JMP Group LLC
JMP Group Inc. (Form: 10-Q, Received: 08/04/2011 13:47:22)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2011 OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission File Number: 001-33448

 

 

JMP Group Inc.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   20-1450327

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

600 Montgomery Street, Suite 1100, San Francisco, California 94111

(Address of principal executive offices)

Registrant’s telephone number: (415) 835-8900

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x     No   ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes   x     No   ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   x
Non-accelerated filer   ¨   (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes   ¨     No   x

The number of shares of the Registrant’s common stock, par value $0.001 per share, outstanding as of July 31, 2011 was 22,387,627.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

         Page  
PART I.   FINANCIAL INFORMATION      4   
Item 1.   Financial Statements - JMP Group Inc.      4   
  Consolidated Statements of Financial Condition - June 30, 2011 and December 31, 2010 (Unaudited)      4   
 

Consolidated Statements of Operations - For the Three and Six Months Ended June 30, 2011 and 2010 (Unaudited)

     6   
  Consolidated Statement of Changes in Equity - For the Six Months Ended June 30, 2011 and 2010 (Unaudited)      7   
  Consolidated Statements of Cash Flows - For the Six Months Ended June 30, 2011 and 2010 (Unaudited)      8   
  Notes to Consolidated Financial Statements (Unaudited)      10   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      51   
Item 3.   Quantitative and Qualitative Disclosures About Market Risk      82   
Item 4.   Controls and Procedures      82   
PART II.   OTHER INFORMATION      82   
Item 1.   Legal Proceedings      82   
Item 1A.   Risk Factors      82   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      83   
Item 3.   Defaults Upon Senior Securities      83   
Item 4.   (Removed and Reserved)      83   
Item 5.   Other Information      83   
Item 6.   Exhibits      83   
SIGNATURES      84   
EXHIBIT INDEX      85   

 

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AVAILABLE INFORMATION

JMP Group Inc. is required to file current, annual and quarterly reports, proxy statements and other information required by the Securities Exchange Act of 1934, as amended, with the Securities and Exchange Commission. You may read and copy any document JMP Group Inc. files with the SEC at the SEC’s Public Reference Room located at 100 F Street, N.E., Washington, DC 20549. Information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an internet website at http://www.sec.gov, from which interested persons can electronically access JMP Group Inc.’s SEC filings.

JMP Group Inc. will make available free of charge through its internet site http://www.jmpg.com, its annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, proxy statements, Forms 3, 4 and 5 filed by or on behalf of directors, executive officers and certain large stockholders, and any amendments to those documents filed or furnished pursuant to the Exchange Act. These filings will become available as soon as reasonably practicable after such material is electronically filed with or furnished to the SEC.

JMP Group Inc. also makes available, in the Investor Relations section of its website and will provide print copies to stockholders upon request, (i) its corporate governance guidelines, (ii) its code of business conduct and ethics, and (iii) the charters of the audit, compensation, and corporate governance and nominating committees of its board of directors. These documents, as well as the information on the website of JMP Group Inc., are not intended to be part of this quarterly report.

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1. Financial Statements

JMP Group Inc.

Consolidated Statements of Financial Condition

(Unaudited)

(Dollars in thousands, except per share data)

 

     June 30, 2011     December 31, 2010  

Assets

    

Cash and cash equivalents

   $ 61,445      $ 71,114   

Restricted cash and deposits (includes cash on deposit with clearing broker of $255 at June 30, 2011 and December 31, 2010)

     44,129        47,718   

Receivable from clearing broker

     1,550        1,331   

Investment banking fees receivable, net of allowance for doubtful accounts of $0 at June 30, 2011 and December 31, 2010

     7,227        9,764   

Marketable securities owned, at fair value

     25,560        23,748   

Incentive fee receivable

     3,861        763   

Other investments (of which $52,595 and $38,672 at fair value at June 30, 2011 and December 31, 2010, respectively)

     52,894        38,702   

Loans held for investment, net of allowance for loan losses

     0        813   

Loans collateralizing asset-backed securities issued, net of allowance for loan losses

     415,618        400,763   

Interest receivable

     1,076        1,163   

Fixed assets, net

     2,065        1,481   

Deferred tax assets

     24,278        32,507   

Other assets

     8,015        7,998   
  

 

 

   

 

 

 

Total assets

   $ 647,718      $ 637,865   
  

 

 

   

 

 

 

Liabilities and Equity

    

Liabilities:

    

Marketable securities sold, but not yet purchased, at fair value

   $ 12,619      $ 10,669   

Accrued compensation

     27,520        37,424   

Asset-backed securities issued

     366,080        351,322   

Interest payable

     554        570   

Note payable

     23,590        26,209   

Deferred tax liability

     30,249        36,176   

Other liabilities

     32,831        33,443   
  

 

 

   

 

 

 

Total liabilities

     493,443        495,813   
  

 

 

   

 

 

 

Commitments and Contingencies

    

JMP Group Inc. Stockholders’ Equity

    

Common stock, $0.001 par value, 100,000,000 shares authorized; 22,387,627 and 22,069,741 shares issued at June 30, 2011 and December 31, 2010, respectively; 22,387,627 and 21,737,367 shares outstanding at June 30, 2011 and December 31, 2010, respectively

     22        22   

Additional paid-in capital

     123,689        128,151   

Treasury stock, at cost, 0 and 332,374 shares at June 30, 2011 and December 31, 2010, respectively

     0        (2,210

Accumulated other comprehensive loss

     (102     (63

Retained earnings

     8,751        4,696   
  

 

 

   

 

 

 

Total JMP Group Inc. stockholders’ equity

     132,360        130,596   

Noncontrolling Interest

     21,915        11,456   
  

 

 

   

 

 

 

Total equity

     154,275        142,052   
  

 

 

   

 

 

 

Total liabilities and equity

   $ 647,718      $ 637,865   
  

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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JMP Group Inc.

Consolidated Statements of Financial Condition - (Continued)

(Unaudited)

(Dollars in thousands, except per share data)

 

Assets and liabilities of consolidated VIE included in total assets and total liabilities above:

 

     June 30, 2011      December 31, 2010  

Restricted cash

   $ 29,127       $ 23,821   

Loans collateralizing asset-backed securities issued, net of allowance for loan losses

     415,618         400,763   

Interest receivable

     1,075         1,162   

Deferred tax assets

     9,785         15,685   

Other assets

     77         41   
  

 

 

    

 

 

 

Total assets of consolidated VIE

   $ 455,682       $ 441,472   
  

 

 

    

 

 

 

Asset-backed securities issued

     366,080         351,322   

Interest payable

     525         545   

Deferred tax liability

     28,097         34,110   

Other liabilities

     1,274         379   
  

 

 

    

 

 

 

Total liabilities of consolidated VIE

   $ 395,976       $ 386,356   
  

 

 

    

 

 

 

The asset-backed securities issued by the VIE are limited recourse obligations payable solely from cash flows of the loans collateralizing them and related collection and payment accounts pledged as security. Accordingly, only the assets of the VIE can be used to settle the obligations of the VIE.

See accompanying notes to consolidated financial statements.

 

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JMP Group Inc.

Consolidated Statements of Operations

(Unaudited)

(In thousands, except per share data)

 

     Three Months Ended June 30,     Six Months Ended June 30,  
     2011     2010     2011     2010  

Revenues

        

Investment banking

   $ 10,059      $ 10,635      $ 30,284      $ 16,104   

Brokerage

     6,187        7,690        12,472        15,360   

Asset management fees

     6,046        3,142        9,199        6,033   

Principal transactions

     2,554        411        6,184        1,833   

Gain on sale and payoff of loans

     6,837        15,762        13,608        19,242   

Net dividend income

     298        499        548        1,115   

Other income

     682        305        1,510        801   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest revenues

     32,663        38,444        73,805        60,488   
  

 

 

   

 

 

   

 

 

   

 

 

 

Interest income

     7,728        13,003        18,348        24,581   

Interest expense

     (8,796     (8,310     (17,436     (16,550
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income (expense)

     (1,068     4,693        912        8,031   
  

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan losses

     (134     (291     (354     (455
  

 

 

   

 

 

   

 

 

   

 

 

 

Total net revenues after provision for loan losses

     31,461        42,846        74,363        68,064   
  

 

 

   

 

 

   

 

 

   

 

 

 

Non-interest expenses

        

Compensation and benefits

     22,017        30,592        50,248        46,112   

Administration

     1,744        1,974        2,814        2,995   

Brokerage, clearing and exchange fees

     1,179        1,223        2,277        2,574   

Travel and business development

     791        1,001        1,461        1,921   

Communications and technology

     995        1,073        1,916        2,146   

Occupancy

     777        671        1,442        1,322   

Professional fees

     797        813        1,505        1,788   

Depreciation

     179        169        337        337   

Impairment loss on purchased management contract

     0        0        700        0   

Other

     134        214        238        344   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total non-interest expenses

     28,613        37,730        62,938        59,539   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income tax expense

     2,848        5,116        11,425        8,525   

Income tax expense

     1,281        2,102        3,764        3,491   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     1,567        3,014        7,661        5,034   

Less: Net income attributable to noncontrolling interest

     49        798        2,605        1,100   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to JMP Group Inc.

   $ 1,518      $ 2,216      $ 5,056      $ 3,934   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income attributable to JMP Group Inc. per common share:

        

Basic

   $ 0.07      $ 0.10      $ 0.23      $ 0.18   

Diluted

   $ 0.07      $ 0.10      $ 0.22      $ 0.18   

Dividends declared per common share

   $ 0.03      $ 0.02      $ 0.05      $ 0.03   

Weighted average common shares outstanding:

        

Basic

     22,254        21,654        22,050        21,633   

Diluted

     22,613        22,295        22,720        22,378   

See accompanying notes to consolidated financial statements.

 

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JMP Group Inc.

Consolidated Statement of Changes in Equity

(Unaudited)

(In thousands)

 

    JMP Group Inc. Stockholders’ Equity                    
                                  Accumulated                    
    Common Stock           Additional           Other                    
          Treasury     Paid-In     Retained     Comprehensive     Noncontrolling     Comprehensive        
    Shares     Amount     Stock     Capital     Earnings     Loss     Interest     Income     Total Equity  

Balance, December 31, 2010

    22,070      $ 22      $ (2,210   $ 128,151      $ 4,696      $ (63   $ 11,456      $ 33,206      $ 142,052   

Net income

    0        0        0        0        5,056        0        2,605        7,661        7,661   

Additonal paid-in capital - stock-based compensation

    0        0        0        (8,295     0        0        0        0        (8,295

Additonal paid-in capital - excess tax benefit related to stock-based compensation

    0        0        0        (335     0        0        0        0        (335

Cash dividends paid to shareholders

    0        0        0        0        (1,001     0        0        0        (1,001

Purchases of shares of common stock for treasury

    0        0        (3,320     0        0        0        0        0        (3,320

Reissuance of shares of common stock from treasury

    0        0        5,530        431        0        0        0        0        5,961   

Common stock issued

    304        0        0        3,737        0        0        0        0        3,737   

Distributions to noncontrolling interest holders

    0        0        0        0        0        0        (900     0        (900

Unrealized gain on cash flow hedge, net of tax

    0        0        0        0        0        (39     0        (39     (39

Capital contributions from noncontrolling interest holders

    0        0        0        0        0        0        8,754        0        8,754   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, June 30, 2011

    22,374      $ 22      $ 0      $ 123,689      $ 8,751      $ (102   $ 21,915      $ 40,828      $ 154,275   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to consolidated financial statements.

 

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JMP Group Inc.

Consolidated Statements of Cash Flows

(Unaudited)

(In thousands)

 

     Six Months Ended June 30,  
     2011     2010  

Cash flows from operating activities:

    

Net income

   $ 7,661      $ 5,034   

Adjustments to reconcile net income to net cash (used in) provided by operating activities:

    

Provision for loan losses

     354        455   

Accretion of deferred loan fees

     (762     (745

Amortization of liquidity discount, net

     8,533        686   

Gain on sale and payoff of loans

     (13,608     (19,242

Change in other investments:

    

Fair value

     (4,618     (1,002

Incentive fees reinvested in general partnership interests

     (2,410     (530

Impairment loss on purchased management contract

     700        0   

Depreciation and amortization of fixed assets

     337        337   

Stock-based compensation expense

     1,026        2,317   

Deferred income taxes

     2,302        3,770   

Net change in operating assets and liabilities:

    

Decrease in interest receivable

     87        46   

(Increase) in receivables

     (925     (1,540

(Increase) in marketable securities

     (1,812     (9,237

Decrease (increase) in restricted cash (excluding restricted cash reserved for lending activities), deposits and other assets

     6,781        (7,584

Increase in marketable securities sold, but not yet purchased

     1,950        8,861   

(Decrease) increase in interest payable

     (16     106   

(Decrease) in accrued compensation and other liabilities

     (10,139     (15,187
  

 

 

   

 

 

 

Net cash used in operating activities

     (4,559     (33,455
  

 

 

   

 

 

 

Cash flows from investing activities:

    

Purchases of fixed assets

     (921     (641

Purchases of other investments

     (10,126     (20,573

Sales of other investments

     4,576        25,150   

Funding of loans collateralizing asset-backed securities issued

     (160,044     (164,579

Funding of loans held for investment

     0        (250

Sale and payoff of loans collateralizing asset-backed securities issued

     148,723        120,530   

Principal receipts on loans collateralizing asset-backed securities issued

     16,706        47,057   

Principal receipts on loans held for investment

     813        150   

Net change in restricted cash reserved for lending activities

     (5,410     (3,209
  

 

 

   

 

 

 

Net cash (used in) provided by investing activities

     (5,683     3,635   
  

 

 

   

 

 

 

 

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JMP Group Inc.

Consolidated Statements of Cash Flows - (Continued)

(Unaudited)

(In thousands)

 

Cash flows from financing activities:

    

Proceeds from issuance of note payable

     0        5,000   

Repayment of note payable

     (2,619     (868

Repayment of asset-backed securities issued

     0        (3,475

Cash dividends paid to stockholders

     (1,001     (547

Purchases of shares of common stock for treasury

     (3,320     (7,242

Capital contributions of noncontrolling interest holders

     8,748        4,149   

Distributions to noncontrolling interest shareholders

     (900     0   

Excess tax benefit related to stock-based compensation

     (335     (279
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     573        (3,262
  

 

 

   

 

 

 

Net decrease in cash and cash equivalents

     (9,669     (33,082

Cash and cash equivalents, beginning of period

     71,114        75,680   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 61,445      $ 42,598   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid during the period for interest

   $ 2,594      $ 2,461   

Cash paid during the period for taxes

   $ 5,598      $ 1,376   

Non-cash investing and financing activities:

    

Reissuance of shares of common stock from treasury related to vesting of restricted stock units and exercises of stock options

   $ 5,530      $ 4,889   

See accompanying notes to consolidated financial statements.

 

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JMP GROUP INC.

Notes to Consolidated Financial Statements

June 30, 2011

(Unaudited)

1. Organization and Description of Business

JMP Group Inc., together with its subsidiaries (collectively, the “Company”), is an independent investment banking and asset management firm headquartered in San Francisco, California. JMP Group Inc. completed its initial public offering on May 16, 2007, and also completed a corporate reorganization in connection with the initial public offering. The Company conducts its brokerage business through JMP Securities LLC (“JMP Securities”), its asset management business through Harvest Capital Strategies LLC (“HCS”), its corporate credit business through JMP Credit Corporation (“JMP Credit”) and JMP Credit Advisors LLC (“JMPCA”), and certain principal investments through JMP Capital LLC (“JMP Capital”). All of the above entities are wholly-owned subsidiaries. JMP Securities is a U.S. registered broker-dealer under the Securities Exchange Act of 1934, as amended, and is a member of the Financial Industry Regulatory Authority (“FINRA”). JMP Securities operates as an introducing broker and does not hold funds or securities for, or owe any money or securities to, customers and does not carry accounts for customers. All customer transactions are cleared through another broker-dealer on a fully disclosed basis. HCS is a registered investment advisor under the Investment Advisers Act of 1940, as amended, and provides investment management services for sophisticated investors in investment partnerships and other entities managed by HCS. Effective April 7, 2009, through its majority-owned subsidiary JMP Credit, the Company completed the acquisition of 100% of the membership interests of Cratos Capital Partners, LLC (changed its name to JMP Credit Advisors LLC on July 12, 2010) and its subsidiaries, including Cratos Capital Management, LLC (which collectively, “Cratos”), a manager of collateralized loan obligations (“CLO”), together with certain securities of Cratos CLO I, Ltd. (“Cratos CLO”). See Note 2 for further details regarding the ownership of Cratos CLO.

2. Summary of Significant Accounting Policies

Basis of Presentation

These consolidated financial statements and related notes are unaudited and have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. These consolidated financial statements should be read in conjunction with the Company’s consolidated financial statements and notes thereto included in its annual report on Form 10-K for the year ended December 31, 2010. These consolidated financial statements reflect all adjustments (consisting only of normal recurring adjustments) that are, in the opinion of management, necessary for the fair statement of the results for the interim periods. The results of operations for any interim period are not necessarily indicative of the results to be expected for a full year.

The consolidated accounts of the Company include the wholly-owned subsidiaries, JMP Securities, HCS, JMP Capital, JMP Credit, JMPCA, and the partially-owned subsidiaries Harvest Growth Capital LLC (“HGC”) (effective April 1, 2010) and Cratos CLO. All material intercompany accounts and transactions have been eliminated in consolidation.

Harvest Mortgage Opportunities Partners (“HMOP”), a hedge fund managed by HCS, had been consolidated from May 1, 2009 through December 31, 2010. On December 31, 2010, HMOP was liquidated, with all of its partners redeeming their interests as of that date. The assets of HMOP were distributed to its partners in January 2011.

The Company follows the authoritative accounting guidance for the consolidation of variable interest entities (“VIEs”). Such guidance applies to VIEs, which are entities in which equity investors do not have the characteristics of a controlling financial interest or do not have sufficient equity at risk for the entity to finance its activities without additional subordinated financial support from other parties. When the Company enters into a transaction with a VIE, the Company determines if it is the primary beneficiary of the VIE by performing a qualitative analysis of the VIE that includes a review of, among other factors, its capital structure, contractual terms, related party relationships, the Company’s fee arrangements and the design of the VIE. The Company performed this analysis for Cratos CLO and concluded that Cratos CLO is a VIE and that the Company, which manages the CLO and owns approximately 94% of the subordinated notes in the CLO, is deemed the primary beneficiary. As a result, the Company consolidates the assets and liabilities of the CLO and the underlying loans owned by the CLO entity are shown on our Consolidated Statements of Financial Condition under loans collateralizing asset-backed securities issued and the asset-backed securities (“ABS”) issued to third parties are shown under asset-backed securities issued. See Note 6 and Note 10 for the information pertaining to the loans owned and ABS issued by Cratos CLO, respectively.

 

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HCS currently manages several asset management funds, which are structured as limited partnerships, and is the general partner of each. In assessing whether or not to consolidate these funds, the Company follows the accounting guidance on determining whether a general partner controls a limited partnership. Such guidance provides that the presumption that the general partner controls the limited partnership may be overcome if the limited partners have substantive kick-out rights. Except for HMOP and HGC, the partnership agreements for these funds provide for the right of the limited partners to remove the general partners by a simple majority vote of the non-affiliated limited partners. Because of these substantive kick-out rights, the Company, as the general partner, does not control these funds, and therefore does not consolidate them except for HGC, and prior to December 31, 2010, HMOP. The Company accounts for its investments in these non-consolidated funds under the equity method of accounting. In December 2009, the accounting guidance on consolidation was amended to improve the financial reporting by entities involved in VIEs. In February 2010, the consolidation requirements under the amended accounting guidance were indefinitely deferred for a reporting entity’s interest in entities that have the attributes of an investment company or for which it is industry practice to apply the specialized industry accounting guidance for investment companies. The Company’s investments in the above asset management funds qualify for the deferral, and therefore the new consolidation requirements did not impact our accounting for these funds. If the deferral were to be removed, the Company would be required to evaluate these funds under the new accounting guidance, and based on such evaluation, some if not all of the funds may require consolidation.

Noncontrolling interest on the Consolidated Statements of Financial Condition at June 30, 2011 and December 31, 2010 relate to the interest of third parties in Cratos CLO and HGC, partially-owned subsidiaries consolidated in our financial statements. On August 6, 2010, the Company and individual employee security holders (the “Unitholders”) of JMP Credit entered into an Exchange Agreement providing for, among other things, an offer to buy the minority interest units and shares in JMP Credit held by the Unitholders in exchange for a combination of (i) restricted common stock of the Company par value $.001 per share, (ii) cash and (iii) certain Cratos CLO subordinated notes. In connection with the Exchange Agreement, the Company issued an aggregate of 381,310 shares of restricted stock and transferred 109 subordinated notes to the Unitholders and the Company received all the remaining units and shares of JMP Credit that it did not previously own. The restricted stock and the Cratos CLO notes are subject to limitations on transfer and repurchase rights of the Company in the event of certain terminations of the Unitholder’s employment with the Company or its affiliates through June 1, 2013. As a result of this transaction, the Company’s ownership of JMP Credit increased from approximately 93% to 100% and the Company’s ownership of Cratos CLO decreased from 100% to approximately 94% effective August 6, 2010.

JMP Realty Trust (“JMPRT”) was a real estate investment trust that was formed in June 2006. As of December 31, 2008, the Company owned 49.5% of JMPRT and certain employees owned 20.1%. Because of its ownership and management position, the Company consolidated JMPRT and recorded a noncontrolling interest through December 31, 2008. On January 2, 2009, all of the assets and liabilities within JMPRT were transferred to HMOP. HMOP was a Delaware limited partnership organized for the purposes of investing in real estate-related assets which may include investments in residential or commercial mortgages or loans, real estate and other assets, loans and participation in loans of all types, other specialty mortgage products, and securities. HCS was the general partner of HMOP. Because of substantive kick-out rights, the Company, as the general partner, did not control HMOP and therefore did not consolidate HMOP from January 2, 2009 through April 30, 2009. During the quarter ended June 30, 2009, several non-affiliated limited partners redeemed their interest in HMOP, and the remaining limited partners were no longer deemed to have substantive kick-out rights. As a result, the Company consolidated HMOP in its consolidated financial statements effective May 1, 2009. HMOP was liquidated on December 31, 2010, with all of its partners redeeming their interests as of that date. The assets of HMOP were distributed to its partners in January 2011.

On July 31, 2009, JMP Capital received 100% of the membership interest in LSC III, LLC (“LSC”) in full satisfaction of a $2.4 million non-revolving credit note. LSC is an investment partnership and owns shares of common and preferred stock of two privately-held companies. LSC subsequently changed its name to Harvest Growth Capital LLC (“HGC”) and amended its limited liability company agreement. Under the amended agreement, HGC appointed HCS as the manager, accepted new members and launched on April 1, 2010 as a new private equity fund. JMP Capital retained an interest in one privately-held company which was valued at $0.6 million as of April 1, 2010. The members of HGC do not have substantive kick-out rights to remove HCS as manager and therefore HCS is deemed to control HGC. As a result, the Company consolidates HGC in its consolidated financial statements.

 

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On January 18, 2008, JMP Group Inc. and certain unconsolidated affiliates made an investment in Series A Cumulative Redeemable Convertible preferred stock of New York Mortgage Trust, Inc. (“NYMT”), a publicly traded real estate investment trust engaged in the investment management of mortgage-backed securities and high credit quality residential adjustable rate mortgage loans. Such investment by JMP Group Inc. and affiliated entities was $20.0 million in total, comprised of $5.0 million by JMP Group Inc., $5.0 million by certain funds managed by HCS, and $10.0 million by JMPRT. JMPRT’s investment in NYMT was transferred to HMOP on January 2, 2009. In addition, JMP Group Inc. invested $4.5 million in the common stock of NYMT on February 14, 2008 via a private investment in public equity (“PIPE”) transaction. The Series A Preferred Stock was convertible into shares of NYMT’s common stock based on a conversion price of $8.00 per share of common stock, which represents a conversion rate of two and one-half (2 1/2) shares of common stock for each share of Series A Cumulative Redeemable Convertible preferred stock. The Series A Cumulative Redeemable Convertible preferred stock was scheduled matured on December 31, 2010. JMP Group Inc. also entered into an advisory agreement between HCS and NYMT to manage certain non-agency assets. The advisory agreement was terminated effective July 26, 2010 upon execution of an amended and restated advisory agreement between HCS and NYMT. Under the amended advisory agreement, HCS manages certain assets of NYMT, which are subject to the base advisory fee and incentive fee calculations, and receives an annual consulting fee equal to $1.0 million. On December 31, 2010, all of the 1.0 million shares of Series A Cumulative Redeemable Convertible preferred stock of NYMT owned by JMP Group Inc. and certain of its affiliates matured and were redeemed at a price per share of $20.00 for a total of $20.0 million. Under the amended advisory agreement, in order to maintain certain rights under the agreement we are required to maintain a minimum $10.0 million of investment commitment in NYMT’s common stock, subject to certain adjustments for variations in NYMT’s stock price subsequent to the effective date of the agreement. At June 30, 2011 and December 31, 2010, the Company had an investment in NYMT’s common stock of $10.7 million and $10.0 million, respectively, which represented 15.2% of NYMT’s outstanding shares of common stock at both periods. Because of its current ownership and management position, the Company does not consolidate NYMT.

Revision to 2010 Consolidated Financial Statements

In preparing the consolidated financial statements for the quarter ended March 31, 2011, the Company discovered an error that impacted the company’s previously issued consolidated financial statements for the second quarter of 2010, the third quarter of 2010 and for the year ended December 31, 2010. The net after tax effect of this error together with errors previously identified, was an understatement of net income of $0.7 million for the year ended December 31, 2010 ($31,000 for the second quarter of 2010, $384,000 for the third quarter of 2010 and $327,000 for the fourth quarter of 2010). The adjustments were primarily related to the newly identified error, a difference in the determination of taxable income, causing a $0.6 million impact to income tax expense for the year ended December 31, 2010 ($31,000 for the second quarter of 2010, $397,000 for the third quarter of 2010 and $148,000 for the fourth quarter of 2010.) The Company evaluated these errors and concluded that they did not, individually or in the aggregate, result in a material misstatement of the company’s previously issued consolidated financial statements. However, the Company also concluded that the effect of correcting the errors in the first quarter of 2011 would have been misleading to the users of the financial statements for the quarter ended March 31, 2011 and expected results for the year ended December 31, 2011. Accordingly, the Company has determined to revise, in this report and future filings, its previously reported Consolidated Statements of Financial Condition as of June 30, 2010, September 30, 2010 and December 31, 2010 and its Consolidated Statements of Operations and Changes in Equity for the periods ended June 30, 2010, September 30, 2010 and December 31, 2010 to adjust for these errors. The effect of this revision had no impact on our Consolidated Statement of Cash Flows.

 

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A summary of the revisions to the Consolidated Financial Statements as of June 30, 2010, September 30, 2010 and December 31, 2010 is as follows:

 

     As Previously
Reported
     Adjustment     As Revised  
(In thousands, except per common share data)                    
Consolidated Statements of Operation        
     For the Three Months Ended June 30, 2010  

Income tax expense

   $ 2,133       $ (31   $ 2,102   

Net income

     2,983         31        3,014   

Net income attributable to JMP Group Inc.

     2,185         31        2,216   

Net income attributable to JMP Group Inc. per common share:

       

Basic

   $ 0.10       $ 0.00      $ 0.10   

Diluted

   $ 0.10       $ 0.00      $ 0.10   
     For the Six Months Ended June 30, 2010  

Income tax expense

   $ 3,522       $ (31   $ 3,491   

Net income

     5,003         31        5,034   

Net income attributable to JMP Group Inc.

     3,903         31        3,934   

Net income attributable to JMP Group Inc. per common share:

       

Basic

   $ 0.18       $ 0.00      $ 0.18   

Diluted

   $ 0.17       $ 0.01      $ 0.18   
Consolidated Statements of Financial Condition        
     As of June 30, 2010  

Deferred tax assets

   $ 41,994       $ 31      $ 42,025   

Total assets

     580,836         31        580,867   

Retained earnings

     2,203         31        2,234   

Total JMP Group Inc. stockholders’ equity

     121,276         31        121,307   

Total equity

     131,541         31        131,572   

Total liabilities and equity

     580,836         31        580,867   
Consolidated Statements of Changes in Equity        
     For the Six Months Ended June 30, 2010  

Net Income

   $ 3,903       $ 31      $ 3,934   

Retained Earnings- Balance, June 30, 2010

     2,203         31        2,234   

 

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     As Previously
Reported
     Adjustment     As Revised  
(In thousands, except per common share data)                    
Consolidated Statements of Operation        
     For the Three Months Ended September 30, 2010  

Interest income

   $ 11,525       $ (23   $ 11,502   

Net interest income

     2,986         (23     2,963   

Total net revenues after provision for loan losses

     32,681         (23     32,658   

Income before income tax expense

     4,579         (23     4,556   

Income tax expense

     1,943         (407     1,536   

Net income

     2,636         384        3,020   

Net income attributable to JMP Group Inc.

     1,431         384        1,815   

Net income attributable to JMP Group Inc. per common share:

       

Basic

   $ 0.07       $ 0.01      $ 0.08   

Diluted

   $ 0.06       $ 0.02      $ 0.08   
     For the Nine Months Ended September 30, 2010  

Interest income

   $ 36,106       $ (23   $ 36,083   

Net interest income

     11,017         (23     10,994   

Total net revenues after provision for loan losses

     100,745         (23     100,722   

Income before income tax expense

     13,103         (23     13,080   

Income tax expense

     5,464         (438     5,026   

Net income

     7,639         415        8,054   

Net income attributable to JMP Group Inc.

     5,334         415        5,749   

Net income attributable to JMP Group Inc. per common share:

       

Basic

   $ 0.25       $ 0.02      $ 0.27   

Diluted

   $ 0.24       $ 0.02      $ 0.26   
Consolidated Statements of Financial Condition        
     As of September 30, 2010  

Deferred tax assets

   $ 37,727       $ 438      $ 38,165   

Total assets

     603,303         438        603,741   

Other liabilities

     28,289         23        28,312   

Total liabilities

     470,779         23        470,802   

Retained earnings

     753         415        1,168   

Total JMP Group Inc. stockholders’ equity

     122,124         415        122,539   

Total equity

     132,524         415        132,939   

Total liabilities and equity

     603,303         438        603,741   
Consolidated Statements of Changes in Equity        
     For the Nine Months Ended September 30, 2010  

Net Income

   $ 5,334       $ 415      $ 5,749   

Retained Earnings - Balance, September 30, 2010

     753         415        1,168   

 

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     As Previously
Reported
     Adjustment     As Revised  
(In thousands, except per common share data)                    
Consolidated Statements of Operation        
     For the Year Ended December 31, 2010  

Investment banking revenues

   $ 45,519       $ 58      $ 45,577   

Non-interest revenues

     134,507         58        134,565   

Interest income

     45,209         (47     45,162   

Net interest income

     11,522         (47     11,475   

Total net revenues after provision for loan losses

     144,702         11        144,713   

Travel and business development

     3,401         46        3,447   

Administration

     5,767         (15     5,752   

Professional fees

     3,380         (300     3,080   

Total non-interest expenses

     123,997         (269     123,728   

Income before income tax expense

     20,705         280        20,985   

Income tax expense

     9,039         (462     8,577   

Net income

     11,666         742        12,408   

Net income attributable to JMP Group Inc.

     8,861         742        9,603   

Net income attributable to JMP Group Inc. per common share:

       

Basic

   $ 0.41       $ 0.03      $ 0.44   

Diluted

   $ 0.40       $ 0.03      $ 0.43   
Consolidated Statements of Financial Condition        
     As of December 31, 2010  

Investment banking fees receivable

   $ 9,706       $ 58      $ 9,764   

Deferred tax assets

     32,542         (35     32,507   

Other assets

     8,008         (10     7,998   

Total assets

     637,852         13        637,865   

Other liabilities

     34,172         (729     33,443   

Total liabilities

     496,542         (729     495,813   

Retained earnings

     3,954         742        4,696   

Total JMP Group Inc. stockholders’ equity

     129,854         742        130,596   

Total equity

     141,310         742        142,052   

Total liabilities and equity

     637,852         13        637,865   
Consolidated Statements of Changes in Equity        
     For the Year Ended December 31, 2010  

Net Income

   $ 8,861       $ 742      $ 9,603   

Retained Earnings - Balance, December 31, 2010

     3,954         742        4,696   

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires the use of estimates and assumptions that affect both the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported amounts of revenues and expenses during the reporting period. Actual results may differ from those estimates.

 

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Revenue Recognition

Investment Banking Revenues

Investment banking revenues consist of underwriting revenues, strategic advisory revenues and private placement fees, and are recorded when the underlying transaction is completed under the terms of the relevant agreement. Underwriting revenues arise from securities offerings in which the Company acts as an underwriter and include management fees, selling concessions and underwriting fees, net of related syndicate expenses. Management fees and selling concessions are recorded on the trade date, which is typically the day of pricing an offering (or the following day) and underwriting fees, net of related syndicate expenses, at the time the underwriting is completed and the related income is reasonably determinable. For these transactions, management estimates the Company’s share of the transaction-related expenses incurred by the syndicate, and recognizes revenues net of such expense. On final settlement, typically 90 days from the trade date of the transaction, these amounts are adjusted to reflect the actual transaction-related expenses and the resulting underwriting fee. Expenses associated with such transactions are deferred until the related revenue is recognized or the engagement is otherwise concluded. If management determines that a transaction is likely not to be completed, deferred expenses related to that transaction are expensed at that time. In connection with some underwritten transactions, the Company may hold in inventory, for a period of time, equity positions to facilitate the completion of the underwritten transactions. Realized and unrealized net gains and losses on these positions are recorded within investment banking revenues. Strategic advisory revenues primarily include success fees on closed merger and acquisition transactions, as well as retainer fees, earned in connection with advising on both buyers’ and sellers’ transactions. Fees are also earned for related advisory work and other services such as providing fairness opinions and valuation analyses. Strategic advisory revenues are recorded when the transactions or the services (or, if applicable, separate components thereof) to be performed are substantially complete, the fees are determinable and collection is reasonably assured. Private placement fees are related to non-underwritten transactions such as private placements of equity securities, private investments in public equity (“PIPE”), Rule 144A private offerings and trust preferred securities offerings and are recorded on the closing date of the transaction. Unreimbursed expenses associated with strategic advisory and private placement transactions, net of client reimbursements, are recorded in the Consolidated Statements of Operations within various expense captions other than compensation expense.

Brokerage Revenues

Brokerage revenues consist of (i) commissions resulting from equity securities transactions executed as agent or principal and are recorded on a trade date basis, (ii) related net trading gains and losses from market making activities and from the commitment of capital to facilitate customer orders and (iii) fees paid for equity research. The Company currently generates revenues from research activities through three types of arrangements. First, through what is commonly known as a “soft dollar” practice, a portion of a client’s commissions may be compensation for the value of access to our research. Those commissions are recognized on a trade date basis, as the Company has no further obligation. Second, a client may issue a cash payment directly to the Company for access to research. Third, the Company has entered into certain commission-sharing or tri-party arrangements in which institutional clients execute trades with a limited number of brokers and instruct those brokers to allocate a portion of the commission to the Company or to issue a cash payment to the Company.

In these commission-sharing or tri-party arrangements, the amount of the fee is determined by the client on a case-by-case basis and agreed to by the Company. An invoice is then sent to the payor. For the second and third type of arrangements, revenue is recognized and an invoice is sent once an arrangement exists, access to research has been provided, a specific amount is fixed or determinable, and collectibility is reasonably assured. None of these arrangements obligate clients to a fixed amount of fees for research, either through trading commissions or direct or indirect cash payments, nor do they obligate the Company to provide a fixed quantity of research or execute a fixed number of trades. Furthermore, the Company is not obligated under any arrangement to make commission payments to third parties on behalf of clients.

 

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Asset Management Fees

Asset management fees for hedge funds, funds of funds and private equity funds consist of base management fees and incentive fees. The Company recognizes base management fees on a monthly basis over the period in which the investment services are performed. Base management fees earned by the Company are generally based on the fair value of assets under management and the fee schedule for each fund and account. Base management fees for hedge funds and hedge funds of funds are calculated at the investor level using their quarter-beginning capital balance adjusted for any contributions or withdrawals. Base management fees for private equity funds are calculated at the investor level using their aggregate capital commitments during the commitment period, which is generally three years from first closing, and on invested capital following the commitment period. The Company also earns incentive fees for hedge funds and hedge funds of funds that are based upon the performance of investment funds and accounts. Such fees are either a specified percentage of the total investment return of a fund or account or a percentage of the excess of an investment return over a specified highwater mark or hurdle rate over a defined performance period. For most funds, the highwater mark is calculated using the greatest value of a partner’s capital account as of the end of any performance period, increased for contributions and decreased for withdrawals. Incentive fees are recognized as revenue at the end of the specified performance period. The performance period used to determine the incentive fee is quarterly for the hedge funds and NYMT, and annually for the hedge funds of funds managed by HCS. Generally the incentive fees are reinvested in the investment funds in which we hold a general partner investment. The incentive fees are not subject to any contingent repayments to investors or any other claw back arrangements. Incentive fees for private equity funds are based on a specified percentage of realized gains from the disposition of each portfolio investment in which each investor participates, and are earned by the Company after returning contributions by the investors for that portfolio investment and for all other portfolio investments in which each such investor participates that have been disposed of at the time of distribution.

Asset management fees for the two CLOs the Company manages currently consist only of senior and subordinated base management fees. For one of the CLOs, the Company earns incentive fees in the event that specified cumulative investment returns are achieved, but such investment returns have not been achieved yet. The Company recognizes base management fees for the CLOs on a monthly basis over the period in which the collateral management services are performed. The base management fees for the CLOs are calculated as a percentage of the average aggregate collateral balances for a specified period. As we consolidate Cratos CLO, the management fees earned at JMPCA from Cratos CLO are eliminated on consolidation in accordance with U.S. GAAP.

Principal Transactions

Principal transaction revenues include realized and unrealized net gains and losses resulting from our principal investments in equity and other securities for the Company’s account and in equity-linked warrants received from certain investment banking assignments, as well as limited partner investments in private funds managed by third parties, our investment in NYMT and interest rate cap. Unrealized gain (loss) on interest rate cap was recorded in principal transaction revenues through June 30, 2010. Effective July 1, 2010, such gain (loss) is recorded in other comprehensive income (loss). See Note 4 and Note 9 for more information on the interest rate cap. Principal transaction revenues also include earnings (or losses) attributable to investment partnership interests held by our asset management subsidiary, HCS, which are accounted for using the equity method of accounting. Principal transaction revenues also include unrealized gains and losses on the private equity securities owned by HGC, a private equity fund managed by HCS which is consolidated in our financial statements, as well as unrealized gains and losses on the investments in private companies sponsored by HCS and JMP Capital.

The Company’s principal transaction revenues for these categories for the three and six month periods ended June 30, 2011 and 2010 are as follows:

 

(In thousands)    Three Months Ended June 30,     Six Months Ended June 30,  
         2011              2010             2011              2010      

Equity and other securities

   $ 1,472       $ (50   $ 4,645       $ 1,295   

Warrants and other investments

     243         (43     365         174   

Investment partnerships

     839         504        1,174         364   
  

 

 

    

 

 

   

 

 

    

 

 

 

Total principal transaction revenues

   $ 2,554       $ 411      $ 6,184       $ 1,833   
  

 

 

    

 

 

   

 

 

    

 

 

 

 

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Gain on Sale and Payoff of Loans

Gain on sale and payoff of loans consists of gains from the sale and payoff of loans collateralizing asset-backed securities at JMP Credit. Gains are recorded when the proceeds exceed our carrying value of the loan.

Interest Income

Interest income primarily relates to income earned on loans. Interest income on loans is comprised of the stated coupon as a percentage of the face amount receivable as well as accretion of accretable or purchase discounts and deferred fees, see Loans held for investment and Loans collateralizing asset-backed securities issued for more information. Interest income is recorded on the accrual basis in accordance with the terms of the respective loans unless such loans are placed on non-accrual status.

Interest Expense

Interest expense primarily relates to expense incurred on asset-backed securities issued and note payable. Interest expense on asset-backed securities issued is the stated coupon as a percentage of the principal amount payable as well as amortization of liquidity discount which was recorded at the acquisition date of Cratos, see Asset-backed securities issued for more information. Interest expense is recorded on the accrual basis in accordance with the terms of the respective asset-backed securities issued and note payable.

Cash and Cash Equivalents

The Company considers highly liquid investments with original maturities or remaining maturities upon purchase of three months or less to be cash equivalents. The Company holds cash in financial institutions in excess of the FDIC insured limits. The Company periodically reviews the financial condition of the financial institutions and assesses the credit risk.

Restricted Cash and Deposits

Restricted cash and deposits include principal and interest payments that are collateral for the asset-backed securities issued by Cratos CLO. They also include proceeds from short sales deposited with brokers that cannot be removed unless the securities are delivered, cash collateral supporting standby letters of credit issued by JMP Credit, cash on deposit for operating leases, and cash on deposit with JMP Securities’ clearing broker. In addition, as of December 31, 2010, restricted cash and deposits included cash distributions payable to noncontrolling interest holders of HMOP of $10.5 million. HMOP was liquidated on December 31, 2010, with all of its partners redeeming their interests as of that date.

Restricted cash consisted of the following at June 30, 2011 and December 31, 2010:

 

(In thousands)    June 30, 2011      December 31, 2010  

Principal and interest payments held as collateral for asset-backed securities issued

   $ 28,879       $ 23,442   

Cash collateral supporting standby letters of credit

     248         379   

Cash collateral supporting indemnity agreement (Note 8)

     1,000         1,000   

Proceeds from short sales

     12,619         10,669   

Cash distributions payable to noncontrolling interest holders

     0         10,514   

Deposit with clearing broker

     255         255   

Deposits for operating leases

     1,128         1,459   
  

 

 

    

 

 

 
   $ 44,129       $ 47,718   
  

 

 

    

 

 

 

 

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Receivable from Clearing Broker

The Company clears customer transactions through another broker-dealer on a fully disclosed basis. At both June 30, 2011 and December 31, 2010, the receivable from clearing broker consisted solely of commissions related to securities transactions.

Investment Banking Fees Receivable

Investment banking fees receivable include receivables relating to the Company’s investment banking or advisory engagements. The Company records an allowance for doubtful accounts on these receivables on a specific identification basis. The allowance for doubtful accounts related to investment banking fees receivable were zero at June 30, 2011 and December 31, 2010.

Fair Value of Financial Instruments

The Company adopted amended accounting principles related to fair value measurements as of January 1, 2008. The amendment establishes a consistent framework for measuring fair value in accordance with GAAP and expands disclosures with respect to fair value measurements. The amendment applies to all financial instruments that are being measured and reported on a fair value basis. This includes those items currently reported in marketable securities owned, at fair value, other investments and marketable securities sold, not yet purchased, at fair value on the Consolidated Statements of Financial Condition. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. See Note 4 for the disclosures related to the fair value of our marketable securities and other investments.

Most of the Company’s financial instruments, other than loans collateralizing asset-backed securities issued, loans held for investment, asset-backed securities issued and investment in HuaMei Capital Company, Inc. (redeemed in December 2010), Sanctuary Wealth Services LLC, and a commercial mortgage originator sponsored by JMP Capital are recorded at fair value or amounts that approximate fair value. See Note 4 for the description of our investments in HuaMei Capital Company, Inc., Sanctuary Wealth Services LLC and a commercial mortgage originator sponsored by JMP Capital.

Marketable securities owned, other investments at fair value and marketable securities sold, but not yet purchased are stated at fair value, with related changes in unrealized appreciation or depreciation reflected in the line item principal transactions in the accompanying Consolidated Statements of Operations.

Fair value of the Company’s financial instruments is generally obtained from quoted market prices, broker or dealer price quotations, or alternative pricing methodologies that the Company believes offer reasonable levels of price transparency. To the extent that certain financial instruments trade infrequently or are non-marketable securities and, therefore, do not have readily determinable fair values, the Company estimates the fair value of these instruments using various pricing models and the information available to the Company that it deems most relevant. Among the factors considered by the Company in determining the fair value of financial instruments are discounted anticipated cash flows, the cost, terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, the Black-Scholes Options Valuation methodology adjusted for active market and other considerations on a case-by-case basis and other factors generally pertinent to the valuation of financial instruments.

Marketable securities owned and securities sold, but not yet purchased, consist of U.S. listed and over-the-counter (“OTC”) equity securities. Other investments include investments in private investment funds managed by the Company or its affiliates and an investment in a private investment fund managed by a third party. Such investments held by non-broker-dealer entities are accounted for under the equity method based on the Company’s share of the earnings (or losses) of the investee. The financial position and operating results of the private investment funds are generally determined on an estimated fair value basis. Generally, securities are valued (i) at their last published sale price if they are listed on an established exchange or (ii) if last sales prices are not published, at the highest closing “bid” price (for securities held “long”) and the lowest closing “asked” price (for “short” positions) as recorded by the composite tape system or such principal exchange, as the case may be. Where the general partner determines that market prices or quotations do not fairly represent the value of a security in the investment fund’s portfolio (for example, if a security is a restricted security of a class that is publicly traded) the general partner may assign a different value. The general partner will determine the estimated fair value of any assets that are not publicly traded.

 

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Also included in other investments are warrants on public and private common stock, private equity securities owned by HGC and JMP Capital, investments in private companies sponsored by HCS and JMP Capital and an interest rate cap derivative instrument. The warrants on public and private common stock are generally received as a result of investment banking transactions. Such warrants are fair valued at the date of issuance and marked-to-market as of each reporting period using the Black-Scholes Options Valuation methodology. The fair value of the private equity securities owned by HGC and JMP Capital is determined by the Company using comparable public company metrics discounted for private company market illiquidity. The interest rate cap derivative instrument fair value is determined from counterparty price quotations. The investments in private companies sponsored by HCS and JMP Capital are carried at cost and evaluated for impairment on a quarterly basis.

The Company follows the authoritative guidance included in GAAP on the fair value option which provides companies with a choice to report selected financial assets and financial liabilities at fair value. The election to use the fair value option is available at specified election dates, such as when an entity first recognizes a financial asset or financial liability or upon entering into a firm commitment. Subsequent changes in fair value must be recorded in the Consolidated Statements of Operations.

The Company received dividends of $0.3 million and $0.5 million during the three months ended June 30, 2011 and 2010 respectively, on NYMT stock, which were recorded in net dividend income on our Consolidated Statements of Operations. The Company received dividends on NYMT stock of $0.6 million and $1.1 million during the six months ended June 30, 2011 and 2010 respectively, which were recorded in net dividend income on our Consolidated Statements of Operations. For the three months ended June 30, 2011 and 2010, the Company recorded unrealized gain of $0.5 million and unrealized loss of $0.5 million on the investments in NYMT. For the six months ended June 30, 2011 and 2010, the Company recorded unrealized gain of $0.7 million and loss of $0.3 million on the investments in NYMT. The unrealized gains and losses on our investments in NYMT are reported in principal transactions in the Consolidated Statements of Operations.

Derivative Financial Instruments

The Company has entered into a derivative contract in order to hedge the interest rate exposure of its short-term and long-term borrowings. Currently, the Company does not enter into derivative contracts for any other purposes. Derivative financial instruments are recorded in the Consolidated Statements of Financial Condition at fair value. At the inception of the contract, the Company designated and documented the derivative contract as a hedge of a forecasted transaction or of the variability of cash flows to be received or paid related to a recognized asset or liability (“cash flow hedge”). For this cash flow hedge, the Company records changes in the fair value of the derivative to the extent that it is effective in other comprehensive (loss) income and subsequently reclassifies these changes in fair value to net income in the same period(s) that the hedged transaction affects earnings. Such reclassification from other comprehensive income (loss) to earnings is recorded in the same financial statement category as the hedged item. The Company formally documents at inception its hedge relationships, including identification of the hedging instruments and the hedged items, its risk management objectives, strategy for undertaking the hedge transaction and the Company’s evaluation of effectiveness of its hedged transactions. Periodically, the Company also formally assesses whether the derivative designated in each hedging relationship is expected to be and has been highly effective in offsetting changes in cash flows of the hedged item using the dollar offset method. If the Company determines that a derivative is not highly effective as a hedge, it discontinues hedge accounting.

Loans

Accounting guidance requires that the Company present and disclose certain information about its financing receivables by portfolio segment and/or by class of receivables. A portfolio segment is defined as the level at which an entity develops and documents a systematic methodology to determine the allowance for credit losses. A class of financing receivables is defined as the level of information (below a portfolio segment) that enables a reader to understand the nature and extent of exposure to credit risk arising from financing receivables. The Company’s portfolio segments are loans held for investment and loans collateralizing asset-backed securities issued. We have treated the loans held for investments segment as a single class given the small size of the loan portfolio. The classes within the loans collateralizing asset-backed securities issued portfolio segment are Asset Backed Loan (“ABL”), ABL – stretch, Cash Flow and Enterprise Value.

 

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Loans Held for Investment

Loans held for investment are carried at their unpaid principal balance, net of any allowance for credit losses or deferred loan origination or commitment fees. For loans held for investment, we establish and maintain an allowance for credit losses based on management’s estimate of credit losses in our loans as of each reporting date. The Company records the allowance against loans held for investment on a specific identification basis. Loans are charged off against the reserve for credit losses if the principal is deemed not recoverable within a reasonable timeframe. Loan origination and commitment fees are deferred and recognized into interest income in the Consolidated Statements of Operations over the life of the related loan. The Company does not accrue interest on loans which are in default for more than 90 days and loans for which we expect full principal payments may not be received. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Any reversals of income from previous years are recorded against the allowance for loan losses. When the Company receives a cash interest payment on a non-accrual loan, it is applied as a reduction of the principal balance. Non-accrual loans are returned to accrual status when the borrower becomes current as to principal and interest and has demonstrated a sustained period of payment performance. The amortization of loan fees is discontinued on nonaccrual loans. The Company applies the above nonaccrual policy consistently to all loans classified as loans held for investment without further disaggregation. Loans that are deemed to be uncollectible are charged off and the charged-off amount is deducted from the allowance.

Loans Collateralizing Asset-Backed Securities Issued

Loans collateralizing asset-backed securities issued are commercial loans securitized and owned by Cratos CLO. Loans acquired through the acquisition and resulting consolidation of Cratos were recorded at their fair value as of the acquisition date. Any unamortized deferred fees or costs related to the loans that existed prior to the acquisition were written off at that date.

For those loans deemed impaired as of the date of the acquisition, the total discount from outstanding principal balance to fair value consists of a nonaccretable credit discount and in most cases an accretable liquidity (or market value) discount. For the remaining loans acquired through the purchase of Cratos, any discounts to fair value were recorded as accretable liquidity discounts as they were not attributable to credit impairment. For both types of loans, the accretable portion of the discount is recognized into interest income as an adjustment to the yield of the loan over the contractual life of the loan using the interest method. For those loans deemed impaired as of the date of the acquisition, such accretion is discontinued when the net realizable value becomes equal or less than the carrying value. For the remaining loans acquired through the purchase of Cratos, such accretion is discontinued when the loan becomes impaired.

The Company continues to estimate the cash flows expected to be collected over the life of the loans acquired through the purchase of Cratos. If, upon subsequent evaluation, the Company believes it is unable to collect all cash flows expected at the acquisition date plus additional cash flows expected to be collected arising from changes in the estimate after the acquisition, the loan is considered impaired. Loans considered impaired at the acquisition date of Cratos continue to be assessed in accordance with the authoritative guidance under GAAP on loan impairment. If, based on current information and events, it is probable that there is a significant increase in cash flows previously expected to be collected or if actual cash flows are significantly greater than cash flows previously expected, the Company will first reduce any remaining credit discounts (including allowances for loan losses) for the loans established after its acquisition for the increase in the present value of cash flows expected to be collected. Then the Company will recalculate the amount of accretable yield for the loan as the excess of the revised cash flows expected to be collected over the sum of (a) the initial investment, less (b) cash collected, less (c) write-downs, plus (d) amount of yield accreted to date. The Company will adjust the amount of accretable yield by reclassification from nonaccretable discount. The adjustment is accounted for as a change in estimate, with the amount of periodic accretion adjusted over the remaining life of the loan. The resulting yield is then used as the effective interest rate in any subsequent accounting.

Loans purchased or originated after the acquisition date of Cratos are stated at the principal amount outstanding net of deferred fees, deferred costs and the allowance for loan losses. Net deferred fees or costs are recognized as an adjustment to interest income over the contractual life of the loans using the interest method. Remaining amounts are recognized into income when the related loans are paid off or sold. Any discount from principal amount of purchased loans is accreted into interest income as a yield adjustment over the contractual life of the loan using the interest method.

 

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The accrual of interest on loans is discontinued when principal or interest payments are 90 days or more past due or when, in the opinion of management, reasonable doubt exists as to the full collection of principal and/or interest. When loans are placed on nonaccrual status, all interest previously accrued but not collected is reversed against current period interest income. Any reversals of income from previous years are recorded against the allowance for loan losses. When the Company receives a cash interest payment on a non-accrual loan, it is applied as a reduction of the principal balance. Non-accrual loans are returned to accrual status when the borrower becomes current as to principal and interest and has demonstrated a sustained period of payment performance. The amortization of loan fees is discontinued on nonaccrual loans and may be considered for write-off. Depending on the terms of the loan, a fee may be charged upon a prepayment which is recognized in the period of the prepayment. The Company applies the above nonaccrual policy consistently to all loans classified as loans collateralizing asset-backed securities issued without further disaggregation.

Allowance for Loan Losses

The Company maintains an allowance for loan losses that is intended to estimate loan losses inherent in its loan portfolio. A provision for loan losses is charged to expense to establish the allowance for loan losses. The allowance for loan losses is maintained at a level, in the opinion of management, sufficient to offset estimated losses inherent in the loan portfolio as of the date of the financial statements. The appropriateness of the allowance and the allowance components are reviewed quarterly. The Company’s estimate of each allowance component is based on observable information and on market and third party data that the Company believes are reflective of the underlying loan losses being estimated.

The Company provides an allowance for loans that are considered impaired. A loan is considered impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. The Company measures impairment of a loan based upon either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price or the fair value of the collateral securing the loan if the loan is collateral dependent, depending on the circumstances and the Company’s collection strategy. For those loans held by Cratos at the date of acquisition by JMP Credit, and deemed impaired at that date or a subsequent date, allowance for loan losses is calculated considering two further factors. For loans deemed impaired at the date of acquisition, if there is a further decline in expected future cash flows, the reduction is recognized as a specific reserve in accordance with the guidance above. For those loans deemed impaired subsequent to the acquisition date, if the net realizable value is lower than the current carrying value, then the carrying value is reduced and the difference is booked as provision for loan losses. If the total discount from unpaid principal balance to carrying value is larger than the expected loss at the date of assessment, no provision for loan losses is recognized.

In addition, the Company provides an allowance on a loan by loan basis at JMP Credit for loans that were purchased after the Cratos acquisition. The Company employs internally developed and third party estimation tools for measuring credit risk (loan ratings, probability of default, and exposure at default), which are used in developing an appropriate allowance for loan losses. The Company performs periodic detailed reviews of its loan portfolio to identify risks and to assess the overall collectibility of loans.

Loans that are deemed to be uncollectible are charged off and the charged-off amount is deducted from the allowance.

Asset-Backed Securities Issued

Asset-backed securities (“ABS”) represent securities issued to third parties by Cratos CLO in 2007. The Company consolidated Cratos CLO for financial reporting purposes as of the April 7, 2009 acquisition date. At the acquisition date, the ABS were recorded at fair value, which comprised the principal balance outstanding less liquidity discount. The liquidity discount will be amortized into interest expense over the expected remaining lives of the ABS using the interest method.

Fixed Assets

Fixed assets represent furniture and fixtures, computer and office equipment, certain software costs and leasehold improvements, which are stated at cost less accumulated depreciation and amortization. Depreciation is computed on the straight-line basis over the estimated useful lives of the respective assets, ranging from three to five years.

Leasehold improvements are capitalized and amortized over the shorter of the respective lease terms or the estimated useful lives of the improvements.

 

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The Company capitalizes certain costs of computer software developed or obtained for internal use and amortizes the amount over the estimated useful life of the software, generally not exceeding three years.

Purchased Management Contract

Purchased management contract relates to the CLO contract the Company purchased from Princeton Advisory Group, Inc. on September 8, 2010 (see Note 8) and is included in other assets on the Consolidated Statements of Financial Condition. The purchased management contract is amortized over its estimated life. The Company tests the purchased management contract for impairment whenever events or changes in circumstances suggest that the asset’s carrying value may not be fully recoverable. An impairment loss, calculated as the difference between the estimated fair value and the carrying value of the asset, is recognized if the sum of the estimated undiscounted cash flows relating to the asset is less than the corresponding carrying value.

Income Taxes

The Company recognizes deferred tax assets and liabilities based upon the temporary differences between the financial reporting and tax bases of its assets and liabilities. Valuation allowances are established when necessary to reduce the deferred tax assets when it is more likely than not that a portion or all of the deferred tax assets will not be realized. The Company recognizes a tax benefit from an uncertain position only if it is more likely than not that the position is sustainable, based solely on its technical merits and consideration of the relevant taxing authority’s widely understood administrative practices and precedents. If this threshold is met, the Company measures the tax benefit as the largest amount of benefit that is greater than fifty percent likely of being realized upon ultimate settlement.

Stock-Based Compensation

The Company recognizes compensation cost for stock-based awards at their fair value on the date of grant and records compensation expense over the service period for awards expected to vest. Such grants are recognized as expense, net of estimated forfeitures.

Stock-based compensation includes restricted stock units and stock options granted under the Company’s 2007 Equity Incentive Plan, and stock options granted under the Company’s 2004 Equity Incentive Plan.

In accordance with generally accepted valuation practices for stock-based awards issued as compensation, the Company uses the Black-Scholes option-pricing model to calculate the fair value of option awards, although such models were originally developed to estimate the fair value of freely tradable, fully transferable options without vesting restrictions, which significantly differ from the Company’s stock options and restricted stock units. The Black-Scholes model requires subjective assumptions regarding variables such as future stock price volatility, dividend yield and expected time to exercise, which greatly affect the calculated values.

Treasury Stock

The Company accounts for treasury stock under the cost method, using an average cost flow assumption, and includes treasury stock as a component of shareholders’ equity.

 

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3. Recent Accounting Pronouncements

Accounting Standards Update (“ASU”) 2011-04: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The adoption of ASU 2011-04 gives fair value the same meaning between U.S. generally accepted accounting principles and International Financial Reporting Standards (IFRS), and improves consistency of disclosures relating to fair value. As a result of this standard, an entity is required to add more robust disclosures regarding the sensitivity of fair value measurements categorized within Level 3 of the fair value hierarchy. The standard is effective for interim periods beginning after December 15, 2011. The adoption of ASU 2011-04 is expected to result in additional disclosures within our consolidated financial statements.

ASU 2011-02, Receivables (Topic 310): A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring. In April 2011, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2011-02, which amends the accounting guidance for troubled debt restructurings. The new standard provides additional guidance for creditors in determining whether a creditor has granted a concession and whether a debtor is experiencing financial difficulties for purposes of determining whether a restructuring constitutes a troubled debt restructuring. The standard sets the effective dates for troubled debt restructuring disclosures required by recent guidance on credit quality disclosures. The standard is effective for interim and annual periods beginning on or after June 15, 2011, and is to be applied retrospectively to modifications occurring on or after the beginning of the annual period of adoption. For purposes of measuring impairments of receivables that are considered impaired as a result of applying the new guidance, the standard should be applied prospectively for the interim or annual period beginning on or after June 15, 2011. The adoption ASU 2011-02 is not expected to have a material impact on the Company’s consolidated financial position or results of operations.

ASU 2010-20, Receivables (Topic 310): Disclosure about the Credit Quality of Financing Receivables and the Allowance for Credit Losses. In July 2010, the FASB issued ASU 2010-20 which amends Topic 310 to improve the disclosures that an entity provides about the credit quality of its financing receivables and the related allowance for credit losses. As a result of these amendments, an entity is required to disaggregate by portfolio segment or class certain existing disclosures and provide certain new disclosures about its financing receivables and related allowance for credit losses. The disclosures required by ASU 2010-20 are effective for annual and interim periods ending on or after December 15, 2010 except for the new disclosures about the activity that occurs during a reporting period which are effective for annual and interim periods beginning on or after December 15, 2010. The Company adopted ASU 2010-20 in the fourth quarter of 2010. The adoption of ASU 2010-20 did not have an impact on our consolidated financial position or results of operations.

ASU 2009-17, Consolidation (Topic 810): Improvements to Financial Reporting by Enterprises Involved in Variable Interest Entities. In December 2009, the FASB issued ASU 2009-17 which amends the accounting guidance related to the consolidation of variable interest entities (“VIE”). The amendments replace the existing guidance on determining which reporting entity, if any, has a controlling financial interest in a VIE with an approach focused on identifying which reporting entity has (1) the power to direct the activities of a VIE that most significantly impact the entity’s economic performance and (2) the obligation to absorb losses or the right to receive benefits of the entity that could potentially be significant to the VIE. In February 2010, the FASB issued ASU 2010-10, Consolidation (Topic 810): Amendments for Certain Investment Funds, which indefinitely defers the consolidation requirements of ASU 2009-17 for a reporting entity’s interest in an entity that has all the attributes of an investment company or for which it is industry practice to apply the specialized industry accounting guidance for investment companies. The hedge funds and hedge funds of funds managed by HCS qualify for the deferral, and therefore, the Company continues to apply the historical accounting guidance related to the consolidation of VIEs to its investment in such funds. The Company adopted ASU 2009-17 and ASU 2010-10 in the first quarter of 2010, and the adoption of these amendments did not have an impact on our consolidated financial position or results of operations.

ASU 2010-06, Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements. In January 2010, the FASB issued ASU 2010-06 which provides amendments to ASC Subtopic 820-10 that will provide more robust disclosures about (1) the different classes of assets and liabilities measured at fair value, (2) the valuation techniques and inputs used, (3) the activity in Level 3 fair value measurements and (4) the transfers between Levels 1, 2, and 3. ASU 2010-06 is effective for annual and interim periods beginning after December 15, 2009, except for the requirement to provide the Level 3 activity on a gross basis which is effective for annual periods beginning after December 15, 2010 and for interim periods within those fiscal years. The Company adopted the standard in the first quarter of 2010, except for the additional disclosures related to the Level 3 activity, which the Company adopted in the first quarter of 2011. The Company’s adoption of ASU 2010-06 did not have an impact on our consolidated financial position or results of operations.

 

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4. Marketable Securities and Other Investments

Other Investments at Fair Value

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. In determining fair value, the Company uses various methods including market, income and cost approaches. Based on these approaches, the Company often utilizes certain assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated, or generally unobservable firm inputs. The Company generally utilizes valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. Based on the observability of the inputs used in the valuation techniques, the Company provides the following information according to the fair value hierarchy. The fair value hierarchy ranks the quality and reliability of the information used to determine fair values. Financial instrument assets and liabilities carried at fair value have been classified and disclosed in one of the following three categories:

 

Level 1    Quoted market prices in active markets for identical assets or liabilities.
Level 2    Observable market based inputs or unobservable inputs that are corroborated by market data.
Level 3    Unobservable inputs that are not corroborated by market data.

Level 1 primarily consists of financial instruments whose value is based on quoted market prices such as U.S. listed and OTC equity securities, all of which are carried at fair value.

Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including discounted anticipated cash flows, the cost, terms and liquidity of the instrument, the financial condition, operating results and credit ratings of the issuer or underlying company, the quoted market price of publicly traded securities with similar duration and yield, time value, yield curve, prepayment speeds, default rates, loss severity, as well as other measurements. Substantially all of these assumptions are observable in the marketplace, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace. Included in this category is the general partner investment in hedge funds, where the underlying hedge funds are mainly invested in publicly traded stocks whose value is based on quoted market prices.

Level 3 is comprised of financial instruments whose fair value is estimated based on internally developed models or methodologies utilizing significant inputs that are generally less readily observable from objective sources. A description of the valuation techniques utilized for the fair value of the financial instruments in this category is as follows:

 

   

General partner investment in funds of funds and limited partner investment in mortgage and private equity fund: determined by net asset value provided by third party general partners;

 

   

Warrants: determined by the Company using the Black-Scholes Options Valuation model; and

 

   

Private equity securities: HGC and JMP Capital investment in private companies, determined by the Company using comparable public company metrics discounted for private company market illiquidity.

At each reporting period, all assets and liabilities for which the fair value measurement is based on significant unobservable inputs are classified as “Level 3.”

 

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The following tables provide fair value information related to the Company’s financial assets and liabilities at June 30, 2011 and December 31, 2010:

 

(In thousands)    Assets at Fair Value as of  
   June 30, 2011  
   Level 1      Level 2      Level 3      Total  

Financial instruments owned, at fair value:

           

Marketable securities owned:

           

Equity securities

   $ 25,560       $ 0       $ 0       $ 25,560   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total marketable securities owned

   $ 25,560       $ 0       $ 0       $ 25,560   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other investments:

           

General partner investment in hedge funds

   $ 0       $ 26,295       $ 0       $ 26,295   

General partner investment in funds of funds

     0         0         105         105   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total general partner investment in funds

     0         26,295         105         26,400   

Limited partner investment in private equity fund

     0         0         3,184         3,184   

Warrants

     0         0         1,061         1,061   

Private equity securities

     0         4,715         17,200         21,915   

Interest rate cap

     35         0         0         35   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other investments

   $ 35       $ 31,010       $ 21,550       $ 52,595   
  

 

 

    

 

 

    

 

 

    

 

 

 
(In thousands)    Assets at Fair Value as of  
   December 31, 2010  
   Level 1      Level 2      Level 3      Total  

Financial instruments owned, at fair value:

           

Marketable securities owned:

           

Equity securities

   $ 23,748       $ 0       $ 0       $ 23,748   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total marketable securities owned

   $ 23,748       $ 0       $ 0       $ 23,748   
  

 

 

    

 

 

    

 

 

    

 

 

 

Other investments:

           

General partner investment in hedge funds

   $ 0       $ 23,629       $ 0       $ 23,629   

General partner investment in funds of funds

     0         0         102         102   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total general partner investment in funds

     0         23,629         102         23,731   

Limited partner investment in private equity fund

     0         0         3,063         3,063   

Warrants

     0         0         532         532   

Private equity securities

     0         0         11,245         11,245   

Interest rate cap

     101         0         0         101   
  

 

 

    

 

 

    

 

 

    

 

 

 

Total other investments

   $ 101       $ 23,629       $ 14,942       $ 38,672   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(In thousands)    Liabilities at Fair Value as of  
   June 30, 2011  
   Level 1      Level 2      Level 3      Total  

Financial instruments sold, but not yet purchased, at fair value:

           

Marketable securities sold, but not yet purchased

   $ 12,619       $ 0       $ 0       $ 12,619   
  

 

 

    

 

 

    

 

 

    

 

 

 
(In thousands)    Liabilities at Fair Value as of  
   December 31, 2010  
   Level 1      Level 2      Level 3      Total  

Financial instruments sold, but not yet purchased, at fair value:

           

Marketable securities sold, but not yet purchased

   $ 10,669       $ 0       $ 0       $ 10,669   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

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The tables below provide a reconciliation of the beginning and ending balances for the assets at fair value using significant unobservable inputs (Level 3) for the three months ended June 30, 2011 and 2010.

 

(In thousands)   Balance as of
March 31,
2011
    Purchases     Sales     Total gains
(losses) -
realized and
unrealized
included in
earnings
    Total gains
(losses) -
realized and
unrealized
included in
other
comprehensive
income
    Transfers
in/(out) of
Level 3
    Balance as of
June 30,
2011
    Unrealized
gains/(losses)
included in
earnings related
to assets still held
at reporting date
 

General partner investment in funds of funds

  $ 106      $ 0      $ 0      $ (1   $ 0      $ 0      $ 105      $ (1

Limited partner investment in private equity fund

    3,220        0        0        (36     0        0        3,184        (36

Warrants

    805        0        0        256        0        0        1,061        256   

Private equity securities

    12,149        6,954        0        (198     0        (1,705     17,200        (198
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3 assets

  $ 16,280      $ 6,954      $ 0      $ 21      $ 0      $ (1,705   $ 21,550      $ 21   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
(In thousands)   Balance as of
March 31,
2010
    Purchases     Sales     Total gains
(losses) -
realized and
unrealized
included in
earnings
    Total gains
(losses) -
realized and
unrealized
included in
other
comprehensive
income
    Transfers
in/(out) of
Level 3
    Balance as of
June 30,
2010
    Unrealized
gains/(losses)
included in
earnings related
to assets still held
at reporting date
 

General partner investment in funds of funds

  $ 3,018      $ 0      $ (2,950   $ 31      $ 0      $ 0      $ 99      $ 31   

Limited partner investment in private equity fund

    2,544        45        0        235        0        0        2,824        235   

Limited partner investment in mortgage fund

    584        0        (368     (2     0        0        214        (2

Investment in NYMT convertible preferred stock

    15,000        0        0        0        0        0        15,000        0   

Warrants

    233        0        0        (233     0        0        0        (233

Private equity securities

    2,690        2,443        0        18        0        0        5,151        18   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3 assets

  $ 24,069      $ 2,488      $ (3,318   $ 49      $ 0      $ 0      $ 23,288      $ 49   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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The tables below provide a reconciliation of the beginning and ending balances for the assets at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2011 and 2010.

 

(In thousands)   Balance as of
December 31,
2010
    Purchases     Sales     Total gains
(losses) -
realized and
unrealized
included in
earnings
    Total gains
(losses) -
realized and
unrealized
included in
other
comprehensive
income
    Transfers
in/(out) of
Level 3
    Balance as of
June 30,
2011
    Unrealized
gains/(losses)
included in
earnings related
to assets still held
at reporting date
 

General partner investment in funds of funds

  $ 102      $ 0      $ 0      $ 3      $ 0      $ 0      $ 105      $ 3   

Limited partner investment in private equity fund

    3,063        0        0        121        0        0        3,184        121   

Warrants

    532        15        0        514        0        0        1,061        514   

Private equity securities

    11,245        8,342        0        1,736        0        (4,123     17,200        1,736   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3 assets

  $ 14,942      $ 8,357      $ 0      $ 2,374      $ 0      $ (4,123   $ 21,550      $ 2,374   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 
(In thousands)   Balance as of
December 31,
2009
    Purchases     Sales     Total gains
(losses) -
realized and
unrealized
included in
earnings
    Total gains
(losses) -
realized and
unrealized
included in
other
comprehensive
income
    Transfers
in/(out) of
Level 3
    Balance as of
June 30,
2010
    Unrealized
gains/(losses)
included in
earnings related
to assets still held
at reporting date
 

General partner investment in funds of funds

  $ 2,933      $ 0      $ (2,950   $ 116      $ 0      $ 0      $ 99      $ 116   

Limited partner investment in private equity fund

    2,476        36        0        312        0        0        2,824        312   

Limited partner investment in mortgage fund

    1,147        0        (1,080     147        0        0        214        (2

Investment in NYMT convertible preferred stock

    15,000        0        0        0        0        0        15,000        0   

Private equity securities

    2,321        2,443        0        387        0        0        5,151        387   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Level 3 assets

  $ 23,877      $ 2,479      $ (4,030   $ 962      $ 0      $ 0      $ 23,288      $ 813   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Purchases and sales of Level 3 assets shown above were either purchased or sold during the period. The amounts were recorded at fair value at the date of the transaction.

Total gains and losses included in earnings (or changes in net assets) represent the total gains and/or losses (realized and unrealized) recorded for the Level 3 assets and are reported in Principal Transactions in the accompanying Consolidated Statements of Operations.

Transfers between levels of the fair value hierarchy result from changes in the observability of fair value inputs used in determining fair values for different types of financial assets and are recognized at the beginning of the reporting period in which the event or change in circumstances that caused the transfer occurs.

There were no transfers in/out of Level 1 during the three and six months ended June 30, 2011 and 2010. There was a transfer into Level 2 from Level 3 of $1.7 million for the three months ended June 30, 2011. There were two transfers into Level 2 from Level 3 of $4.1 million for the six months ended June 30, 2011, which were a result of the observability of fair value associated with the private equity securities. There were no transfers in/out of Level 2 during the three and six months ended June 30, 2010. In addition, there were no other transfers in/out of Level 3 during the three and six months ended June 30, 2011 and 2010.

The amount of unrealized gains and losses included in earnings attributable to the change in unrealized gains and losses relating to Level 3 assets still held at the end of the period are reported in Principal Transactions in the accompanying Consolidated Statements of Operations.

 

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Included in other investments are investments in partnerships in which one of the Company’s subsidiaries is the investment manager and general partner. The Company accounts for these investments using the equity method as described in Note 2. The Company’s share of those investments is included in the tables above. In addition, other investments include warrants, and two investments in funds managed by third parties.

Other Investments

On February 13, 2009, the Company entered into a business arrangement with China Merchants Securities Co. (HK), Ltd., a securities brokerage and investment banking firm, through a $2.0 million investment in HuaMei Capital Company, Inc. (“HuaMei”) to expand the Company’s investment banking capabilities in China. The Company accounted for its investment in HuaMei under the equity method of accounting within other investments on the Consolidated Statements of Financial Condition. In December 2010, the Company redeemed its investment in HuaMei and received $2.0 million in cash, resulting in no gain or loss.

On February 11, 2010, the Company made a $1.5 million investment in Class D Preferred Units of Sanctuary Wealth Services LLC (“Sanctuary”). Sanctuary provides a turnkey platform that will allow independent wealth advisors to establish an independent advisory business without the high startup costs and regulatory hurdles. The Class D Preferred Units entitle the Company to receive a preferred dividend with units that are convertible into equity of Sanctuary at the option of the Company prior to the maturity date, which is three years from the investment date. The Company carries its investment in Sanctuary at cost within other investments on the Consolidated Statements of Financial Condition and evaluates the investment for impairment on a quarterly basis. During the fourth quarter of 2010, the Company determined that its investment in Sanctuary is fully impaired and recorded an impairment loss of $1.5 million, which was included in Principal Transactions on the Consolidated Statements of Operations. The carrying value of the Company’s investment in Sanctuary was zero at December 31, 2010 and June 30, 2011.

In 2008, the Company made a $4.2 million loan to a private commercial mortgage originator in the form of a note and warrants. The loan was recorded net of loan loss reserves of $3.8 million and a deferred loan fee of $0.2 million at December 31, 2009. On February 10, 2010, the loan note was converted into non-voting preferred equity of a newly formed entity which succeeded to the assets of the borrower. As of the conversion date, the Company determined the fair value of both the loan note and the non-voting preferred equity of the newly formed entity to be zero, and therefore, recognized no gain or loss on the conversion. During the year ended December 31, 2010 and the six months ended June 30, 2011, the Company invested an additional $0.8 million and $0.3 million, respectively, in the newly formed entity for the commencement of a new commercial loan origination program. The Company carries its investment in the newly formed entity at cost within other investments on the Consolidated Statements of Financial Condition and evaluates the investment for impairment on a quarterly basis. In the fourth quarter of 2010 and the first half of 2011, the Company determined its investment in the newly formed entity is impaired and recorded a loss of $0.8 million and $0.3 million, respectively. The loss is included in principal transactions in the Consolidated Statements of Operations.

Derivative Financial Instruments

On May 29, 2010, the Company entered into an interest rate cap with City National Bank (the “Lender”) to effectively lock in or fix the interest rate on its revolving line of credit and term loan from July 1, 2010 through maturity. The interest rate cap will allow the Company to receive payments from the Lender in the event that LIBOR plus 2.25% exceeds 3.75%, limiting the interest rate on the outstanding balance of the line of credit and term loan to such rate. On July 1, 2010, the Company designated the interest rate cap as a cash flow hedge of the interest rate risk of a total of $23.6 million of outstanding borrowings with the Lender. See Note 9 for the information pertaining to the Company’s borrowing from the Lender.

The interest rate cap is recorded at fair value in other investments on the Consolidated Statements of Financial Condition, with unrealized gains and losses recorded as other comprehensive income. For the three and six months ended June 30, 2011, the Company recorded $0 million of other comprehensive loss representing unrealized loss on the interest rate cap. In addition, during the three and six months ended June 30, 2011, $13,674 and $27,348 were reclassified from accumulated other comprehensive income into interest expense as amortization of the interest cap.

 

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5. Loans Held for Investment

Loans held for investment at June 30, 2011 is comprised of one loan note. At December 31, 2010, loans held for investment also included advances on one non-revolving credit note commitment. Given the small size of this loan portfolio segment, the Company reviews credit quality of the loans within this portfolio segment on a loan by loan basis mainly focusing on the borrower’s financial position and results of operations as well as the current and expected future cash flows on the loan.

Non-Impaired Loans

As of December 31, 2010, the Company had a $0.8 million advance, on a $1.3 million non-revolving commitment to a public non-traded REIT. The advance currently had an interest rate of 20.0% per annum. The Company determined the credit quality of this loan to be high based on the borrower’s financial position, results of operations and payment history. This advance was fully paid in June 2011. As of June 30, 2011 and December 31, 2010, the Company had no unfunded credit commitments.

Impaired Loans

The Company had a loan outstanding at June 30, 2011 and December 31, 2010, which is a participation interest in a loan made by JMPRT to a client during 2007. The loan is collateralized by real estate related assets, and bears interest at the rate of 20.0% per annum, payable monthly in arrears. The principal of the loan was due and payable on December 1, 2007, but was extended until September 2008 for an additional fee at the borrower’s option and in connection with a partial repayment. At December 31, 2008, the outstanding principal balance of $0.8 million was in default and the loan was deemed impaired and was place on non-accrual status. The Company recorded a loan loss provision of $0.4 million in the third quarter of 2008, $0.1 million in the fourth quarter of 2009 and $0.3 million in the third quarter of 2010. Recovery of the loan is being sought through bankruptcy court proceedings; however, considering the legal cost it expects to incur, the Company believes that any significant recovery is doubtful. The recorded investment, outstanding principal and related allowance balance of the loan were each $0.8 million at June 30, 2011 and December 31, 2010. No interest income was recorded on this impaired loan for the three and six months ended June 30, 2011 and 2010.

In addition, in the third quarter of 2008, the Company made a $4.2 million loan to a private commercial mortgage originator in the form of a note and warrants. The loan was placed on non-accrual status on April 1, 2009. Accordingly, the interest payments of $0.2 million received subsequent to that date were applied to the principal balance, reducing the outstanding principal balance to $4.0 million at December 31, 2009. At December 31, 2009, the carrying value of the loan was zero, net of loan loss reserves of $3.8 million and a deferred loan fee of $0.2 million. On February 10, 2010, the loan note was converted into non-voting preferred equity of a newly formed entity which succeeded to the assets of the borrower. As of the conversion date, the Company determined the fair value of both the loan note and the non-voting preferred equity of the newly formed entity to be zero, and therefore, recognized no gain or loss on the conversion. The Company carries its investment in the newly formed entity at cost within other investments on the Consolidated Statements of Financial Condition (see Note 4).

The following table presents components of loans held for investment, net, on the Consolidated Statements of Financial Condition at June 30, 2011 and December 31, 2010:

 

(In thousands)    June 30, 2011     December 31, 2010  

Loans held for investment

   $ 857        1,670   

Allowance for loan losses

     (857     (857
  

 

 

   

 

 

 

Total loans held for investment, net

   $ 0      $ 813   
  

 

 

   

 

 

 

A summary of the activity in the allowance for loan losses for the three and six months ended June 30, 2011 and 2010 was as follows:

 

(In thousands)    Three Months Ended June 30,     Six Months Ended June 30,  
       2011             2010             2011             2010      

Balance at beginning of period

   $ (857   $ (4,285   $ (857   $ (4,285

Loans charged off, net of recoveries

     0        3,757        0        3,757   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ (857   $ (528   $ (857   $ (528
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The Company determined the fair value of loans held for investment to be zero and $0.8 million as of June 30, 2011 and December 31, 2010, respectively, using anticipated cash flows, discounted at an appropriate market credit adjusted interest rate.

6. Loans Collateralizing Asset-backed Securities Issued

Loans collateralizing asset-backed securities issued are commercial loans securitized and owned by Cratos CLO. The loans consist of those loans within the CLO securitization structure at the acquisition date of Cratos and loans purchased by the CLO subsequent to the Cratos acquisition date. The following table presents the components of loans collateralizing asset-backed securities issued at June 30, 2011 and December 31, 2010:

 

(In thousands)    June 30, 2011     December 31, 2010  

Loans collateralizing asset-backed securities

   $ 449,165      $ 453,358   

Allowance for loan losses

     (2,346     (1,992

Liquidity discount

     (20,881     (35,594

Credit discount

     (4,763     (8,558

Deferred loan fees, net

     (5,557     (6,451
  

 

 

   

 

 

 

Total loans collateralizing asset-backed securities, net

   $ 415,618      $ 400,763   
  

 

 

   

 

 

 

Loans recorded upon the acquisition of Cratos at fair value reflect a liquidity discount and a credit discount. In addition, most loans purchased subsequent to the acquisition were purchased at a discount to their principal value, reflecting deferred loan fees. The tables below summarize the activity in the loan principal, allowance for loan losses, liquidity discount, credit discount, deferred loan fees and carrying values, net for the impaired loans and non-impaired loans as of and for the three months ended June 30, 2011:

Impaired loans:

 

(In thousands)    Three Months Ended June 30, 2011  
   Principal     Allowance for
Loan Losses
    Liquidity Discount     Credit Discount     Deferred Loan
Fees
    Carrying Value,
Net
 

Balance at beginning of period

   $ 7,223      $ (582   $ (1,841   $ (4,763   $ 0      $ 37   

Purchases / funding

     2        0        0        0        0        2   

Repayments

     (116     0        0        0        0        (116

Accretion of discount

     0        0        43        0        0        43   

Sales and payoff

     0        0        0        0        0        0   

Transfers to/from non-impaired loans, net

     6,949        0        (4,153     0        (54     2,742   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 14,058      $ (582   $ (5,951   $ (4,763   $ (54   $ 2,708   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-impaired loans:

 

(In thousands)    Three Months Ended June 30, 2011  
   Principal     Allowance for
Loan Losses
    Liquidity Discount     Deferred Loan
Fees
    Carrying Value,
Net
 

Balance at beginning of period

   $ 451,339      $ (1,630   $ (27,108   $ (5,733   $ 416,868   

Purchases / funding

     70,402        0        0        (883     69,519   

Repayments

     (9,769     0        0        0        (9,769

Accretion of discount

     0        0        1,876        334        2,210   

Provision for loan losses

     0        (134     0        0        (134

Sales and payoff

     (69,916     0        6,149        725        (63,042

Transfers to/from non-impaired loans, net

     (6,949     0        4,153        54        (2,742
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 435,107      $ (1,764   $ (14,930   $ (5,503   $ 412,910   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

The tables below summarize the activity in the loan principal, liquidity discount, credit discount, deferred loan fees and carrying values, net for the impaired loans and non-impaired loans as of and for the three months ended June 30, 2010:

Impaired loans:

 

(In thousands)    Three Months Ended June 30, 2010  
   Principal     Allowance for
Loan Losses
    Liquidity Discount     Credit Discount     Carrying Value,
Net
 

Balance at beginning of period

   $ 59,839      $ (1,581   $ (12,807   $ (33,119   $ 12,332   

Purchases / funding

     390        0        0        0        390   

Repayments

     (617     0        0        19        (598

Accretion of discount

     0        0        93        0        93   

Sales and payoff

     (20,490     0        7,314        5,420        (7,756

Write-off / restructuring

     (7,956     0        0        7,956        0   

Transfers to/from non-impaired loans, net

     (6,734     0        2,418        2,077        (2,239
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 24,432      $ (1,581   $ (2,982   $ (17,647   $ 2,222   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-impaired loans:

 

(In thousands)    Three Months Ended June 30, 2010  
   Principal     Allowance for
Loan Losses
    Liquidity Discount     Deferred Loan Fees     Carrying Value,
Net
 

Balance at beginning of period

   $ 409,282      $ (577   $ (71,964   $ (5,097   $ 331,644   

Purchases / funding

     98,470        0        0        (1,005     97,465   

Repayments

     (20,417     0        0        0        (20,417

Accretion of discount

     0        0        7,392        357        7,749   

Provision for loan losses

     0        (291     0        0        (291

Sales and payoff

     (71,467     0        7,964        678        (62,825

Transfers to/from non-impaired loans, net

     7,059        0        (4,820     0        2,239   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 422,927      $ (868   $ (61,428   $ (5,067   $ 355,564   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The tables below summarize the activity in the loan principal, liquidity discount, credit discount, deferred loan fees and carrying values, net for the impaired loans and non-impaired loans as of and for the six months ended June 30, 2011:

Impaired loans:

 

     Six Months Ended June 30, 2011  
(In thousands)    Principal     Allowance for
Loan Losses
    Liquidity Discount     Credit Discount     Deferred Loan Fees     Carrying Value,
Net
 

Balance at beginning of period

   $ 13,867      $ (582   $ (2,557   $ (8,558   $ 0      $ 2,170   

Purchases / funding

     18        0        0        0        0        18   

Repayments

     (194     0        0        0        0        (194

Accretion of discount

     0        0        99        0        0        99   

Sales and payoff

     (6,582     0        659        3,795        0        (2,128

Transfers to/from non-impaired loans, net

     6,949        0        (4,152     0        (54     2,743   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 14,058      $ (582   $ (5,951   $ (4,763   $ (54   $ 2,708   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

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Table of Contents

Non-impaired loans:

 

     Six Months Ended June 30, 2011  
(In thousands)    Principal     Allowance for
Loan Losses
    Liquidity Discount     Deferred Loan Fees     Carrying Value,
Net
 

Balance at beginning of period

   $ 439,491      $ (1,410   $ (33,037   $ (6,451   $ 398,593   

Purchases / funding

     161,579        0        0        (1,553     160,026   

Repayments

     (16,512     0        0        0        (16,512

Accretion of discount

     0        0        6,125        762        6,887   

Provision for loan losses

     0        (354     0        0        (354

Sales and payoff

     (142,502     0        7,830        1,685        (132,987

Transfers to/from impaired loans, net

     (6,949     0        4,152        54        (2,743
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 435,107      $ (1,764   $ (14,930   $ (5,503   $ 412,910   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

The tables below summarize the activity in the loan principal, liquidity discount, credit discount, deferred loan fees and carrying values, net for the impaired loans and non-impaired loans as of and for the six months ended June 30, 2010:

   

Impaired loans

 

  

     Six Months Ended June 30, 2010  
(In thousands)    Principal     Allowance for
Loan Losses
    Liquidity Discount     Credit Discount     Carrying Value,
Net
 

Balance at beginning of period

   $ 74,369      $ (1,581   $ (18,411   $ (35,105   $ 19,272   

Purchases / funding

     816        0        0        0        816   

Repayments

     (3,704     0        0        174        (3,530

Accretion of discount

     0        0        411        0        411   

Sales and payoff

     (20,490     0        7,314        5,420        (7,756

Write-off / restructuring

     (7,956     0        0        7,956        0   

Transfers to/from non-impaired loans, net

     (18,603     0        7,704        3,908        (6,991
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 24,432      $ (1,581   $ (2,982   $ (17,647   $ 2,222   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Non-impaired loans:

 

 

     Six Months Ended June 30, 2010  
(In thousands)    Principal     Allowance for
Loan Losses
    Liquidity Discount     Deferred Loan Fees     Carrying Value,
Net
 

Balance at beginning of period

   $ 387,090      $ (413   $ (73,133   $ (4,849   $ 308,695   

Purchases / funding

     166,736        0        0        (2,157     164,579   

Repayments

     (44,343     0        0        0        (44,343

Accretion of discount

     0        0        12,884        745        13,629   

Provision for loan losses

     0        (455     0        0        (455

Sales and payoff

     (106,220     0        11,494        1,194        (93,532

Transfers to/from impaired loans, net

     19,664        0        (12,673     0        6,991   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 422,927      $ (868   $ (61,428   $ (5,067   $ 355,564   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for Loan Losses

The Company maintains an allowance for loan losses that is intended to estimate loan losses inherent in its loan portfolio. A provision for loan losses is charged to expense to establish the allowance for loan losses. The allowance for loan losses consists of two components: estimated loan losses for specifically identified loans and estimated loan losses inherent in the remainder of the portfolio. The Company’s loan portfolio consists primarily of loans made to middle market, privately owned companies. Loans made to these companies generally have higher risks compared to larger, publicly traded companies that have greater access to financial resources. Given these considerations, the Company believes that it is necessary to reserve for estimated loan losses inherent in the portfolio.

 

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In determining the required allowance for loan losses inherent in the portfolio, the following factors are considered: 1) the expected loss severity rate for each class of loans, 2) the current Moody’s rating and related probability of default, 3) the existing liquidity discount on the loans and 4) internal loan ratings.

 

   

Expected loss severity rate for each class of loans: The Company’s loans are classified as either Asset Backed Loan (“ABL”), ABL – stretch, Cash Flow or Enterprise Value. The loss severity given a default is expected to be the least on a conforming ABL loan since the value of the collateral is typically enough to satisfy most of the amount owed. For ABL – stretch loans, the loss severity given a default is expected to be higher than for a conforming ABL loan because of less collateral coverage. For Cash flow loans, the loss severity given a default is expected to be higher than ABL - stretch loans since generally less collateral coverage is provided for this class of loans. For Enterprise Value loans, the loss severity given a default is expected to be the highest, assuming that if the obligor defaults there has probably been a significant loss of enterprise value in the business as well.

 

   

Moody’s rating and related probability of default: See section entitled Credit Quality of Loans within this footnote.

 

   

Existing liquidity discount on the loans: For non-impaired loans held at Cratos at the acquisition date, liquidity discount was recorded to reflect the fair value of those loans. To the extent that the liquidity discount on a loan is greater than the component of the general reserve attributable to that loan, that asset is excluded from the general reserve calculation. If the general reserve for a loan is greater than its liquidity discount, the amount by which it exceeds the liquidity discount will be included in the general reserve calculation.

 

   

Internal loan ratings: See section entitled Credit Quality of Loans within this footnote.

Based on the above evaluation, the Company recorded additions to the general reserves of $0.1 million and $0.3 million during the quarters ended June 30, 2011 and 2010, respectively, on non-impaired loans. The Company recorded additions of $0.4 million and $0.5 million for the six months ended June 30, 2011 and 2010, respectively.

A summary of the activity in the allowance for loan losses for the three and six months ended June 30, 2011 and 2010 is as follows:

 

     Three Months Ended June 30,     Six Months Ended June 30,  
(In thousands)    2011     2010     2011     2010  

Balance at beginning of period

   $ (2,212   $ (2,158   $ (1,992   $ (1,994

Provision for loan losses:

        

General reserve

     (134     (291     (354     (455
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ (2,346   $ (2,449   $ (2,346   $ (2,449
  

 

 

   

 

 

   

 

 

   

 

 

 

Impaired Loans

A loan is considered to be impaired when, based on current information, it is probable that the Company will be unable to collect all amounts due in accordance with the contractual terms of the original loan agreement, including scheduled principal and interest payments. There were $14.1 million unpaid principal balance of impaired loans as of June 30, 2011, with allocated specific reserves of $0.6 million and credit discount of $4.8 million. There were $13.9 million unpaid principal balance of impaired loans as of December 31, 2010, with allocated specific reserves of $0.6 million and credit discount of $8.6 million.

 

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The tables below present, by class of loans, certain information pertaining to the impaired loans at June 30, 2011 and December 31, 2010:

 

       As of June 30, 2011  
(In thousands)    Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

Cash Flow (CF)

     3,290         14,058         582   
  

 

 

    

 

 

    

 

 

 
   $ 3,290       $ 14,058       $ 582   
  

 

 

    

 

 

    

 

 

 
     As of December 31, 2010  
(In thousands)    Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
 

Cash Flow (CF)

   $ 2,752       $ 13,867       $ 582   
  

 

 

    

 

 

    

 

 

 
   $ 2,752       $ 13,867       $ 582   
  

 

 

    

 

 

    

 

 

 

The tables below present, by class of loans, certain information pertaining to the impaired loans for the three and six months ended June 30, 2011 and 2010:

 

     Three Months Ended          Six Months Ended  
     June 30, 2011          June 30, 2011  
(In thousands)    Average
Recorded
Investment
     Interest
Income

Recognized
         Average
Recorded
Investment
     Interest
Income
Recognized
 

Cash Flow (CF)

     3,296         38 (1)         3,661         126 (1) 
  

 

 

    

 

 

      

 

 

    

 

 

 
   $ 3,296       $ 38         $ 3,661       $ 126   
  

 

 

    

 

 

      

 

 

    

 

 

 
     Three Months Ended          Six Months Ended  
     June 30, 2010          June 30, 2010  
(In thousands)    Average
Recorded
Investment
     Interest
Income
Recognized
         Average
Recorded
Investment
     Interest
Income
Recognized
 

Cash Flow (CF)

     4,824         0           11,307         0   
  

 

 

    

 

 

      

 

 

    

 

 

 
   $ 4,824       $ 0         $ 11,307       $ 0   
  

 

 

    

 

 

      

 

 

    

 

 

 

 

(1) Represents cash interest payments received on impaired loans.

As of June 30, 2011 and December 31, 2010, $6.5 million and $8.5 million of recorded investment amount of loans collateralizing asset-backed securities issued were individually evaluated for impairment, respectively. As of June 30, 2011 and December 31, 2010, $411.5 million and $394.5 million of recorded investment amount of loans collateralizing asset-backed securities issued were collectively evaluated for impairment, respectively.

At June 30, 2011 and December 31, 2010, the impaired loans included three loans with the aggregated recorded investment balance of $0.6 million for both these periods, whose terms were modified in a troubled debt restructuring (“TDR”). A restructuring is considered a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The creditor may receive an asset from the debtor in a TDR, but the value of the asset received is typically significantly less than the amount of the debt forgiven. For two of the TDR loans, the Company received an equity interest in the debtor as compensation for reducing the loan principal balance. At June 30, 2011 and December 31, 2010, there were no remaining commitments to lend funds to debtors whose terms have been modified in a TDR.

 

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Non-Accrual Status and Past Due Loans

At June 30, 2011, three loans, all of which were Cash Flow loans, with the aggregate principal amount of $14.1 million and recorded investment amount of $3.3 million were on non-accrual status. At December 31, 2010, four loans, all of which were Cash Flow loans, with the aggregate principal amount of $13.9 million and recorded investment amount of $2.8 million were on non-accrual status. The Company recognized $38,345 and $125,856 in interest income, other than the accretion of liquidity discounts, for three and four impaired loans with a weighted average loan balance of $8.9 million and $10.1 million that were on non-accrual status during the three and six months ended June 30, 2011. The Company did not recognize any interest income, other than the accretion of liquidity discounts, for nine and 10 impaired loans with a weighted average loan balance of $45.2 million and $67.0 million that were on non-accrual status during the three and six months ended June 30, 2010.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. At June 30, 2011 and December 31, 2010, none of the loans, including non-accrual status loans, were past due.

Credit Quality of Loans

The Company’s management, at least on a quarterly basis, reviews each loan and evaluates the credit quality of the loan. The review primarily includes the following credit quality indicators with regard to each loan: 1) Moody’s rating, 2) current internal rating and 3) performance. The tables below present, by credit quality indicator, the Company’s recorded investment in loans collateralizing asset-backed securities issued at June 30, 2011 and December 31, 2010.

 

       Cash Flow (CF)      Asset Based
Loan (ABL)
     Enterprise Value (EV)      Total  
(In thousands)    June 30,
2011
     December 31,
2010
     June 30,
2011
     December 31,
2010
     June 30,
2011
     December 31,
2010
     June 30,
2011
     December 31,
2010
 

Moody’s rating:

                       

Baa1 - Baa3

     5,575         5,750         0         0         0         0         5,575         5,750   

Ba1 - Ba3

     147,110         139,351         0         0         0         0         147,110         139,351   

B1 - B3

     256,850         235,394         0         6,851         1,966         1,975         258,816         244,220   

Caa1 - Caa3

     5,892         12,865         0         0         0         0         5,892         12,865   

Ca

     570         569         0         0         0         0         570         569   

C

     0         0         0         0         0         0         0         0   

D

     0         0         0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

     415,997         393,929         0         6,851         1,966         1,975         417,963         402,755   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Internal rating:

                       

Performing

     392,040         366,522         0         6,851         1,966         1,975         394,006         375,348   

Moderate

     17,495         18,895         0         0         0         0         17,495         18,895   

Watchlist

     6,462         5,839         0         0         0         0         6,462         5,839   

Substandard

     0         2,104         0         0         0         0         0         2,104   

Non-Accrual

     0         569         0         0         0         0         0         569   

Charge Off

     0         0         0         0         0         0         0         0   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total:

     415,997         393,929         0         6,851         1,966         1,975         417,963         402,755   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Performance:

                       

Performing

     412,708         391,177         0         6,851         1,966         1,975         414,674         400,003