XNYS:JMP JMP Group, Inc. Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

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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, 2012 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, 2012 was 22,741,519. 
 
 
   
Page
PART I.
4
     
Item 1.
4
 
4
 
6
 
7
 
7
 
8
 
10
Item 2.
30
Item 3.
52
Item 4.
53
     
PART II.
53
     
Item 1.
53
Item 1A.
53
Item 2.
54
Item 3.
54
Item 4.
54
Item 5.
54
Item 6.
54
   
55
   
56
 
 
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 (the "Exchange Act"), with the Securities and Exchange Commission (the "SEC"). 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. provides 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 free of charge on the Investor Relations section of its website located at http://www.jmpg.com. 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.
 
 
 
 JMP Group Inc.
(Unaudited)
(Dollars in thousands, except per share data)
 
 
June 30, 2012
   
December 31, 2011
 
           
Assets
         
Cash and cash equivalents
$ 63,005     $ 70,363  
Restricted cash and deposits (includes cash on deposit with clearing broker of $150 and $255 at June 30, 2012 and December 31, 2011, respectively)
  47,345       48,440  
Receivable from clearing broker
  1,003       1,138  
Investment banking fees receivable, net of allowance for doubtful accounts of zero at June 30, 2012 and December 31, 2011
  6,740       2,539  
Marketable securities owned, at fair value
  15,625       24,309  
Incentive fee receivable
  1,510       2,097  
Other investments (of which $76,749 and $51,517 are recorded at fair value at June 30, 2012 and December 31, 2011, respectively)
  77,008       51,706  
Loans held for sale
  2,814       2,957  
Small business loans, net of allowance for loan losses
  21,454       7,477  
Loans collateralizing asset-backed securities issued, net of allowance for loan losses
  417,349       410,770  
Interest receivable
  1,546       1,358  
Fixed assets, net
  2,255       2,285  
Deferred tax assets
  21,051       26,221  
Other assets
  7,223       8,961  
Total assets
$ 685,928     $ 660,621  
               
Liabilities and Equity
             
Liabilities:
             
Marketable securities sold, but not yet purchased, at fair value
$ 12,083     $ 10,921  
Accrued compensation
  24,441       38,143  
Asset-backed securities issued
  397,906       381,556  
Interest payable
  644       651  
Note payable
  27,341       19,222  
Deferred tax liability
  17,225       23,214  
Other liabilities
  28,235       30,430  
Total liabilities
  507,875       504,137  
               
Redeemable Non-controlling Interest
  106       50  
Commitments and Contingencies
             
JMP Group Inc. Stockholders' Equity
             
Common stock, $0.001 par value, 100,000,000 shares authorized; 22,788,019 and 22,069,741 shares issued at June 30, 2012 and December 31, 2011, respectively; 22,741,519 and 21,737,367 shares outstanding at June 30, 2012 and December 31, 2011, respectively
  23       22  
Additional paid-in capital
  126,630       132,944  
Treasury stock, at cost, 46,500 and 332,374 shares at June 30, 2012 and December 31, 2011, respectively
  (284 )     (3,011 )
Accumulated other comprehensive loss
  (82 )     (102 )
Accumulated deficit
  (2,902 )     (148 )
Total JMP Group Inc. stockholders' equity
  123,385       129,705  
Nonredeemable Non-controlling Interest
  54,562       26,729  
Total equity
  177,947       156,434  
Total liabilities and equity
$ 685,928     $ 660,621  
 
See accompanying notes to consolidated financial statements. 

 
JMP Group Inc.
Consolidated Statements of Financial Condition - (Continued)
(Unaudited)
(Dollars in thousands, except per share data)
 
Assets and liabilities of consolidated variable interest entities ("VIE") included in total assets and total liabilities above:
 
   
June 30, 2012
   
December 31, 2011
 
             
Restricted cash
  $ 33,984     $ 36,137  
Loans held for sale
    2,814       2,957  
Loans collateralizing asset-backed securities issued, net of allowance for loan losses
    417,349       410,770  
Interest receivable
    1,188       1,191  
Deferred tax assets
    5,009       8,567  
Other assets
    22       40  
Total assets of consolidated VIE
  $ 460,366     $ 459,662  
                 
Asset-backed securities issued
    397,906       381,556  
Interest payable
    595       601  
Deferred tax liability
    15,129       21,791  
Other liabilities
    2,879       2,042  
Total liabilities of consolidated VIE
  $ 416,509     $ 405,990  
 
The asset-backed securities issued (“ABS”) 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.
 
Consolidated Statements of Operations
(Unaudited)
(In thousands, except per share data)
 
   
Three Months Ended June 30,
   
Six Months Ended June 30,
 
   
2012
   
2011
   
2012
   
2011
 
                         
Revenues
                       
Investment banking
  $ 9,133     $ 10,059     $ 25,792     $ 30,284  
Brokerage
    5,412       6,187       10,904       12,472  
Asset management fees
    3,492       6,046       6,966       9,199  
Principal transactions
    7,780       2,554       14,264       6,184  
Gain on sale and payoff of loans
    1,449       6,837       2,439       13,608  
Net dividend (expense) income
    (9 )     298       (23 )     548  
Other income
    2,407       682       3,142       1,510  
Non-interest revenues
    29,664       32,663       63,484       73,805  
                                 
Interest income
    8,260       7,728       15,718       18,348  
Interest expense
    (9,878 )     (8,796 )     (19,486 )     (17,436 )
Net interest (expense) income
    (1,618 )     (1,068 )     (3,768 )     912  
                                 
Provision for loan losses
    (1,429 )     (134 )     (1,741 )     (354 )
                                 
Total net revenues after provision for loan losses
    26,617       31,461       57,975       74,363  
                                 
Non-interest expenses
                               
Compensation and benefits
    16,704       22,017       38,475       50,248  
Administration
    1,709       1,744       2,959       2,814  
Brokerage, clearing and exchange fees
    858       1,179       1,754       2,277  
Travel and business development
    987       791       1,689       1,461  
Communications and technology
    825       995       1,733       1,916  
Occupancy
    721       777       1,538       1,442  
Professional fees
    718       797       1,357       1,505  
Depreciation
    217       179       415       337  
Impairment loss on purchased management contract
    0       0       0       700  
Other
    (51 )     134       215       238  
Total non-interest expenses
    22,688       28,613       50,135       62,938  
Income before income tax expense
    3,929       2,848       7,840       11,425  
Income tax (benefit) expense
    (975 )     1,281       (653 )     3,764  
Net income
    4,904       1,567       8,493       7,661  
Less: Net income attributable to nonredeemable non-controlling interest
    6,529       49       9,766       2,605  
Net (loss) income attributable to JMP Group Inc.
  $ (1,625 )   $ 1,518     $ (1,273 )   $ 5,056  
Net (loss) income attributable to JMP Group Inc. per common share:
                               
Basic
  $
(0.07
)   $
0.07
    $
(0.06
)   $
0.23
 
Diluted
  $
(0.07
)   $
0.07
    $
(0.06
)   $
0.22
 
                                 
Dividends declared per common share
  $
0.035
    $
0.03
    $
0.065
    $
0.05
 
                                 
Weighted average common shares outstanding:
                               
Basic
   
22,772
     
22,254
     
22,476
     
22,050
 
Diluted
   
22,859
     
22,613
     
23,057
     
22,720
 
 
See accompanying notes to consolidated financial statements.
 
 
- 6 -

 
Consolidated Statements of Comprehensive Income
(Unaudited)
(In thousands)

 
Three Months Ended June 30,
   
Six Months Ended June 30,
 
 
2012
   
2011
   
2012
   
2011
 
                       
Net income
$ 4,904     $ 1,567     $ 8,493     $ 7,661  
Other comprehensive income
                             
Unrealized gain (loss) on cash flow hedge, net of tax
  12       (47 )     20       (39 )
Comprehensive income
  4,916       1,520       8,513       7,622  
Less: Comprehensive income attributable to non-controlling interest
  6,529       49       9,766       2,605  
Comprehensive (loss) income attributable to JMP Group Inc.
$ (1,613 )   $ 1,471     $ (1,253 )   $ 5,017  


 


 
Consolidated Statement of Changes in Equity
(Unaudited)
(In thousands)
 
    JMP Group Inc. Stockholders' Equity              
   
Common Stock
                                     
   
Shares
   
Amount
   
Treasury
Stock
   
Additional
Paid-In
Capital
   
Retained
Earnings
   
Accumulated
Other
Comprehensive
Loss
   
Nonredeemable Non-controlling Interest
   
Total Equity
 
Balance, December 31, 2011
    22,410     $ 22     $ (3,011 )   $ 132,944     $ (148 )   $ (102 )   $ 26,729     $ 156,434  
Net income
    -       -       -       -       (1,273 )     -       9,766       8,493  
Additonal paid-in capital - stock-based compensation
    -       -       -       (9,314 )     -       -       -       (9,314 )
Cash dividends paid to shareholders
    -       -       -       -       (1,481 )     -       -       (1,481 )
Purchases of shares of common stock for treasury
    -       -       (4,511 )     -       -       -       -       (4,511 )
Reissuance of shares of common stock from treasury
    -       -       7,238       260       -       -       -       7,498  
Common stock issued
    402       1       -       2,740       -       -       -       2,741  
Retirement of shares
    (24 )     -       -       -       -       -       -       -  
Distributions to non-controlling interest holders
    -       -       -       -       -       -       (2,854 )     (2,854 )
Unrealized gain on cash flow hedge, net of tax
    -       -       -       -       -       20       -       20  
Capital contributions from non-controlling interest holders (1)
    -       -       -       -       -       -       20,921       20,921  
Balance, June 30, 2012
    22,788     $ 23     $ (284 )   $ 126,630     $ (2,902 )   $ (82 )   $ 54,562     $ 177,947  
 
(1) Excludes $106.3 thousand attributable to redeemable non-controlling interest.




See accompanying notes to consolidated financial statements.
 
 
Consolidated Statements of Cash Flows
(Unaudited)
(In thousands)

 
Six Months Ended June 30,
 
 
2012
   
2011
 
Cash flows from operating activities:
         
Net income $ 8,493     $ 7,661  
Adjustments to reconcile net income to net cash (used in) provided by operating activities:              
Provision for loan losses   1,741       354  
Accretion of deferred loan fees   (671 )     (762 )
Amortization of liquidity discount, net   14,175       8,533  
Gain on sale and payoff of loans   (2,439 )     (13,608 )
Change in other investments:              
Fair value   (11,177 )     (4,618 )
Incentive fees reinvested in general partnership interests   (1,062 )     (2,410 )
Realized gain on other investments   (1,024 )     0  
Impairment loss on purchased management contract   0       700  
Depreciation and amortization of fixed assets   415       337  
Stock-based compensation expense   388       1,026  
Deferred income taxes   (694 )     2,302  
Net change in operating assets and liabilities:              
(Increase) decrease in interest receivable   (188 )     87  
Increase in receivables   (6,034 )     (925 )
Decrease (increase) in marketable securities   8,684       (1,812 )
Decrease in restricted cash (excluding restricted cash reserved for lending activities), deposits and other assets   850       6,781  
Increase in deferred tax liabilities   (125 )     0  
Increase in marketable securities sold, but not yet purchased   1,162       1,950  
Decrease in interest payable   (7 )     (16 )
Decrease in accrued compensation and other liabilities   (15,361 )     (10,139 )
Net cash used in operating activities   (2,874 )     (4,559 )
               
Cash flows from investing activities:
             
Purchases of fixed assets   (384 )     (921 )
Purchases of other investments   (16,689 )     (10,126 )
Sales of other investments   7,229       4,576  
Funding of loans collateralizing asset-backed securities issued   (86,371 )     (160,044 )
Funding of small business loans   (14,863 )     0  
Sale and payoff of loans collateralizing asset-backed securities issued   67,277       148,723  
Principal receipts on loans collateralizing asset-backed securities issued   17,088       16,706  
Principal receipts on loans held for investment   0       813  
Net change in restricted cash reserved for lending activities   1,983       (5,410 )
Net cash used in investing activities   (24,730 )     (5,683 )
 
See accompanying notes to consolidated financial statements.
 
 
JMP Group Inc.
Consolidated Statements of Cash Flows - (Continued)
(Unaudited)
(In thousands)

Cash flows from financing activities:
             
Proceeds from borrowing on line of credit   12,487       0  
Repayment of note payable   (4,368 )     (2,619 )
Cash dividends paid to stockholders   (1,481 )     (1,001 )
Purchases of shares of common stock for treasury   (4,511 )     (3,320 )
Capital contributions of redeemable non-controlling interest holders   20,917       8,748  
Capital contributions of nonredeemable non-controlling interest holders   56       0  
Distributions to non-controlling interest shareholders   (2,854 )     (900 )
Excess tax benefit related to stock-based compensation   0       (335 )
Net cash provided by financing activities   20,246       573  
Net decrease in cash and cash equivalents   (7,358 )     (9,669 )
Cash and cash equivalents, beginning of period
  70,363       71,114  
Cash and cash equivalents, end of period
$ 63,005     $ 61,445  
               
Supplemental disclosures of cash flow information:
             
Cash paid during the period for interest $ 3,141     $ 2,594  
Cash paid during the period for taxes $ 745     $ 5,598  
               
Non-cash investing and financing activities:
             
Issuance of shares of common stock from treasury related to vesting of restricted stock units and exercises of stock options
$ 7,238     $ 5,530  
 
See accompanying notes to consolidated financial statements. 

 
Notes to Consolidated Financial Statements
June 30, 2012
(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 ("IPO") on May 16, 2007, and also completed a corporate reorganization in connection with the IPO. 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”), JMP Credit Advisors LLC (“JMPCA”), Harvest Capital Credit LLC ("HCC"), formed in the third quarter of 2011, and certain principal investments through JMP Capital LLC (“JMP Capital”). The above entities are wholly-owned subsidiaries, with the exception of HCC which is a partly-owned subsidiary. JMP Securities is a U.S. registered broker-dealer under the Exchange Act 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 JMP Credit, the Company completed the acquisition of 100% of the membership interests of Cratos Capital Partners, LLC (which changed its name to JMP Credit Advisors LLC on July 12, 2010) and its subsidiaries, including Cratos Capital Management, LLC (collectively, “Cratos”), a manager of collateralized loan obligations (“CLO”), together with certain securities of Cratos CLO I, Ltd. (“Cratos CLO”). For further details regarding the ownership of Cratos CLO, see Note 2 - Summary of Significant Accounting Policies in the Company's annual report for year ended December 31, 2011 (the "2011 10-K").
 
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 2011 10-K. 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 partly-owned subsidiaries Harvest Growth Capital LLC (“HGC”) (effective April 1, 2010), Cratos CLO and HCC (effective August 18, 2011). All material intercompany accounts and transactions have been eliminated in consolidation. Non-controlling interest on the Consolidated Statements of Financial Condition at June 30, 2012 and December 31, 2011 relate to the interest of third parties in the partly-owned subsidiaries.
 
See Note 2 - Summary of Significant Accounting Policies in the Company's 2011 10-K for the Company's significant accounting policies.
 
3. Recent Accounting Pronouncements
 
Accounting Standards Update (“ASU”) 2011-05: Presentation of Other Comprehensive Income was issued to increase the prominence of other comprehensive income in financial statements, by eliminating the option to report other comprehensive income in the statement of changes in stockholder's equity. The standard requires comprehensive income to be reported in either a single statement that presents the components of net income, the components of other comprehensive income, and total comprehensive income, or in two consecutive statements. The standard also required separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income. This standard was scheduled to be effective for periods starting after December 15, 2011. However, ASU 2011-12: Deferral of the Effective Date for Amendments to the Presentation of Reclassifications of Items Out of Accumulated Other Comprehensive Income deferred the effective date of the requirement to present separate line items on the income statement for reclassification adjustments of items out of accumulated other comprehensive income into net income. The adoption of ASU 2011-05 resulted in the disclosure of other comprehensive income as a stand alone statement outside the statement of changes in stockholder's equity.
 
ASU 2011-04: Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in GAAP and International Financial Reporting Standards ("IFRS"). The adoption of ASU 2011-04 gives fair value the same meaning between GAAP and 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 resulted in additional disclosures within Note 4.
 
 
- 10 -

 
4. Fair Value Measurements
 
The following tables provide fair value information related to the Company’s financial instruments at June 30, 2012 and December 31, 2011:
 
 
At June 30, 2012
 
(In thousands)
Carrying Value
   
Fair Value
 
        Level 1     Level 2     Level 3     Total  
Assets:
                           
Marketable securities owned
$ 15,625     $ 15,625     $ 0     $ 0     $ 15,625  
Other investments
  76,749       1,581       28,141       47,027       76,749  
Loans held for sale (1)
  2,814       0       2,814       0       2,814  
Small business loans, net of allowance for loan losses (2), (3)
  21,454       0       5,867       16,490       22,357  
Loans collateralizing asset-backed securities issued, net of allowance for loan losses (2), (4)
  417,349       0       417,873       10,598       428,471  
Total assets:
$ 533,991     $ 17,206     $ 454,695     $ 74,115     $ 546,016  
                                       
Liabilities:
                                     
Marketable securities sold, but not yet purchased
$ 12,083     $ 12,083     $ 0     $ 0     $ 12,083  
Asset-backed securities issued (2)
  397,906       0       384,105       0       384,105  
Note payable (2)
  27,341       0       27,341       0       27,341  
Total liabilities:
$ 437,330     $ 12,083     $ 411,446     $ 0     $ 423,529  
 
(1) The Company carries the financial instrument at the lower of cost or market.
(2) The Company carries the financial instrument at cost.
(3) See Note 5 for valuation process and sensitivity of the fair value measurement to changes in unobservable inputs.
(4) See Note 6 for valuation process and sensitivity of the fair value measurement to changes in unobservable inputs.
 
 
At December 31, 2011
 
(In thousands)
Carrying Value
   
Fair Value
 
        Level 1     Level 2     Level 3     Total  
Assets:
                           
Marketable securities owned
$ 24,309     $ 24,309     $ 0     $ 0     $ 24,309  
Other investments
  51,517       3,434       24,072       24,011       51,517  
Loans held for sale (1)
  2,957       0       2,979       0       2,979  
Small business loans, net of allowance for loan losses (2), (3)
  7,477       0       3,790       4,000       7,790  
Loans collateralizing asset-backed securities issued, net of allowance for loan losses (2), (4)
  410,770       0       405,386       14,769       420,155  
Total assets:
$ 497,030     $ 27,743     $ 436,227     $ 42,780     $ 506,750  
                                       
Liabilities:
                                     
Marketable securities sold, but not yet purchased
$ 10,921     $ 10,921     $ 0     $ 0     $ 10,921  
Asset-backed securities issued (2)
  381,556       0       375,902       0       375,902  
Note payable (2)
  19,222       0       19,222       0       19,222  
Total liabilities:
$ 411,699     $ 10,921     $ 395,124     $ 0     $ 406,045  
 
(1) The Company carries the financial instrument at the lower of cost or market.
(2) The Company carries the financial instrument at cost.
(3) See Note 5 for valuation process and sensitivity of the fair value measurement to changes in unobservable inputs.
(4) See Note 6 for valuation process and sensitivity of the fair value measurement to changes in unobservable inputs.
 
 
Other Investments
 
 The following tables provide information related to the Company’s other investments held at fair value at June 30, 2012 and December 31, 2011:
 
(In thousands)  
June 30, 2012
 
    Level 1     Level 2     Level 3     Total  
Other investments:
                       
General partner investment in hedge funds
  $ 0     $ 26,466     $ 0     $ 26,466  
General partner investment in funds of funds
    0       0       104       104  
Total general partner investment in funds
    0       26,466       104       26,570  
Limited partner investment in private equity fund
    0       0       2,741       2,741  
Warrants and other
    0       0       782       782  
Equity securities in HGC and JMP Capital
    1,581       1,675       43,400       46,656  
Total other investments
  $ 1,581     $ 28,141     $ 47,027     $ 76,749  
 
 
- 11 -

 
(In thousands)
 
December 31, 2011
 
    Level 1     Level 2     Level 3     Total  
Other investments:
                       
General partner investment in hedge funds
  $ 0     $ 24,072     $ 0     $ 24,072  
General partner investment in funds of funds
    0       0       102       102  
Total general partner investment in funds
    0       24,072       102       24,174  
Limited partner investment in private equity fund
    0       0       2,585       2,585  
Warrants and other
    0       0       617       617  
Equity securities in HGC and JMP Capital
    3,426       0       20,707       24,133  
Interest rate cap
    8       0       0       8  
Total other investments
  $ 3,434     $ 24,072     $ 24,011     $ 51,517  
 
 The tables below provide a reconciliation of the beginning and ending balances for the assets held at fair value using significant unobservable inputs (Level 3) for the three months ended June 30, 2012 and 2011.
 
(In thousands)  
Balance as of 
March 31, 2012
   
Purchases
   
Sales
   
Total gains (losses) - realized and unrealized included in earnings (1)
   
Transfers in/(out) of Level 3
   
Balance as of June 30, 2012
   
Unrealized gains/(losses) included in earnings related to assets still held at reporting date
 
General partner investment in funds of funds
  $ 105     $ 0     $ 0     $ (1   $ 0     $ 104     $ 2  
Limited partner investment in private equity fund
    2,625       0       (49 )     165       0       2,741       165  
Warrants and other
    805       2       0       (25 )     0       782       (25 )
Equity securities in HGC and JMP Capital
    31,963       5,100       0       6,337       0       43,400       6,337  
Total Level 3 assets
  $ 35,498     $ 5,102     $ (49 )   $ 6,476     $ 0     $ 47,027     $ 6,476  
 
(1) No Level 3 asset gains (losses) are included in other comprehensive income. All realized and unrealized gains (losses) related to Level 3 assets are included in earnings.
 
(In thousands)  
Balance as of March 31, 2011
   
Purchases
   
Sales
   
Total gains (losses) - realized and unrealized included in earnings (1)
   
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     $ 105     $ (1 )
Limited partner investment in private equity fund
    3,220       0       0       (36 )     0       3,184       (36 )
Warrants
    805       0       0       256       0       1,061       256  
Equity securities in HGC and JMP Capital
    12,149       6,954       0       (198 )     (1,705 )     17,200       (198 )
Total Level 3 assets
  $ 16,280     $ 6,954     $ 0     $ 21     $ (1,705 )   $ 21,550     $ 21  
 
(1) No Level 3 asset gains (losses) are included in other comprehensive income. All realized and unrealized gains (losses) related to Level 3 assets are included in earnings.
 
 
- 12 -

 
The tables below provide a reconciliation of the beginning and ending balances for the assets held at fair value using significant unobservable inputs (Level 3) for the six months ended June 30, 2012 and 2011.
 
(In thousands)
 
Balance as of December 31, 2011
   
Purchases
   
Sales
   
Total gains (losses) - realized and unrealized included in earnings (1)
   
Transfers in/(out) of Level 3
   
Balance as of June 30, 2012
   
Unrealized gains/(losses) included in earnings related to assets still held at reporting date
 
General partner investment in funds of funds
  $ 102     $ 0     $ 0     $ 2     $ 0     $ 104     $ 2  
Limited partner investment in private equity fund
    2,585       0       (49 )     205       0       2,741       205  
Warrants and other
    617       2       0       163       0       782       163  
Equity securities in HGC and JMP Capital
    20,707       14,502       0       9,104       (913 )     43,400       9,104  
Total Level 3 assets
  $ 24,011     $ 14,504     $ (49 )   $ 9,474     $ (913 )   $ 47,027     $ 9,474  
 
(1) No Level 3 asset gains (losses) are included in other comprehensive income. All realized and unrealized gains (losses) related to Level 3 assets are included in earnings.
 
(In thousands)
  Balance as of December 31, 2010    
Purchases
   
Sales
   
Total gains (losses) - realized and unrealized included in earnings (1)
   
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     $ 105     $ 3  
Limited partner investment in private equity fund
    3,063       0       0       121       0       3,184       121  
Warrants and other
    532       15       0       514       0       1,061       514  
Equity securities in HGC and JMP Capital
    11,245       8,342       0       1,736       (4,123 )     17,200       1,736  
Total Level 3 assets
  $ 14,942     $ 8,357     $ 0     $ 2,374     $ (4,123 )   $ 21,550     $ 2,374  
 
(1) No Level 3 asset gains (losses) are included in other comprehensive income. All realized and unrealized gains (losses) related to Level 3 assets are included in earnings.
 
 
Purchases and sales of Level 3 assets shown above 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, 2012 and 2011. There were no transfers in/out of Level 2 for the three months ended June 30, 2012. There was a transfer into Level 2 from Level 3 of $0.9 million for the six months ended June 30, 2012 as a result of the observability of fair value associated with the equity securities in HGC and JMP Capital. There was a transfer into Level 2 from Level 3 of $4.1 million for the three months ended June 30, 2011 as a result of the observability of fair value associated with the equity securities in HGC and JMP Capital. There were no other transfers in/out of Level 2 or Level 3 during either the three and six months ended June 30, 2012 and 2011.
 
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.
 
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 - Summary of Significant Accounting Policies in the Company's 2011 annual report. The Company’s proportionate share of those investments is included in the tables above. In addition, other investments include warrants and investments in funds managed by third parties. The investments in private investment funds managed by third parties are generally not redeemable at the option of the Company. As of June 30, 2012, the Company had unfunded investment commitments of $0.1 million related to private investment funds managed by third parties.
 
 
- 13 -

 
The Company used the following valuation techniques with unobservable inputs when estimating the fair value of the Level 3 assets:
 
Dollars in thousands   Fair Value at June 30, 2012   Valuation Technique   Unobservable Input   Range (Weighted Average)
General Partner in Funds of Funds (1)
  $ 104  
Net Asset Value
  N/A     N/A    
Limited Partner in Private Equity Fund (1)
  $ 2,741  
Net Asset Value
  N/A     N/A    
Warrants and Other
  $ 782  
Black-Scholes Option Model
 
Annualized volatility of credit (2)
  15.7% - 35.5% (15.8%)
Equity securities in HGC and JMP Capital
  $ 43,400   Market comparable companies  
Revenue multiples (3)
  2.4x - 7.9x (4.2x)
             
EBITDA multiples (3)
  7.0x - 26.9x (13.3x)
             
Free cash flow multiples (3)
  23.7x - 65.5x (38.8x)
             
Discount for lack of marketability (4)
  30% - 40% (34%)
         
Market transactions
 
Revenue multiples (3)
  3.3x - 7.1x (4.9x)
             
EBITDA multiples (3)
  11.5x - 25.9x (17.7x)
             
Control premium (4)
    25%    
 
(1) The Company uses the reported net asset value per share as a practical expedient to estimate the fair value of the general partner investment in funds of funds and limited partner investment in mortgage and private equity funds.
(2) The range represents amounts used in the analysis that the Company has determined market participants would use when pricing the warrants.
(3) The rates represent amounts used when the Company has determined that market participants would use such multiples when pricing the investments.
(4) The rates represent amounts used when the Company has determined that market participants would take into account these premiums and discounts when pricing the investments.

The significant unobservable input used in the fair value measurement of the warrants is the annualized volatility of credit. Significant increases in the rate would result in a significantly higher fair value measurement.
 
The significant unobservable inputs used in the fair value measurement of the equity securities in HGC and JMP Capital are Revenue, EBITDA and Free Cash Flow multiples, discount for lack of marketability, and control premiums. Significant increases in the multiples in isolation would result in a significantly higher fair value measurement. Increases in the discounts and premium in isolation would result in decreases to the fair value measurement.
 
Investments at Cost
 
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 allows 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, February 11, 2013. During the fourth quarter of 2010, the Company determined that its investment in Sanctuary was fully impaired and recorded an impairment loss of $1.5 million, which was included in Principal Transactions on the Consolidated Statements of Operations. On April 3, 2012, the Company purchased a $2.3 million receivable from Sanctuary for $1.4 million. The $1.4 million was composed of cash consideration of $0.5 million and $0.9 million applied to the redemption of 60 Class D Preferred Units owned by the Company. The Company recognized the $0.9 million as a gain in Principal Transactions, and the $2.3 million receivable in Other Assets. The carrying value of the Company’s investment in Sanctuary remained at zero at June 30, 2012.
 
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 $27.1 million of outstanding borrowings with the Lender as of that date. The notional principal amount of the cap was $14.9 million at June 30, 2012. See Note 7 for 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, 2012, the Company recorded $1,037 and $7,514 of other comprehensive loss representing unrealized loss on the interest rate cap, respectively. In addition, for the three and six months ended June 30, 2012, $13,674 and $27,348, respectively, were reclassified from accumulated other comprehensive income into interest expense as amortization of the interest cap.
 
 
- 14 -

 
5. Small Business Loans
 
Small business loans consist of loans held at HCC. HCC was formed in the third quarter of 2011 to generate both current income and capital appreciation by primarily making direct investments in the form of subordinated debt, and, to a lesser extent, senior debt and minority equity investments in small to mid-size companies. As of June 30, 2012, the $21.5 million net loans outstanding were commercial loans. The following table summarizes the components of this small business loan receivable balance:

(In thousands)
 
June 30, 2012
   
December 31, 2011
 
Small business loans
  $ 22,863     $ 8,000  
Allowance for loan losses
    (757 )     (216 )
Deferred loan fees
    (652 )     (307 )
Small business loans, net   $ 21,454     $ 7,477  
 
The Company, at least on a quarterly basis, reviews and evaluates the credit quality of each 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 review follows a similar methodology as the review over loans collateralizing asset-backed securities issued. See Note 2 - Summary of Significant Accounting Policies in the Company's 2011 10-K for the policy and methodology in determining an allowance for loan losses and further descriptions of the credit quality factors analyzed.
 
(In thousands)
 
Cash Flow (CF)
 
   
June 30, 2012
   
December 31, 2011
 
Moody's rating:
           
B1 - B3
    6,000       4,000  
NR
    16,863       4,000  
Total:
  $ 22,863     $ 8,000  
                 
Internal rating:
               
Rating 2
    22,863       8,000  
Total:
  $ 22,863     $ 8,000  
                 
Performance:
               
Performing
  $ 22,863     $ 8,000  
Total:
  $ 22,863     $ 8,000  
 
A summary of the activity in the allowance for loan losses for the three and six months ended June 30, 2012 was as follows:
 
(In thousands)
 
Three Months Ended
June 30, 2012
   
Six Months Ended
June 30, 2012
 
Balance at beginning of period
  $ (435 )   $ (216 )
Provision for loan losses
    (322 )     (541 )
Loans charged off
    0       0  
Recoveries
    0       0  
Balance at end of period
  $ (757 )   $ (757 )
 
The Company determined the fair value of small business loans to be $22.4 million and $7.8 million as of June 30, 2012 and December 31, 2011, respectively. The fair value of the loans are calculated using the average market bid and ask quotation obtained from a loan pricing service. Such loans are identified as Level 2 assets. When average market bid and ask quotations are not available, the loans are identified as Level 3 assets. The fair value of these Level 3 loans are calculated internally based on their performance. This analysis incorporates comparable loans traded in the marketplace, the obligor's industry, future business prospects, capital structure, and expected credit losses. Significant declines in the performance of the loan would result in decreases to the fair value measurement.
 
6. Loans Collateralizing Asset-backed Securities Issued and Loans Held for Sale
 
Loans collateralizing asset-backed securities issued and loans held for sale 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 and loans held for sale at June 30, 2012 and December 31, 2011: 
 
(In thousands)
 
Loans Collateralizing Asset-backed Securities
   
Loans Held for Sale
 
   
June 30,
2012
   
December 31,
2011
   
June 30,
2012
   
December 31,
2011
 
Loans
  $ 435,088     $ 436,954     $ 4,686     $ 4,686  
Allowance for loan losses
    (3,646 )     (4,199 )     0       0  
Liquidity discount
    (6,304 )     (14,459 )     (1,279 )     (1,279 )
Credit discount
    (938 )     (1,335 )     0       0  
Deferred loan fees, net
    (6,851 )     (6,191 )     (156 )     (168 )
Valuation allowance
    N/A       N/A       (437 )     (282 )
Total loans, net
  $ 417,349     $ 410,770     $ 2,814     $ 2,957  
 
 
- 15 -

 
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, 2012:
 
   
Three Months Ended June 30, 2012
 
(In thousands)
 
Principal
   
Allowance for Loan Losses
   
Liquidity Discount
   
Credit Discount
   
Deferred Loan Fees
   
Carrying Value,
Net
 
Impaired Loans
                                   
Balance at beginning of period
  $ 10,520     $ (2,277 )   $ (5,907 )   $ (1,335 )   $ (54 )   $ 947  
Repayments
    (55 )     0       0       0       0       (55 )
Accretion of discount
    0       0       54       0       0       54  
Write-off/restructuring
    (7,167 )     1,753       5,017       397       54       54  
Provision for loan losses
    0       (1,000 )     0       0       0       (1,000 )
Balance at end of period
  $ 3,298     $ (1,524 )   $ (836 )   $ (938 )   $ 0     $ 0  
                                                 
Non-impaired Loans
                                               
Balance at beginning of period
  $ 426,388     $ (2,015 )   $ (6,709 )   $ 0     $ (6,871 )   $ 410,793  
Purchases / funding
    41,591       0       0       0       (1,006 )     40,585  
Repayments
    (8,548 )     0       0       0       0       (8,548 )
Accretion of discount
    0       0       1,241       0       402       1,643  
Provision for loan losses
    0       (107 )     0       0       0       (107 )
Sales and payoff
    (27,641 )     0       0       0       624       (27,017 )
Balance at end of period
  $ 431,790     $ (2,122 )   $ (5,468 )   $ 0     $ (6,851 )   $ 417,349  
 
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:
 
   
Three Months Ended June 30, 2011
 
(In thousands)
 
Principal
   
Allowance for Loan Losses
   
Liquidity Discount
   
Credit Discount
   
Deferred Loan Fees
   
Carrying Value,
Net
 
Impaired Loans
                                   
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  
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
                                               
Balance at beginning of period
  $ 451,339     $ (1,630 )   $ (27,108 )   $ 0     $ (5,733 )   $ 416,868  
Purchases / funding
    70,402       0       0       0       (883 )     69,519  
Repayments
    (9,769 )     0       0       0       0       (9,769 )
Accretion of discount
    0       0       1,876       0       334       2,210  
Provision for loan losses
    0       (134 )     0       0       0       (134 )
Sales and payoff
    (69,916 )     0       6,149       0       725       (63,042 )
Transfers to/from non-impaired loans, net
    (6,949 )     0       4,153       0       54       (2,742 )
Balance at end of period
  $ 435,107     $ (1,764 )   $ (14,930 )   $ 0     $ (5,503 )   $ 412,910  
 
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 six months ended June 30, 2012:
 
(In thousands)
 
Six Months Ended June 30, 2012
 
   
Principal
   
Allowance for Loan Losses
   
Liquidity Discount
   
Credit Discount
   
Deferred Loan Fees
   
Carrying Value,
Net
 
Impaired Loans
                                   
Balance at beginning of period
  $ 10,538     $ (2,277 )   $ (5,924 )   $ (1,335 )   $ (54 )   $ 948  
Purchases / funding
    5       0       0       0       0       5  
Repayments
    (78 )     0       0       0       0       (78 )
Accretion of discount
    0       0       71       0       0       71  
Write-off/ restructuring
    (7,167 )     1,753       5,017       397       54       54  
Provision for loan losses
    0       (1,000 )     0       0       0       (1,000 )
Balance at end of period
  $ 3,298     $ (1,524 )   $ (836 )   $ (938 )   $ 0     $ 0  
                                                 
Non-impaired Loans
                                               
Balance at beginning of period
  $ 426,416     $ (1,922 )   $ (8,535 )   $ 0     $ (6,137 )   $ 409,822  
Purchases / funding
    89,087       0       0       0       (2,721 )     86,366  
Repayments
    (17,010 )     0       0       0       0       (17,010 )
Accretion of discount
    0       0       2,104       0       962       3,066  
Provision for loan losses
    0       (200 )     0       0