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CIFC > SEC Filings for CIFC > Form 10-K on 1-Apr-2013All Recent SEC Filings

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Form 10-K for CIFC CORP.


1-Apr-2013

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The statements in this discussion regarding the industry outlook and our expectations regarding the future performance of our business and the other non-historical statements are forward-looking statements. These forward-looking statements are subject to numerous risks and uncertainties, including, but not limited to, the risks and uncertainties described in Special Note Regarding Forward-Looking Statements and Part I-Item 1A-"Risk Factors". You should read the following discussion together with our consolidated financial statements and notes thereto included in Part II-Item 8- "Financial Statements and Supplementary Data."
Overview

CIFC Corp. ("CIFC" and, together with its subsidiaries, "we" or "us" ) is a Delaware corporation that specializes in managing investment products which have corporate credit obligations, primarily senior secured corporate loans ("SSCLs"), as the primary underlying investments. On April 13, 2011 (the "Merger Closing Date"), we completed a merger (the "Merger") with Commercial Industrial Finance Corp. ("Legacy CIFC").

Following the Merger, we re-focused on our core business as a fee-based corporate credit asset manager for third party investors. In a process that began in 2011, and most of which was completed during 2012, we exited non-core activities and assets, through the sales of (1) our residential mortgage-backed securities ("RMBS") portfolio in 2011, (2) our rights to manage our sole European CLO, Gillespie CLO PLC ("Gillespie") in January 2012, and (3) our investments in and rights to manage the DFR Middle Market CLO Ltd. ("DFR MM CLO") in February 2012 as (i) the DFR MM CLO did not generate contractual investment advisory fee revenues, (ii) the risk profile of the loans underlying our investment in the DFR MM CLO were not deemed suitable, and (iii) the investment tied up a substantial amount of capital.
We establish and manage investment products for various types of investors, including pension funds, hedge funds and other asset management firms, banks, insurance companies and other types of institutional investors located across the world. Our existing investment products are primarily collateralized loan obligations ("CLOs") and also include collateralized debt obligations ("CDOs") and other investment vehicles. We also make investments in certain investment products we manage and SSCLs that we warehouse to launch new investment products.
The investment advisory fees paid to us by these investment products is our primary source of revenue and are generally paid on a quarterly basis and are ongoing as long as we manage the products. Investment advisory fees typically consist of management fees based on the amount of assets held in the investment product and, in some cases, incentive fees based on the returns generated for certain investors. We also earn net investment income and incur gains/losses from our investments in CLOs, warehouses and other investment products we manage.
Executive Overview

2012 was a year of strong growth and positioning CIFC for the opportunities ahead. We issued three new CLOs totaling $1.6 billion, raised an additional $0.7 billion in Fee Earning Assets Under Management ("Fee Earning AUM") from other corporate loan-based products, and acquired four CLOs with $0.7 billion of loan-based AUM. This more than offset the normal course runoff of older CLOs resulting in a net increase of $1.2 billion in AUM from loan-based products. We also sold certain non-core assets, including our rights to manage our sole European CLO and our investments in the DFR MM CLO. The latter sale, as expected, resulted in the Company having lower net investment and interest income in 2012 than in 2011 but, as a result of the sale proceeds, we are better positioned to seed and issue new funds in 2013. We are excited for the upcoming year as we continue to seek growth opportunities in the current market environment.

CIFC reported GAAP net income (loss) attributable to CIFC Corp. of $(9.6) million for 2012, compared to $(32.6) million in the same period of the prior year. GAAP operating results increased $23.0 million primarily due to (i) prior year net losses from our investments in the DFR MM CLO, which were sold in February 2012, (ii) a full year of investment advisory fees results from the Legacy CIFC CLOs, which were acquired in April 2011, (iii) gains from the sale of the management contract of Gillespie CLO in January 2012, (iv) increases in net investment and interest income from our investment in CLOs compared to the prior year, and (v) increases in investment advisory fee revenue due to the issuance of three new CLOs and the acquisition of the rights to manage four CLOs from General Electric Capital Corporation ("GE Capital", also known as the "GECC Transaction") during 2012. These increases were slightly offset by (i) decreases in investment advisory fees from principal paydown, calls and redemptions of certain legacy CLOs and CDOs, (ii) decreases in net investment and interest income from the liquidation of our RMBS portfolio during the first half of 2011,
(iii) decreases in net gains on an embedded derivative due to the expiration of the anti-dilution feature of our convertible notes, (iv) increase in net losses on liabilities due to changes in fair value of our contingent liabilities, (v) higher expenses to support the continued growth of the business and (vi) higher income tax expenses.


Table of Contents

We are replacing our previous non-GAAP measure of Adjusted Earnings before Taxes ("AEBT") with Economic Net Income ("ENI") to align our financial performance metric with other leading alternative asset managers and our evolving view of the business. The replacement did not significantly change our non-GAAP measure except to include unrealized gains/losses on our core investments. In the non-GAAP presentations that follow, we have provided comparable non-GAAP information for the prior comparative period. See Economic Net Income "ENI" (Non-GAAP Measures) below for further details and a reconciliation from net income (loss) attributable to CIFC Corp. (the most comparable GAAP measure) and ENI.

CIFC reported ENI of $25.3 million for 2012, compared to $29.5 million for the prior year. ENI results from the prior year included $25.3 million of net investment and interest income from the DFR MM CLO which was sold in February 2012 and the RMBS portfolio which was liquidated during the first half of 2011. Offsetting this decline, ENI increased year over year by approximately $21.1 million primarily due to (i) a full year of results from the Legacy CIFC CLOs, acquired in April 2011, (ii) increases in net investment and interest income from our investment in CLOs and warehouses, excluding the DFR MM CLO sale, (iii) increases in investment advisory fee and net investment and interest revenues from the issuance of three CLOs and from the acquisition of the rights to manage four CLOs from GE Capital as well as (iv) increases in incentive management fees earned on certain CLOs which reached their incentive fee hurdle during 2012. These increases were slightly offset by decreases in investment advisory fees from principal paydown, calls and redemptions of certain legacy CLOs and CDOs as well as higher expenses to support the continued growth of the Company.

Market and Economic Conditions

Market conditions improved during the year as the economy continued its stable but slow rate of growth. Price volatility in financial assets moderated in the absence of surprises, particularly with respect to the Euro zone. The syndicated loan market experienced generally larger volumes with a vast majority of the new loans brought to market used to refinance existing loans, while prices firmed in the absence of net new supply. The CLO market set a post crisis new issuance record and benefited from a number of new entrants, particularly in the senior most level of the capital structure. As CLO tranche yields tightened throughout the year all aspects of our business benefited from favorable market and economic conditions.

Fee Earning AUM

The following table summarizes the Fee Earning AUM, for which we are paid a
management fee by significant investment product category (1):


                                              As of December 31, 2012                As of December 31, 2011
                                        Number of                              Number of
                                         Accounts      Fee Earning AUM (2)      Accounts      Fee Earning AUM (1)
                                                         (In thousands)                         (In thousands)
Post 2011 CLOs                                 3     $           1,579,558            -     $                   -
Legacy CLOs (3)                               29                 9,599,220           29                10,555,255
   Total CLOs                                 32                11,178,778           29                10,555,255
Other Loan-Based Products                      3                   666,120            1                    73,249
Total Loan-Based AUM                          35                11,844,898           30                10,628,504
ABS CDOs                                      10                 2,402,088           10                 2,931,478
Corporate Bond CDOs                            4                    67,053            4                   271,072
Total Fee Earning AUM                         49     $          14,314,039           44     $          13,831,054

Explanatory Notes:

(1) We do not expect to issue new CDOs in the future. Fee Earning AUM on CDOs are expected to continue to decline as these funds run-off per their contractual terms.

(2) Fee Earning AUM numbers generally reflect the aggregate principal or notional balance of the collateral and, in some cases, the cash balance held by the CLOs and CDOs and are as of the date of the last trustee report received for each CLO and CDO prior to the respective AUM date.

(3) Legacy CLOs represents all CLO management contracts issued prior to 2011 including the acquisition of CLOs since 2011.


Table of Contents

Total loan-based Fee Earning AUM activity for the year ended December 31, 2012 is as follows:
(In thousands)

Total loan-based AUM - December 31, 2011    $    10,628,504
CLO New Issuances                                 1,579,558
CLO Acquisitions                                    718,583
CLO Principal Paydown                              (760,289 )
CLO Calls, Redemptions and Sales                   (936,009 )
Fund Subscriptions                                  713,889
Fund Redemptions                                   (121,624 )
Other (1)                                            22,286
Total loan-based AUM - December 31, 2012         11,844,898
                               Total CDOs         2,469,141
Total Fee Earning AUM - December 31, 2012   $    14,314,039

Explanatory Note:

(1) Other includes changes in collateral balances of CLOs between periods and market appreciation on other Loan-Based products.

During the year ended December 31, 2012, total AUM increased by $0.5 billion primarily as a result of increases in loan-based AUM of $1.2 billion, offset by the decreases in CDO AUM of $(0.7) billion. The increase in loan-based AUM was primarily a result of the issuance of three CLOs, the acquisition of the rights to manage four CLOs through the completion of the GECC Transaction and an increase in other loan-based products we managed. These increases were offset by the calls and redemptions of two CLOs: Primus CLO I, Ltd. and Long Grove CLO Ltd., the sale of the management contracts of two CLOs: DFR MM CLO and Gillespie CLO as well as declines in AUM from certain CLOs which have reached the end of their contractual reinvestment periods. Most of the CLOs and CDOs we manage have passed their first optional call date and are generally callable by their subordinated note holders, subject to satisfaction of certain conditions. CDO AUM declined during the year ended December 31, 2012, primarily due to the exit of their scheduled "reinvestment periods." We do not expect to issue new CDOs so we expect CDO AUM to continue to decline going forward as these funds run-off per their contractual terms.


Table of Contents

The structure of the CLOs we manage affects the investment advisory fees paid to us. The following summarizes select details of the structure of each of the CLOs we manage:

                                                                                            Termination of
                                                     December 31, 2012     First Optional    Reinvestment     Maturity
                                   Issuance Date      Fee Earning AUM      Call Date (1)      Period (2)      Year (3)
                                    Month/Year        (In thousands)                 Month/Year
Post 2011 CLOs
CIFC Funding 2011-I, Ltd. ("CIFC
CLO 2011-I")                           01/12       $           402,838         01/14            01/15           2023
CIFC Funding 2012-I, Ltd. ("CIFC
CLO 2012-I")                           07/12                   451,529         08/14            08/16           2024
CIFC Funding 2012-II, Ltd.
("CIFC CLO 2012-II")                   11/12                   725,191         12/14            12/16           2024
Total Post 2011 CLOs                                         1,579,558
Legacy CLOs
Rosemont CLO, Ltd.                     01/02                     7,296         10/05            01/07           2013
Forest Creek CLO Ltd.                  05/03                    31,912         07/07            07/08           2015
Navigator 2003 CLO, Ltd. (4)           12/03                    28,430         02/07            11/08           2015
Navigator 2004 CLO, Ltd. (4)           10/04                   102,913         01/11            01/11           2017
Hewett's Island CLO II, Ltd.           12/04                    72,646         12/08            12/10           2016
Market Square CLO Ltd.                 05/05                   107,145         07/07            04/11           2017
Navigator 2005 CLO, Ltd. (4)           07/05                   206,925         10/11            10/11        2017, 2021
Hewett's Island CLO III, Ltd.          08/05                   173,597         08/09            08/11           2017
Cumberland II CLO Ltd.                 09/05                   213,354         02/10            11/11           2019
Marquette Park CLO Ltd.                12/05                   221,330         04/10            01/12           2020
Bridgeport CLO Ltd.                    06/06                   482,187         10/09            07/13           2020
CIFC Funding 2006-I, Ltd.              08/06                   516,445         10/10            10/12           2020
Columbus Nova 2006-I, Ltd.             08/06                   389,068         10/09            10/12           2018
Navigator 2006 CLO, Ltd. (4)           09/06                   322,893         09/10            09/13           2020
CIFC Funding 2006-I B, Ltd.            10/06                   394,536         12/10            12/12           2020
Burr Ridge CLO Plus Ltd.               12/06                   283,415         06/12            03/13           2023
CIFC Funding 2006-II, Ltd.             12/06                   617,522          3/11            03/13           2021
Columbus Nova 2006-II, Ltd.            12/06                   495,198         02/10            02/13           2018
Hewett's Island CLO V, Ltd.            12/06                   361,751         12/09            12/12           2018
CIFC Funding 2007-I, Ltd.              02/07                   396,011         05/11            11/13           2021
CIFC Funding 2007-II, Ltd.             03/07                   591,066         04/11            04/14           2021
Columbus Nova 2007-I, Ltd.             03/07                   478,594         05/10            05/13           2019
Hewett's Island CLO VI, Ltd.           05/07                   365,327         06/10            06/13           2019
Schiller Park CLO Ltd.                 05/07                   411,311         07/11            04/13           2021
Bridgeport CLO II Ltd.                 06/07                   493,675         12/10            09/14           2021
CIFC Funding 2007-III, Ltd.            07/07                   439,273         07/10            07/14           2021
Primus CLO II, Ltd.                    07/07                   368,820         10/11            07/14           2021
CIFC Funding 2007-IV, Ltd.             09/07                   593,374         09/10            09/12           2019
Columbus Nova 2007-II, Ltd.            11/07                   433,206         10/10            10/14           2021
Total Legacy CLOs                                            9,599,220
Total CLOs                                         $        11,178,778


Explanatory Notes:
_________________________________


(1) CLOs are generally callable by equity holders once per quarter beginning on the "first optional call date" and subject to satisfaction of certain conditions.

(2) Termination of reinvestment period refers to the date after which we can no longer use certain principal collections to purchase additional collateral, and such collections are instead used to repay the outstanding amounts of certain debt securities issued by the CLO.

(3) Represents the contractual maturity of the CLO. Generally, the actual maturity of the deal is expected to occur in advance of contractual maturity.

(4) Represents acquisition of rights to manage four CLOs through the completion of the GECC transaction. See "Item 8 - Financial Statements and Supplementary Data - Note 4" for further details.


Table of Contents

Results of Consolidated Operations

We are required to consolidate into our financial statements certain variable interest entities ("Consolidated VIEs") which we are deemed to be the primary beneficiary in accordance with GAAP consolidation guidance. This includes certain of the CLOs, CDOs and other entities we manage. See below-Consolidated VIEs for the additional information. The following table presents our comparative Consolidated Statements of Operations for the years ended December 31, 2012 and 2011:

                                            For the Year Ended December 31,               2012 vs. 2011
                                               2012                  2011            Variance      % Variance
                                                             (in thousands)
Revenues
Investment advisory fees                $        10,696       $         11,455     $      (759 )         (7 )%
Net investment and interest income:
Investment and interest income                      227                  3,332          (3,105 )        (93 )%
Interest expense                                      1                    350            (349 )       (100 )%
Net investment and interest income                  226                  2,982          (2,756 )        (92 )%
Total net revenues                               10,922                 14,437          (3,515 )        (24 )%
Expenses
Compensation and benefits                        22,945                 19,993           2,952           15  %
Professional services                             6,221                  9,111          (2,890 )        (32 )%
General and administrative expenses               6,096                  6,783            (687 )        (10 )%
Depreciation and amortization                    17,931                 16,423           1,508            9  %
Impairment of intangible assets                   1,771                  1,822             (51 )         (3 )%
Restructuring charges                             5,877                  3,686           2,191           59  %
Total expenses                                   60,841                 57,818           3,023            5  %
Other Income (Expense) and Gain (Loss)
Net gain (loss) on investments, loans,
derivatives and liabilities                      (9,565 )                1,915         (11,480 )    >(100)%
Corporate interest expense                       (5,912 )               (5,678 )          (234 )          4  %
Net gain on the sale of management
contract                                          5,772                      -           5,772          100  %
Strategic transactions expenses                    (657 )               (1,459 )           802          (55 )%
Net other income (expense) and gain
(loss)                                          (10,362 )               (5,222 )        (5,140 )         98  %
Operating income (loss)                         (60,281 )              (48,603 )       (11,678 )         24  %

Results of Consolidated VIEs
Net gain (loss) from activities of
Consolidated VIEs                              (144,472 )             (281,459 )       136,987          (49 )%
Expenses of Consolidated VIEs                   (23,908 )               (6,712 )       (17,196 )      >100%
Net results of Consolidated VIEs               (168,380 )             (288,171 )       119,791          (42 )%
Income (loss) before income tax expense
(benefit)                                      (228,661 )             (336,774 )       108,113          (32 )%
Income tax expense (benefit)                     11,667                  6,980           4,687           67  %
Net income (loss)                              (240,328 )             (343,754 )       103,426          (30 )%
Net (income) loss attributable to
noncontrolling interest and
Consolidated VIEs                               230,712                311,162         (80,450 )        (26 )%
Net income (loss) attributable to CIFC
Corp.                                   $        (9,616 )     $        (32,592 )   $    22,976          (70 )%
Earnings (loss) per share:
Basic and diluted                       $         (0.47 )     $          (1.82 )   $      1.35          (74 )%
Weighted-average number of shares
outstanding:
Basic and diluted                            20,355,807             17,892,184       2,463,623           14  %

Net loss attributable to CIFC Corp. was $(9.6) million, or $(0.47) per fully diluted share, for the year ended December 31, 2012, compared to $(32.6) million, or $(1.82) per fully diluted share, in the prior year. Operating results increased by $23.0 million from the prior year predominantly due to the following:


Table of Contents

Net Revenues-During the second quarter of 2011, we liquidated our investment in the RMBS portfolio which resulted in a decrease in net investment and interest income in the current year.

Total Expenses-Our total expenses increased year over year primarily as a result of increased compensation and benefits, restructuring charges and depreciation and amortization expenses. These increases were offset by decreased professional fees.

Compensation and benefits increased by $3.0 million from the prior year, primarily as a result of the amortization of stock options granted during 2012 and a portion of non-cash compensation related to profits interests of CIFC Parent Holdings LLC ("CIFC Parent," one of our significant shareholders). See Item 8-"Financial Statements and Supplementary Data-Note 13" for additional information.

During 2012, restructuring charges included the termination of our Rosemont, Illinois lease related to the consolidation of operations at the corporate headquarters in New York, the disposal of the related fixed assets from the lease termination and additional severance costs from the final integration of management teams after the Merger. In the prior year, restructuring costs included severance and other termination benefits directly resulting from the Merger.

Depreciation and amortization increased year over year primarily due to a full year of amortization expense recognized in 2012 from intangibles related to management contracts acquired from the Merger in April 2011. This increase was slightly offset by a decrease in amortization expense from the run-off of certain management contracts acquired as part of our DCM acquisition.

During 2011, we incurred certain "one-time" expenses related to the issuance of our first CLO since 2007, CIFC CLO 2011-I, and professional fees from the sale of our investments in and rights to manage the DFR MM CLO.

Net other income (expense) and gain (loss)-Total Net other income (expense) and gain (loss) decreased primarily related to a decrease in Net gains (losses) on investments, loans, derivatives and liabilities, partially offset by increases in Net gain on sale of management contracts and a reduction in strategic transactions expenses.

The components of total Net gain (loss) on investments, loans, derivatives and liabilities for the years ended December 31, 2012 and 2011 are as follows:

                                                  For the Year Ended December 31,         2012 vs. 2011
                                                      2012             2011          Variance     % Variance
                                                                (In thousands)
Net gain (loss) on investments at fair value      $   2,308       $       2,209     $      99            4  %
Net gain (loss) on liabilities at fair value        (11,452 )            (7,469 )      (3,983 )         53  %
Net gain (loss) on loans                                  -                 (38 )          38         (100 )%
Net gain (loss) on derivatives                            -               7,208        (7,208 )       (100 )%
Other, net                                             (421 )                 5          (426 )    >(100)%
   Net gain (loss) on investments, loans,
derivatives and liabilities                       $  (9,565 )     $       1,915     $ (11,480 )    >(100)%

Total Net gain (loss) on investments, loans, derivatives and liabilities decreased by $(11.5) million from the prior year predominantly due to a decrease in Net gains on our derivatives and increases in Net losses on our liabilities. The option to convert our senior subordinated convertible notes (the "Convertible Notes") was deemed to be an embedded derivative instrument (the "Embedded Derivative") and was required to be recorded at fair value. In December 2011, this feature expired resulting in a reduction of Net gain (loss) on derivatives. In addition, net losses on liabilities increased predominately as a result of an increase in the fair value of our contingent liabilities related to fee sharing due to better than expected performance on CLOs.

The total decrease in our Net gain (loss) on investments, loans, derivatives and liabilities was offset by a gain on the sale of our rights to manage Gillespie during 2012 and decreases in strategic transaction expenses. Strategic transactions expenses related to the GECC Transaction in 2012 was lower than strategic transaction expenses related to the Merger in 2011 (see Item 8-"Financial Statements and Supplementary Data-Note 4" for further details).

Net results of Consolidated VIEs-During the year ended December 31, 2012 and 2011, we had $62.3 million and $23.0 million, respectively, of Consolidated . . .

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