis in the Operating LLC. Valuation allowances are applied to deferred tax assets when management determines that the assets may not be fully realized. This determination requires significant judgement and is primarily based on management's expectations regarding the generation of future taxable income. ASC 740 indicates that all available evidence should be considered when assessing the need for and the appropriate level of a valuation allowance. All available evidence includes historical information supplemented by all currently available information about future periods.

Net Income / (Loss) Attributable to the Non-Convertible Non-Controlling Interest

Net income / (loss) attributable to the non-convertible non-controlling interest for the three months ended September 30, 2023 and 2022 was comprised of the non-controlling interest related to member interests in consolidated subsidiaries of the Operating LLC other than interests held by us therein for the relevant periods. These interests are not convertible into Common Stock.

SUMMARY CALCULATION OF NON-CONVERTIBLE NON-CONTROLLING INTEREST

For the Three Months Ended September 30, 2023

Insurance SPAC III Sponsor Entities are the sponsor entities formed by us for Insurance SPAC III. SPAC PIPE Entities are entities that invest in private investment in public equity ("PIPEs") of post business combination SPACs. Other SPAC Sponsor Investor represents an entity that we consolidate, but do not wholly own, that invests in other SPAC sponsor entities. The GP of the SPAC Fund is consolidated by us, but we do not wholly own it.

Net Income / (Loss) Attributable to the Convertible Non-Controlling Interest

Net income / (loss) attributable to the convertible non-controlling interest for the three months ended September 30, 2023 and 2022 was comprised of the non-controlling interest related to member interests in the Operating LLC other than interests held by us therein for the relevant periods. These interests are convertible into Common Stock. See note 21 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2022.

SUMMARY CALCULATION OF CONVERTIBLE NON-CONTROLLING INTEREST

For the Three Months Ended September 30, 2023

SUMMARY CALCULATION OF NON-CONTROLLING INTEREST

For the Three Months Ended September 30, 2022

(1) Non-controlling interest is recorded on a quarterly basis. Because earnings are recognized unevenly throughout the year and the non-controlling interest percentage may change during the period, the average effective non-controlling interest percentage may not equal the percentage at the end of any period or the simple average of the beginning and ending percentages.

Liquidity and Capital Resources

Liquidity is a measurement of our ability to meet potential cash requirements including ongoing commitments to repay debt borrowings, make interest payments on outstanding borrowings, fund investments, and support other general business purposes. In addition, our United States and European broker-dealer subsidiaries are subject to certain regulatory requirements to maintain minimum levels of net capital. Historically, our primary sources of funds have been our operating activities and general corporate borrowings. In addition, our trading operations have generally been financed by the use of collateralized securities financing arrangements as well as margin loans.

Certain subsidiaries of the Operating LLC have restrictions on the withdrawal of capital and otherwise in making distributions and loans. JVB is subject to net capital restrictions imposed by the SEC and FINRA that require certain minimum levels of net capital to remain in this subsidiary. In addition, these restrictions could potentially impose notice requirements or limit our ability to withdraw capital above the required minimum amounts (excess capital) whether through a distribution or a loan. CCFESA is subject to the regulations of the ACPR, which imposes minimum capital requirements. See note 25 to our consolidated financial statements included in our Annual Report on Form 10-K for the year ended December 31, 2022.

See Liquidity and Capital Resources – Contractual Obligations below.

During the third quarter of 2010, our board of directors initiated a dividend of $0.50 per quarter, which was paid regularly through December 31, 2011. Beginning in 2012, our board of directors declared a dividend of $0.20 per quarter, which was paid regularly through the first quarter of 2019. Each time a cash dividend was declared by our board of directors, a pro rata distribution was made to the other members of the Operating LLC upon payment of dividends to our stockholders.

On July 29, 2021, our board of directors reinstated our quarterly dividend declaring a cash dividend of $0.25 per share. We have paid a quarterly cash dividend of $0.25 regularly since that date. In addition to our routine quarterly distribution, on March 8, 2022, our board of directors declared a special cash dividend of $0.75 per share. On November 2, 2023, the Company's board of directors declared a quarterly cash dividend of $0.25 per share on its Common Stock. The dividends are payable on December 1, 2023 to stockholders of record on November 17, 2023.

During the nine months ended September 30, 2023 and 2022, we had the following other financing transactions in excess of $1,000. This excludes non-cash transactions. See note 23 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

During the nine months ended September 30, 2023:

• We drew and repaid $15,000 on the Byline Bank line of credit.
• We paid dividends of $1,369.
• We made distributions to the convertible non-controlling interest of $3,341.
• We made distributions to the non-convertible non-controlling interest of $2,400.

During the nine months ended September 30, 2022:

• We issued a new 2020 Senior Note for $2,250 and used the proceeds to pay off an existing 2020 Senior Note.
• We paid dividends of $2,201.
• We made distributions to the convertible non-controlling interest of $5,535.
• We made distributions to the non-convertible non-controlling interest of $2,236.

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Cash Flows

We have seven primary uses for capital:

(1) To fund the operations of our Capital Markets business segment. Our Capital Markets business segment utilizes capital (i) to fund securities inventory to facilitate client trading activities; (ii) for risk trading for our own account; (iii) to fund our collateralized securities lending activities; (iv) for temporary capital needs associated with underwriting activities; (v) to fund business expansion into existing or new product lines including additional capital dedicated to our mortgage group as well as our gestation repo business; and (vi) to fund any operating losses incurred.

(2) To fund the expansion of our Asset Management business segment. We generally grow our AUM by sponsoring new Investment Vehicles. The creation of a new Investment Vehicle often requires us to invest a certain amount of our own capital to attract outside capital to manage. Also, these new Investment Vehicles often require warehouse and other third-party financing to fund the acquisition of investments. Finally, we generally will hire employees to manage new Investment Vehicles and will operate at a loss for a startup period.

(3) To fund investments. We make principal investments (including sponsor and other investments in SPACs) to generate returns. We may need to raise additional debt or equity financing in order to ensure we have the capital necessary to take advantage of attractive investment opportunities.

(4) To fund mergers or acquisitions. We may opportunistically use capital to acquire other asset managers, individual asset management contracts, or financial services firms. To the extent our liquidity sources are insufficient to fund our future merger or acquisition activities, we may need to raise additional funding through an equity or debt offering. No assurances can be given that additional financing will be available in the future, or that if available, such financing will be on favorable terms.

(5) To fund potential dividends and distributions. We sometimes pay dividends. Each time a cash dividend was declared by our board of directors, a pro rata distribution was made to the other members of the Operating LLC upon payment of dividends to our stockholders.

(6) To fund potential repurchases of Common Stock. We have opportunistically repurchased Common Stock in private transactions.

(7) To pay off debt as it matures. We have indebtedness that must be repaid as it matures. See note 16 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

If we are unable to raise sufficient capital on economically favorable terms, we may need to reduce the amount of capital invested for the uses described above, which may adversely impact earnings and our ability to pay dividends.

As of September 30, 2023 and December 31, 2022, we maintained cash and cash equivalents of $ 13,350 and $ 29,101, respectively. We generated cash from or used cash for the activities described below.

SUMMARY CASH FLOW INFORMATION

(Dollars in Thousands)

See the statement of cash flows in our consolidated financial statements. We believe our available cash and cash equivalents, as well as our investment in our trading portfolio and related borrowing capacity, will provide sufficient liquidity to meet the cash needs of our ongoing operations in the near term.

Nine Months Ended September 30, 2023

As of September 30, 2023, our cash and cash equivalents were $ 13,350, representing a decrease of $ 15,751 from December 31, 2022. The decrease was attributable to cash used in operating activities of $ 36,177, cash provided by investing activities of $ 28,549, cash used in financing activities of $ 8,080, and an decrease in cash caused by the change in exchange rates of $ 43.

The cash used in operating activities of $ 36,177 was comprised of (a) net cash outflows of $ 82,768 related to working capital fluctuations; (b) net cash inflows of $ 61,904 from trading activities comprised of our investments-trading, trading securities sold, not yet purchased, receivables under resale agreements, securities sold under agreements to repurchase, and receivables and payables from brokers, dealers, and clearing agencies, as well as the changes in unrealized gains and losses on the investments-trading and trading securities sold, not yet purchased; and (c) net cash outflows from other earnings items of $ 15,313 (which represents net income or loss adjusted for the following non-cash operating items: other income / (expense), non cash revenue, realized and unrealized gains and losses and accretion of income on other investments, income/(loss) from equity method affiliates, equity based compensation, depreciation and amortization, deferred taxes, and amortization of discount on debt).

The cash provided by investing activities of $ 28,549 was comprised of (a) $35,955 of sales of other investments sold, not yet purchased, at fair value; (b) $51,412 of sales of other investments, at fair value; (c) $5 in distributions received from equity method affiliates; partially offset by (d) $55,605 of cash used to purchase other investments, at fair value; (e) $1,112 of cash used to purchase other investments sold, not yet purchased, at fair value; (f) $1,806 of cash used to invest in equity method affiliates; and (g) $300 in cash used to purchase furniture, equipment, and leasehold improvements.

The cash used in financing activities of $ 8,080 was comprised of (a) $175 in cash used to net settle equity awards; (b) $1,369 in cash used to pay dividends; (c) $3,341 in convertible non-controlling interest distributions; (d) $2,400 in non-convertible non-controlling interests distributions; (e) $834 of redemptions of convertible non-controlling interests; partially offset by (f) $39 in investments received from non-controlling interests. We also drew and repaid $15,000 on the Byline Bank line of credit.

Nine Months Ended September 30, 2022

As of September 30, 2022, our cash and cash equivalents were $47,287, representing a decrease of $3,280 from December 31, 2021. The decrease was attributable to cash provided by operating activities of $4,247, cash provided by investing activities of $3,176, cash used in financing activities of $10,197, and a decrease in cash caused by the change in exchange rates of $506.

The cash provided by operating activities of $4,247 was comprised of (a) net cash outflows of $11,544 related to working capital fluctuations; (b) net cash inflows of $13,840 from trading activities comprised of our investments-trading, trading securities sold, not yet purchased, receivables under resale agreements, securities sold under agreements to repurchase, and receivables and payables from brokers, dealers, and clearing agencies, as well as the changes in unrealized gains and losses on the investments-trading and trading securities sold, but not yet purchased; and (c) net cash inflows from other earnings items of $1,951 (which represents net income or loss adjusted for the following non-cash operating items: other income / (expense), realized and unrealized gains and losses and accretion of income on other investments, income from equity method affiliates, equity based compensation, depreciation and amortization, deferred taxes, and amortization of discount on debt).

The cash provided by investing activities of $3,176 was comprised of (a) $15,791 of cash inflows from sales and returns of principal from other investments, at fair value; (b) $3,054 of cash inflows from sales and returns of principal from other investments sold, not yet purchased at fair value; and (c) $75 in distributions received from equity method affiliates; partially offset by (d) $8,651 in cash used to purchase other investments, at fair value; (e) $5,994 in cash used to purchase other investments sold, not yet purchased at fair value, (f) $617 in cash invested in equity method affiliates, and (g) $482 in cash used to purchase furniture, equipment, and leasehold improvements.

The cash used in financing activities of $10,197 was comprised of (a) $2,250 in cash used to repay debt; (b) $234 in cash used to settle equity awards; (c) $2,201 in cash used to pay dividends; (d) $5,535 in cash used to pay distributions to the convertible non-controlling interest; and (e) $2,236 in cash used to pay distributions to the non-convertible non-controlling interest; partially offset by (f) $9 in contributions received from non-convertible non-controlling interests; and (g) $2,250 in cash proceeds from debt.

Regulatory Capital Requirements

We have two subsidiaries that are licensed securities dealers: JVB in the United States and CCFESA in France. As a U.S. broker-dealer, JVB is subject to the Uniform Net Capital Rule in Rule 15c3-1 under the Exchange Act. CCFESA is subject to the regulations of the ACPR. The amount of net assets that these subsidiaries may distribute is subject to restrictions under the applicable net capital rules. These subsidiaries have historically operated in excess of minimum net capital requirements. Our minimum capital requirements at September 30, 2023 were as follows.

MINIMUM NET CAPITAL REQUIREMENTS

(Dollars in Thousands)

We operate with more than the minimum regulatory capital requirement in our licensed broker-dealers and at September 30, 2023, total net capital, or the equivalent as defined by the relevant statutory regulations, in our licensed broker-dealers totaled $52,614. See note 18 to our consolidated financial statements included in Item 1 in this Quarterly Report on Form 10-Q. In addition, our licensed broker-dealers are generally subject to capital withdrawal notification and restrictions.

Restrictions of Distributions of Capital from JVB

As of September 30, 2023, our total equity on a consolidated basis was $72,721 and the total equity of JVB was $78,002. Therefore, an equity deficit of $5,281 of equity exists outside of JVB.

From time to time, we may need to take distributions of income (and potentially returns of capital) from JVB to satisfy the cash needs as a result of the losses incurred outside of JVB or to satisfy other obligations that come due outside of JVB. However, we are subject to significant limitations on our ability to make distributions from JVB. These limitations include limitations imposed by FINRA under rule 15c3-1 (described immediately above) and limitations under our line of credit with Byline Bank (see note 16 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q). Furthermore, counterparties to JVB have their own internal counterparty credit requirements. The specific requirements are not generally shared with us. However, if we take too much in capital distributions from JVB (beyond its net income), we may not be able to trade with certain counterparties, which may cause JVB’s operations to deteriorate.

Securities Financing

We maintain repurchase agreements with various third-party institutions. There is no maximum limit as to the amount of securities that may be transferred pursuant to these agreements, and transactions are approved on a case-by-case basis. The repurchase agreements do not include substantive provisions other than those covenants and other customary provisions contained in standard master repurchase agreements. The repurchase agreements generally require us to transfer additional securities to the counterparty in the event the value of the securities then held by the counterparty in the margin account falls below specified levels and contain events of default in cases where we breach our obligations under the agreement. We receive margin calls from our repurchase agreement counterparties from time to time in the ordinary course of business. To date, we have maintained sufficient liquidity to meet margin calls, and we have always been able to satisfy a margin call, however, no assurance can be given that we will be able to satisfy requests from our counterparties to post additional collateral in the future. See note 10 to our consolidated financial statements included in Item 1 in this Quarterly Report on Form 10-Q.

If there were an event of default under a repurchase agreement, the counterparty would have the option to terminate all repurchase transactions existing with us and make any amount due from us to the counterparty payable immediately. Repurchase obligations are full recourse obligations to us. If we were to default under a repurchase obligation, the counterparty would have recourse to our other assets if the collateral was not sufficient to satisfy the obligation in full. Most of our repurchase agreements are entered into as part of our gestation repo business.

Our clearing brokers provide securities financing arrangements including margin arrangements and securities borrowing and lending arrangements. These arrangements generally require us to transfer additional securities or cash to the clearing broker in the event the value of the securities then held by the clearing broker in the margin account falls below specified levels and contain events of default in cases where we breach our obligations under such agreements.

An event of default under the clearing agreement would give our counterparty the option to terminate our clearing arrangement. Any amounts owed to the clearing broker would be immediately due and payable. These obligations are recourse to us. Furthermore, a termination of any of our clearing arrangements would result in a significant disruption to our business and would have a significant negative impact on our dealings and relationship with our customers.

The following table presents our period end balance, average monthly balance, and maximum balance at any month end during the nine months ended September 30, 2023 and the twelve months ended December 31, 2022 for receivables under resale agreements and securities sold under agreements to repurchase.

Fluctuations in the balance of our repurchase agreements from period to period and intra-period are dependent on business activity in those periods. The fluctuations in the balances of our receivables under resale agreements over the periods presented were impacted by our clients' desires to execute collateralized financing arrangements through the repurchase market or other financing products.

Average balances and period end balances will fluctuate based on market and liquidity conditions and we consider such intra-period fluctuations as typical for the repurchase market. Month-end balances may be higher or lower than average period balances.

Debt Financing

The following table summarizes our long-term indebtedness and other financing outstanding. See note 16 to our consolidated financial statements included in Item 1 in this Quarterly Report on Form 10-Q for a discussion of the Company’s outstanding debt.

DETAIL OF DEBT

(Dollars in Thousands)

(1) The junior subordinated notes listed represent debt the Company owes to the two trusts noted above. The total par amount owed by the Company to the trusts is $49,614. However, the Company owns the common stock of the trusts in a total par amount of $1,489. The Company pays interest (and at maturity, principal) to the trusts on the entire $49,614 junior notes outstanding. However, the Company receives back from the trusts the pro rata share of interest and principal on the common stock held by the Company. These trusts are VIEs and the Company does not consolidate them even though the Company holds the common stock. The Company carries the common stock on its balance sheet at a value of $0. The junior subordinated notes are recorded at a discount to par. When factoring in the discount, the yield to maturity of the junior subordinated notes as of September 30, 2023 on a combined basis was 21.74% assuming the variable rate in effect on the last day of the reporting period remains in effect until maturity.

(2) Represents the interest rate in effect as of the last day of the reporting period.

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Redeemable Financial Instruments

As of September 30, 2023 and December 31, 2022, we had a redeemable financial instrument payable to JKD Investor. See note 16 to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q.

Off-Balance Sheet Arrangements

Other than as described in note 9 (derivative financial instruments) and note 14 (variable interest entities) to our consolidated financial statements included in Item 1 of this Quarterly Report on Form 10-Q, there were no material off balance sheet arrangements as of September 30, 2023.

Contractual Obligations

The table below summarizes our significant contractual obligations as of September 30, 2023 and the future periods in which such obligations are expected to be settled in cash. Our junior subordinated notes are assumed to be repaid on their respective maturity dates. Excluded from the table below are obligations that are short-term in nature, including trading liabilities (including derivatives) and repurchase agreements. In addition, amortization of discount on debt is excluded.

CONTRACTUAL OBLIGATIONS

September 30, 2023

(Dollars in Thousands)

(1) The 2020 Senior Notes mature on January 31, 2024. However, any time after January 31, 2023, the holder can give us 31 days' notice and require full repayment. For purposes of the table above, we show the maturity on the earlier date, but show the interest payments out to the stated maturity date.

(2) The interest on the junior subordinated notes related to Alesco Capital Trust I is variable. The interest rate of 9.63% (based on the Term SOFR rate in effect as of September 30, 2023 plus 4.00%) was used to compute the contractual interest payment in each period noted. The interest on the junior subordinated notes related to Sunset Financial Statutory Trust I is variable. The interest rate of 9.81% (based on the Term SOFR rate in effect as of September 30, 2023 plus 4.15%) was used to compute the contractual interest payment in each period noted.

(3) Represents redemption value of the redeemable financial instruments as of the reporting period. The redeemable financial instruments do not have a fixed maturity date. The period shown above represents the first period the holder of these instruments has the ability to require redemption by us.

(4) Represents material operating contracts for various services.

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We believe that we will be able to continue to fund our current operations and meet our contractual obligations through a combination of existing cash resources and other sources of credit. Due to the uncertainties that exist in the economy, we cannot be certain that we will be able to replace existing financing or find sources of additional financing in the future.

Recent Accounting Pronouncements

The following is a list of recent accounting pronouncements that we believe will have a continuing impact on our financial statements going forward.

In August 2020, the FASB issued ASU 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity's Own Equity. This ASU simplifies accounting for convertible instruments by removing major separation models currently required. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception. The ASU also simplifies the diluted earnings per share (EPS) calculation in certain areas. This ASU is effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In June 2022, the FASB issued ASU 2022-03, Fair Value Measurement (Topic 820): Fair Value Measurement of Equity Securities Subject to Contractual Sale Restrictions. The amendments clarify that a contractual restriction on the sale of an equity security is not considered part of the unit of account of the equity security and, therefore, is not considered in measuring fair value. This ASU is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In March 2023, the FASB issued ASU 2023-02, Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Tax Credit Structures Using the Proportional Amortization Method. These amendments allow reporting entities to elect to account for qualifying tax equity investments using the proportional amortization method, regardless of the program giving rise to the related income tax credits. The ASU responds to stakeholder feedback that the proportional amortization method provides investors and other allocators of capital with a better understanding of the returns from investments that are made primarily for the purpose of receiving income tax credits and other income tax benefits. This ASU is effective for fiscal years beginning after December 15, 2023. Early adoption is permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In August 2023, the FASB issued ASU 2023-05, Business Combinations— Joint Venture Formations (Subtopic 805-60): Recognition and Initial Measurement. The ASU applies to the formation of entities that meet the definition of a joint venture (or a corporate joint venture) as defined in the FASB Accounting Standards Codification Master Glossary. The amendments in the ASU require that a joint venture apply a new basis of accounting upon formation. As a result, a newly formed joint venture, upon formation, would initially measure its assets and liabilities at fair value. The ASU is effective on a prospective basis for all joint ventures with a formation date on or after January 1, 2025. Early adoption of ASU No. 2023-05 is permitted in any interim or annual period in which financial statements have not yet been issued. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

Critical Accounting Policies and Estimates

Our accounting policies are essential to understanding and interpreting the financial results reported in our condensed consolidated financial statements. Our industry is subject to a number of highly complex accounting rules and requirements many of which place heavy burdens on management to make judgments relating to our business. The significant accounting policies used in the preparation of our condensed consolidated financial statements are summarized in note 3 to our consolidated financial statements and notes thereto found in our Annual Report on Form 10-K for the year ended December 31, 2022. Certain of those policies are considered to be particularly important to the presentation of our financial results because they require us to make assumptions and estimates about future events and apply judgments that affect the reported amounts of assets, liabilities, revenues, expenses, and the related disclosures. We base our assumptions, estimates, and judgments on historical experience, current trends, and other factors that management believes to be relevant at the time our consolidated financial statements are prepared. On a regular basis, management reviews the accounting policies, assumptions, estimates, and judgments to ensure that our financial statements are presented fairly and in accordance with U.S. GAAP. However, because future events and their effects cannot be determined with certainty, actual results could differ from our assumptions and estimates, and such differences could be material. During the three months ended September 30, 2023, there were no material changes to matters discussed under the heading “Critical Accounting Policies and Estimates” in Part II, Item 7 of our Annual Report on Form 10-K for the year ended December 31, 2022.

All amounts in this section are in thousands unless otherwise noted.

Market Risk

Market risk is the risk of economic loss arising from the adverse impact of market changes to the market value of our trading and investment positions. Market risk is inherent to both derivative and non-derivative financial instruments, and, accordingly, the scope of our market risk management procedures extends beyond derivatives to include all market risk sensitive financial instruments. For purposes of analyzing the components of market risk, we have broken out our investment portfolio into three broad categories, plus debt, as described below.

Fixed Income Securities: We hold, from time to time, the following securities: U.S. Treasury securities, U.S. government agency MBS, U.S. government agency debt securities, CMOs, non-government MBS, corporate bonds, non-redeemable and redeemable preferred stock, municipal bonds, certificates of deposits, residential mortgage loans, whole loans, and unconsolidated investments in the middle and senior tiers of securitization entities and TruPS. We attempt to mitigate our exposure to market risk by entering into economic hedging transactions, which may include TBAs and other forward agency MBS contracts. The fixed income category can be broadly broken down into two subcategories: fixed rate and floating rate.

Floating rate securities are not in themselves particularly sensitive to interest rate risk. Because they generally accrue income at a variable rate, the movement in interest rates typically does not impact their fair value. Fluctuations in their current income due to variations in interest rates are generally not material to us. Floating rate fixed income securities are subject to other market risks such as default risk of the underlying issuer, changes in issuer’s credit spreads, prepayment rates, investor demand and supply of securities within a particular asset class or industry class of the ultimate obligor. The sensitivity to any individual market risk can be difficult to quantify.

The fair value of fixed rate securities is sensitive to changes in interest rates. However, fixed rate securities that have low credit ratings or represent junior interests in securitizations are not particularly interest rate sensitive. In general, when we acquire interest rate sensitive securities, we enter into an offsetting short position for a similar fixed rate security. Alternatively, we may enter into other interest rate hedging arrangements such as interest rate swaps or Eurodollar futures. We measure our net interest rate sensitivity by determining how the fair value of our net interest rate sensitive assets would change as a result of a 100 basis point (“bps”) adverse shift across the entire yield curve. Based on this analysis, as of September 30, 2023, we would incur a loss of ($1,682) if the yield curve rises 100 bps across all maturities and a gain of $1,678 if the yield curve falls 100 bps across all maturities.

Equity Securities: We hold equity interests in both public and private entities. These investments are subject to equity price risk. Equity price risk results from changes in the level or volatility of underlying equity prices, which affect the value of equity securities or instruments that in turn derive their value from a particular stock. We also hold a significant amount of equity in public companies that recently completed a merger with a SPAC we sponsored or invested in. A significant portion of the equity we hold in these types of entities are subject to sale restrictions. We attempt to reduce the risk of loss inherent in our inventory of equity securities by closely monitoring those security positions or in some cases entering into derivatives trades to hedge this exposure. We also have had equity investments in entities where the investment is denominated in a foreign currency, or where the investment is denominated in U.S. Dollars but the investee primarily makes investments in foreign currencies. The fair values of these investments are subject to change as the spot foreign exchange rate between these currencies and the U.S. Dollar (our functional currency) fluctuates. We may, from time to time, enter into foreign exchange rate derivatives to hedge all or a portion of this risk. We measure our net equity price sensitivity and foreign currency sensitivity by determining how the net fair value of our equity price sensitive and foreign exchange sensitive assets would change as a result of a 10% adverse change in equity prices or foreign exchange rates. Based on this analysis, as of September 30, 2023, our equity price sensitivity was $745 and our foreign exchange currency sensitivity was $0.

Other Securities: These investments are primarily made up of residual interests in securitization entities. The fair value of these investments will fluctuate over time based on a number of factors including, but not limited to, liquidity of the investment type, the credit performance of the individual assets and issuers within the securitization entity, the asset class of the securitization entity and the relative supply of and demand for investments within that asset class, credit spreads in general, the transparency of valuation of the assets and liabilities of the securitization entity, and investors’ view of the accuracy of ratings prepared by the independent rating agencies. The sensitivity to any individual market risk cannot be quantified.

Debt: In addition to the risks noted above, we incur interest rate risk related to our debt obligations. We have debt that accrues interest at either variable rates or fixed rates. As of September 30, 2023, a 100 bps change in the appropriate variable base rate would result in a change in our annual cash paid for interest in the amount of $481. A 100 bps adverse change in the market yield to maturity would result in an increase in the fair value of the debt in the amount of $1,989 as of September 30, 2023.

Counterparty Risk and Settlement Risk

We are subject to counterparty risk primarily in two areas: (i) our collateralized securities transactions described in note 10 to our consolidated financial statements included in Item 1 in this Quarterly Report on Form 10-Q and (ii) our TBA and other forward agency MBS activities described in note 9 to our consolidated financial statements included in Item 1 in this Quarterly Report on Form 10-Q. With respect to the gestation repo financing activities, our risk is that the counterparty does not fulfill its obligation to repurchase the underlying security when it is due. In this case, we would typically liquidate the underlying security, which may result in a loss if the security has declined in value in relation to the balance due from the counterparty under the reverse repurchase agreement.

With respect to our TBA and other forward agency MBS activities, our risk is that the counterparty does not settle the TBA trade on the scheduled settlement date. In this case, we would have to execute the trade, which may result in a loss based on market movement in the value of the underlying trade between its initial trade date and its settlement date (which in the case of TBAs can be as long as 90 days). If we were to incur a loss under either of these activities, we have recourse to the counterparty pursuant to the underlying agreements.

Finally, we have general settlement risk in all of our regular way fixed income and equity trading activities. If a counterparty fails to settle a trade, we may incur a loss in closing out the position and would be forced to try to recover this loss from the counterparty. If the counterparty has become insolvent or does not have sufficient liquid assets to reimburse us for the loss, we may not get reimbursed.

How we manage these risks

Market Risk

We seek to manage our market risk by utilizing our underwriting and credit analysis processes that are performed in advance of acquiring any investment. In addition, we continually monitor our investments on a daily basis. We perform an in-depth monthly analysis on all our investments and our risk committee meets on a weekly basis to review specific issues within our portfolio and to make recommendations for dealing with these issues. In addition, our broker-dealer has an assigned chief risk officer that reviews the firm’s positions and trading activities on a daily basis.

Counterparty Risk

We seek to manage our counterparty risk primarily through two processes. First, we perform a credit assessment of each counterparty to ensure the counterparty has sufficient equity, liquidity, and profitability to support the level of trading or lending we plan to do with them. Second, we may require counterparties to post cash or other liquid collateral (“margin”) to support changes in the market value of the underlying securities or trades on an ongoing basis.

In the case of collateralized securities financing transactions, we will generally lend less than the market value of the underlying security initially. The difference between the amount lent and the value of the security is referred to as the haircut. We will seek to maintain this haircut while the loan is outstanding. If the value of the security declines, we will require the counterparty to post margin to offset this decline. If the counterparty fails to post margin, we will sell the underlying security. The haircut serves as a buffer against market movements to prevent or minimize a loss.

In the case of TBA and other forward agency MBS activities, we sometimes require counterparties to post margin with us when the market value of the underlying TBA trade declines. If the counterparty fails to post margin, we will close out the underlying trade. In the case of TBA and other forward agency MBS activities, we will sometimes obtain initial margin or a cash deposit from the counterparty, which serves a purpose similar to the haircut as an additional buffer against losses. However, some of our TBA and other forward agency MBS activities are done without initial margin or cash deposits.

Risks Related to our Gestation Repo Business

We have entered into repurchase and reverse repurchase agreements as part of our gestation repo business. In general, we will lend money to a counterparty after obtaining collateral securities from that counterparty pursuant to a reverse repurchase agreement. We will borrow money from another counterparty using those same collateral securities pursuant to a repurchase agreement. We seek to earn net interest income on these matched transactions.

In our gestation repo business, we will generally ensure that the maturity dates of our reverse repurchase agreements match the maturity dates of the matched repurchase agreements. Because our maturities are matched, we can pass along any changes in funding terms imposed upon us by our repurchase agreement counterparty to our reverse repurchase agreement counterparty. Therefore, we are not exposed to a great deal of interest rate or funding risk. The main risk we are exposed to is credit risk. We manage this risk by obtaining collateral in excess of the contractual repo balance and performing credit reviews of counterparties and updating them on a routine basis.

Evaluation of Disclosure Controls and Procedures

We have established and maintain disclosure controls and procedures that are designed to ensure that material information relating to the Company (and its consolidated subsidiaries) required to be disclosed in our Exchange Act reports is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including our chief executive officer and chief financial officer, who certify our financial reports, and to other members of senior management and the Company’s board of directors. Under the supervision and with the participation of our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) and 15d-15(e) of the Exchange Act) as of September 30, 2023. Based on that evaluation, the chief executive officer and the chief financial officer concluded that our disclosure controls and procedures were effective at September 30, 2023.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting during the quarter ended September 30, 2023 that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

In addition to the information set forth in this Quarterly Report on Form 10-Q, you should also carefully review and consider the risk factors contained in our other reports and periodic filings with the SEC, including without limitation the risk factors contained under the caption “Item 1A—Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2022, that could materially and adversely affect our business, financial condition, and results of operations. The risk factors discussed in that Form 10-K do not identify all risks that we face because our business operations could also be affected by additional factors that are not presently known to us or that we currently consider to be immaterial to our operations. There have been no material changes in the significant factors that may affect our business and operations as described in “Item 1A—Risk Factors” of the Annual Report on 10-K for the year ended December 31, 2022.

Interest rate changes could affect our profitability.

The Company’s profitability may be adversely affected by inflation and inflationary expectations. Inflation has been rising at historically high rates, and the Federal Reserve has signaled that it will continue increasing the target federal funds effective rate.

Inflation and future expectations of inflation can negatively influence securities prices, including the fair value of fixed income securities we hold on our balance sheet. Rising interest rates may create instability in the equity markets, reduce the volumes of new issue fixed income instruments, and significantly reduce mortgage activity, all of which negatively affects our profitability. Additionally, the impact of inflation on the Company’s operating expenses may affect profitability to the extent that additional costs are not recoverable through increased prices of services offered by the Company.