Cohen & Co Inc.: Form 10-Q for the period ended Mar 31, 2024

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, 2023.

“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 that provides innovative strategic and financial advice in M&A, capital markets, and SPAC advisory.
• 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 March 31, 2024, we had approximately $2.3 billion in assets under management (“AUM”) of which 43% 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 made to support our trading and other Capital Markets business segment activities. In addition, we have received financial instruments as consideration for advisory services provided by our Capital Markets business segment which are included in this segment. These investments are included in our other investments, at fair value; other investments sold, not yet purchased; and investments in equity method affiliates in our consolidated balance sheets.

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) origination fees for newly created financial instruments originated by us; (b) revenue from advisory services; and (c) new issue revenue associated with origination, arranging, or placing newly created financial instruments.

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 and Principal Investing business segments 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. 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 March 31, 2024, 43% 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. In addition, in recent quarters, we have received significant portions of new issue and advisory revenue in the form of financial instruments rather than cash. Typically, these financial instruments are carried at fair value and included as a component of our principal investment segment. 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 Vellar GP, 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 2023 and the first three months of 2024. 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 2023 and the first three months of 2024 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 and 2023, 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, Vellar GP had an investment in the SPAC Fund, the potential to earn incentive fees, and did not consolidate the SPAC Fund. We own an interest in and consolidate Vellar GP. Effective April 1, 2023, all of the investors in the SPAC Fund, other than Vellar GP, redeemed all of their interests in the SPAC Fund. Therefore, effective April 1, 2023, Vellar GP became the sole owner of the SPAC Fund and began consolidating it. Because we consolidate Vellar GP, 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.

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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.

Three Months Ended March 31, 2024 Compared to the Three Months Ended March 31, 2023

The following table sets forth information regarding our consolidated results of operations for the three months ended March 31, 2024 and 2023.

COHEN & COMPANY INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(Dollars in Thousands)

(Unaudited)

Revenues

Revenues increased by $9,740, or 110%, to $18,564 for the three months ended March 31, 2024, as compared to $8,824 for the three months ended March 31, 2023. As discussed in more detail below, the change was comprised of (i) an increase of $1,638 in net trading revenue, (ii) an increase of $692 in asset management revenue, (iii) an increase of $23,488 in new issue and advisory revenue, and (iv) a decrease of $16,078 in principal transactions and other income.

Net Trading

Net trading revenue increased by $1,638, or 20%, to $9,848 for the three months ended March 31, 2024, as compared to $8,210 for the three months ended March 31, 2023. The following table shows the detail by trading group.

NET TRADING

(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.

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 increased by $692, or 34%, to $2,717 for the three months ended March 31, 2024, as compared to $2,025 for the three months ended March 31, 2023, 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. Asset management fees from other increased primarily due to the recognition in 2024 of deferred performance fees related to certain PriDe Funds.

New Issue and Advisory

New issue and advisory revenue increased by $23,488 to $24,388 for the three months ended March 31, 2024, as compared to $900 for the three months ended March 31, 2023. 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.

In some cases, CCM will receive financial instruments in lieu of cash for its advisory transactions. In these cases, we record advisory revenue equal to the fair value of the instruments received. Subsequent to receipt, the instruments are carried at fair value as a component of other investments, at fair value in our consolidated balance sheets. Any change in the fair value of these instruments subsequent to recording the new issue revenue will be recorded as principal transactions gain or loss in the consolidated statement of operations. Further, it should be noted that the financial instruments we receive in these cases are often either (i) common stock investments that are restricted for resale for some period of time; (ii) convertible or non-convertible debt investments that are not publicly traded; (iii) equity investments in special purpose entities that are not publicly traded; or (iv) unrestricted common stock investments in public companies but the company does not have significant trading volume. Therefore, it may take us a significant period of time to liquidate these investments. We may suffer significant principal transactions loss prior to final liquidation of these financial instruments which will impact the results of our Principal Investing segment.

Principal Transactions and Other Income (Loss)

Principal transactions and other income (loss) decreased by $16,078 to ($18,389) for the three months ended March 31, 2024, as compared to ($2,311) for the three months ended March 31, 2023. 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.

Interests in Public Companies

These items represent our direct and indirect investments in certain public companies. These investments may be in the form of unrestricted common stock, restricted common stock, equity derivatives, convertible notes, non-convertible notes, fair value receivables, as well as equity interest in SPVs that have investments in these public companies. The name and ticker symbol of each public company in which we have a direct or indirect investment is listed in the table above. The amounts shown represent the change in the fair value of our investment in each time period noted in the table. All of the interests in the public companies listed above with the exception of OPTX, SELX, and ZPTA were acquired as non-cash compensation related to new issue and advisory engagements. When we received these investments, we recorded new issue and advisory revenue for the fair value of those instruments at that time.

Other Principal Investments

We have engaged in several 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 regarding our SFAs.

The U.S. Insurance JV invests in insurance company debt. We carry our investment in the U.S. Insurance JV at its reported NAV.

The CREO JV invests in primarily multi-family commercial real estate mortgage-backed loans. We carry our investment in the CREO JV at its reported NAV.

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 $6,161. In any particular year, the IIFC revenue share earned by us cannot exceed $2,000.

Operating Expenses

Operating expenses increased by $5,632, or 35%, to $21,939 for the three months ended March 31, 2024, as compared to $16,307 for the three months ended March 31, 2023. As discussed in more detail below, the change was comprised of (i) an increase of $4,302 in compensation and benefits; (ii) an increase of $140 in business development, occupancy, and equipment; (iii) a decrease of $39 in subscriptions, clearing, and execution; (iv) an increase of $1,249 in professional fee and other operating; and (v) a decrease of $20 in depreciation and amortization.

Compensation and Benefits

Compensation and benefits increased by $4,302, or 41%, to $14,839 for the three months ended March 31, 2024, as compared to $10,537 for the three months ended March 31, 2023.

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. The change was primarily the result of changes in incentive compensation. Our total headcount decreased from 121 at March 31, 2023 to 116 at March 31, 2024. Equity-based compensation remained relatively unchanged.

Business Development, Occupancy, and Equipment

Business development, occupancy, and equipment increased by $140, or 11%, to $1,441 for the three months ended March 31, 2024, as compared to $1,301 for the three months ended March 31, 2023. This increase was comprised of an increase in occupancy and equipment of $84, and an increase in business development of $56.

Subscriptions, Clearing, and Execution

Subscriptions, clearing, and execution decreased by $39, or 2%, to $2,086 for the three months ended March 31, 2024, as compared to $2,125 for the three months ended March 31, 2023. The decrease was due to a decrease in clearing and execution of $104, partially offset by an increase in subscriptions and dues of $65.

Professional Fee and Other Operating Expenses

Professional fee and other operating expenses increased by $1,249, or 57%, to $3,449 for the three months ended March 31, 2024, as compared to $2,200 for the three months ended March 31, 2023. This increase was comprised of an increase in professional fees of $649 and an increase in other operating expense of $600.

Depreciation and Amortization

Depreciation and amortization decreased by $20, or 14%, to $124 for the three months ended March 31, 2024, as compared to $144 for the three months ended March 31, 2023.

Non-Operating Income and Expense

Interest Expense, net

Interest expense, net increased by $74 to $1,666 for the three months ended March 31, 2024, as compared to $1,592 for the three months ended March 31, 2023.

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 $29,440 to $29,045 for the three months ended March 31, 2024, as compared to ($395) for the three months ended March 31, 2023. 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.

Changes in fair value of those investments are included as a component of principal transactions and other income. 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 $86 to $498 for the three months ended March 31, 2024, as compared to $584 for the three months ended March 31, 2023.

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 March 31, 2024, Cohen & Company Inc. owned 28.1% 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 71.9% 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 March 31, 2024 and 2023 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

Other SPAC Sponsor Investor represents an entity that we consolidate, but do not wholly own, that invests in other SPAC sponsor entities. The Vellar GP 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 March 31, 2024 and 2023 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, 2023.

SUMMARY CALCULATION OF CONVERTIBLE NON-CONTROLLING INTEREST

For the Three Months Ended March 31, 2024

SUMMARY CALCULATION OF NON-CONTROLLING INTEREST

For the Three Months Ended March 31, 2023

(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, 2023.

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 May 2, 2024, 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 June 5, 2024 to stockholders of record on May 20, 2024.

During the three months ended March 31, 2024 and 2023, we had no 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.

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 March 31, 2024 and December 31, 2023, we maintained cash and cash equivalents of $ 11,829 and $ 10,650, 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.

Three Months Ended March 31, 2024

As of March 31, 2024, our cash and cash equivalents were $ 11,829, representing an increase of $ 1,179 from December 31, 2023. The increase was attributable to cash provided by operating activities of $ 5,137, cash used in investing activities of $ 2,856, cash used in financing activities of $ 999, and a decrease in cash caused by the change in exchange rates of $ 103.

The cash provided by operating activities of $ 5,137 was comprised of (a) net cash outflows of $ 5,362 related to working capital fluctuations; (b) net cash inflows of $ 3,923 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 inflows from other earnings items of $ 6,576 (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 used in investing activities of $ 2,856 was comprised of (a) $214 of sales of other investments sold, not yet purchased, at fair value; (b) $22,383 of sales of other investments, at fair value; (c) $5 in distributions received from equity method affiliates; partially offset by (d) $25,146 of cash used to purchase other investments, at fair value; (e) $213 of cash used to purchase other investments sold, not yet purchased, at fair value; and (f) $99 in cash used to purchase furniture, equipment, and leasehold improvements.

The cash used in financing activities of $ 999 was comprised of (a) $185 in cash used to net settle equity awards; (b) $245 in cash used to pay dividends; and (c) $569 in convertible non-controlling interest distributions.

Three Months Ended March 31, 2023

As of March 31, 2023, our cash and cash equivalents were $3,641, representing a decrease of $25,460 from December 31, 2022. The decrease was attributable to cash used in operating activities of $27,709, cash provided by investing activities of $2,714, cash used in financing activities of $556, and an increase in cash caused by the change in exchange rates of $91.

The cash used in operating activities of $27,709 was comprised of (a) net cash outflows of $7,271 related to working capital fluctuations; (b) net cash outflows of $14,656 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 outflows from other earnings items of $5,782 (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 $2,714 was comprised of (a) $3,908 in sales and returns of principal from other investments, at fair value; (b) $1 in distributions from equity method affiliates; partially offset by (c) $363 in cash used to purchase other investments, at fair value; (d) $736 in cash used to invest in equity method affiliates; and (e) $96 of cash used to purchase furniture and equipment.

The cash used in financing activities of $ 556 was comprised of (a) $164 in cash used to net settle equity awards; (b) $215 in cash used to pay dividends; (c) $215 in convertible non-controlling interest distributions; partially offset by (d) $38 in investments received from non-controlling interests.

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 March 31, 2024 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 March 31, 2024, total net capital, or the equivalent as defined by the relevant statutory regulations, in our licensed broker-dealers totaled $54,598. See note 19 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 March 31, 2024, our total equity on a consolidated basis was $113,323 and the total equity of JVB was $91,249. Therefore, only $22,074 of equity exists outside of JVB. However, it should be noted that our non-redeemable NCI represents equity that is included in our consolidated financial statements but is not available to the Operating LLC to fund operations outside of those specific consolidated but not wholly owned subsidiaries. As of March 31, 2024, our non-convertible non-controlling interest balance was $25,876. Therefore, a deficit of available equity exists outside of JVB of $3,802.

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 three months ended March 31, 2024 and the twelve months ended December 31, 2023 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 on balance sheet collateralized financing arrangements.

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 March 31, 2024 on a combined basis was 21.67% 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 March 31, 2024 and December 31, 2023, 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 March 31, 2024.

Contractual Obligations

The table below summarizes our significant contractual obligations as of March 31, 2024 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

March 31, 2024

(Dollars in Thousands)

(1) The 2020 Senior Notes mature on January 31, 2026. However, any time after January 31, 2025, 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 9.58% (based on the Term SOFR rate in effect as of March 31, 2024 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 9.71% (based on the Term SOFR rate in effect as of March 31, 2024 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 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.

In October 2023, the FASB issued ASU 2023-06*, Disclosure Improvements—Codification Amendments in Response to the Securities and Exchange Commission (“SEC’”) Disclosure Update and Simplification Initiative*. These amendments clarify or improve disclosure and presentation requirements of a variety of topics and align the requirements in the FASB accounting standard codification with the SEC’s regulations. The ASU will be effective on the date the related disclosure requirements are removed from Regulation S-X or Regulation S-K by the SEC and will no longer be effective if the SEC has not removed the applicable disclosure requirement by June 30, 2027. Early adoption is not permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In November 2023, the FASB issued ASU 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The amendments in this ASU are designed to improve reportable segment disclosure requirements primarily through enhanced disclosures about significant segment expenses. The ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740). The amendments in this ASU address investor requests for more transparency about income tax information through improvements to income tax disclosures primarily related to the rate reconciliation and income taxes paid information. The amendments in this ASU are effective for annual periods beginning after December 15, 2024 and should be applied on a prospective basis. Retrospective application is permitted. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In March 2024, the FASB issued ASU 2024-01, Compensation—Stock Compensation (Topic 718): Scope Application of Profits Interest and Similar Awards. The ASU provides an illustrative example intended to demonstrate how entities that account for profits interest and similar awards would determine whether a profits interest award should be accounted for as share-based payment arrangements in accordance with FASB Accounting Standards Codification (FASB ASC) 718, Compensation-Stock Compensation. The ASU is effective for public business entities for annual periods beginning after December 15, 2024 and interim periods with those annual periods. We are currently evaluating the new guidance to determine the impact it may have on our consolidated financial statements.

In March 2024, the FASB issued ASU 2024-02, Codification Improvements — Amendments to Remove References to the Concepts Statements. The ASU amends the Codification to remove references to various concepts statements. In most instances, the references are extraneous and not required to understand or apply the guidance. In other instances, the references were used in prior Statements to provide guidance in certain topical areas. The ASU is effective for public business entities for annual periods beginning after December 15, 2024. 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, 2023. 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 March 31, 2024, 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, 2023.

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 March 31, 2024, we would incur a loss of ($2,078) if the yield curve rises 100 bps across all maturities and a gain of $2,072 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 March 31, 2024, our equity price sensitivity was $806 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 March 31, 2024, 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 $2,292 as of March 31, 2024.

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 March 31, 2024. Based on that evaluation, the chief executive officer and the chief financial officer concluded that our disclosure controls and procedures were effective at March 31, 2024.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting during the quarter ended March 31, 2024 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, 2023, 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, 2023.

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.