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Marlin Business Services Corp  (NASDAQ:MRLN)
Q1 2019 Earnings Call
May. 03, 2019, 9:00 a.m. ET


  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:


Greetings, and welcome to the Marlin Business Services Corp First quarter 2019 Earnings Conference Call.

At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instruction). As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Lasse Glassen, Managing Director, Investor Relations. Thank you, sir. You may begin.

Lasse Glassen -- Managing Director, Investor Relations -- Analyst

Good morning, and thank you for joining us today for Marlin Business Services Corp's 2019 first quarter results Conference Call.

On the call today is Jeff Hilzinger, President and Chief Executive Officer. Lou Maslowe, Senior Vice President and Chief Risk Officer; and Mike Bogansky, Senior Vice President and Chief Financial Officer.

Before beginning today's call, let me remind you that some of the statements made today will be forward looking and are made under the Private Securities Litigation Reform Act of 1995. Actual results may differ materially from those projected or implied due to a variety of factors. We refer you to Marlin's recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition.

With that, it's now my pleasure to turn the call over to Marlin's President and CEO Jeff Hilzinger. Jeff?

Jeffrey A. Hilzinger -- PRESIDENT & CEO

Thank you, Lasse. Good morning and thank you everyone for joining us to discuss our 2019 first quarter results. I'll begin with an overview of the highlights from the first quarter along with our recent progress on our strategy that is transforming our company from an equipment lessor into a nationwide provider of capital solutions to small businesses.

Lou Maslowe our Chief Risk Officer will comment on portfolio performance. And Mike Bogansky our chief financial officer will follow with additional details on our financial results and business outlook. We enjoyed a solid start to 2019 and strong execution delivered excellent origination volume growth and stable portfolio performance.

First quarter total source origination volume was $208.4 million, up 27.1% year over year and an all-time record for the first quarter. Growth in the quarter was driven by strong customer demand for both our equipment finance and working capital loan products.

Origination volume growth was also strong in both our direct and indirect origination channels, and we referred or sold $56.5 million of leases and loans as part of our capital markets initiatives. As a result of these origination and capital markets activities, our net investment in leases and loans is now consistently in excess of $1 billion and up 10% from a year ago.

Total managed assets which includes both our balance sheet portfolio and assets we sell or continue to service for others grew to more than $1.2 billion, an increase of 19.1% from the first quarter last year. In addition, our focus on maintaining disciplined underwriting standards continues to be a top priority and portfolio performance during the quarter was stable and within expectations.

Looking at our profitability, we reported gap earnings of $0.41 per diluted share compared with $0.50 per diluted share in the first quarter of last year. First quarter net income was negatively impacted by $0.04 as a result of the timing of expense recognition due to the adoption of a new lease accounting standard.

We expect the timing impact to normalize over the course of the year, which Mike will discuss in more detail in his remarks. We also continue to expect earnings to be more heavily weighted toward the second half of 2019 as the recent investments we've made in our sales force continue to generate returns.

Importantly, we are reiterating our earnings guidance for the full-year. It also gives me great pleasure to formally introduce you to Mike Bogansky, who is participating today in his first earnings call as Marlin's Senior Vice President and Chief Financial Officer. Mike officially joined the company in early February and has definitely hit the ground running. As CFO, Mike is responsible for our accounting, financial reporting, financial planning and analytics, treasury, tax, and investor relations functions. When you hear from him today and interact with him more regularly in the future. I'm confident that you will agree with me that Mike is the right person to lead Marlin's financial activities at an increasingly strategic level and I'm delighted that he's now part of the Marlin team.

Also, in early February, we announced the launch of our new brand identity to reflect Marlin's mission of helping small businesses fulfil their American dream. In order to be more congruent with this mission, our new brand unifies us and reaffirms Marlin's vision of becoming the leading provider of credit products and services to small businesses nationwide. The rebrand is accompanied by a new logo, website and tag line. The new logo incorporates a spark shape, which symbolizes the energy, capital and knowledge that we inject into small businesses. Our new website features videos and customers and partners reflecting on their relationship with Marlin and how we've helped them achieve their business goals. The new tag line, lending that works, speaks to the helpful, agile, trustworthy, approachable and informal voice behind the new brand. If you haven't already I'll invite you to take a look at the new brand and new website at marlincapitalsolutions.com.

I'd now like to switch gears and provide an update on our business transformation initiative better known as Marlin 2.0. By executing this initiative, we expect to drive growth and improve returns on equity by first strategically expanding our target market, second, better leveraging the company's capital base and fixed cost through origination and portfolio growth, third, improving our operating efficiency by better leveraging fixed cost through scale and through operational improvements to reduce unit processing cost, and fourth, proactively managing the company's risk profile to be consistent with our risk appetite.

I'd like to share with you the progress we've made in each of these areas since our last call. First, with respect to our strategic market expansion rather than thinking of ourselves as solely an equipment lessor, we are now focused on providing multiple products and financing solutions to meet the needs of our partners and small business customers. In addition we have also expanded our go to market strategy by not only continuing to originate through our equipment vendor partners but also directly with our end user customers. As a complement to our traditional equipment finance business, we continue to be very pleased with the consistently strong performance of our working capital loan product.

First quarter working capital loan origination volume expanded by more than 30% year-over-year to $23.6 six million. This marked the largest single quarter for working capital loan origination volume since we began offering the product in mid-2015. We also remain pleased with our efforts to provide financing solutions directly to our end user customers. Here we are successfully leveraging relationships built over the past two decades, including more than 80,000 active small business customers along with approximately 5,000 new customer relationships that we originate each quarter. The objective under our direct strategy is to identify additional financing opportunities with these existing customers by offering multiple products, and to create ongoing relationships with these customers by meeting a broader set of their financing needs.

During the quarter direct origination volume increased to $43.6 million, up from $30.9 million in the first quarter last year, resulting in a year-over-year increase of 41%. We also made good progress during this past year on our second key priority, which focuses on leveraging Marlon's capital and fixed cost through growth. Driven by strong origination volume and solid portfolio growth during the quarter and full-year, we were able to reduce Marlin's equity-to-assets ratio by approximately 100 basis points to 16.2% from 17.2% a year ago.

Our assets syndication program also remains very active and continues to diversify Marlin's funding sources. Overall we view asset sales as a way to achieve portfolio optimization by better managing its overall size and composition in terms of returns, credit risk and exposure to particular industries, geographies and asset classes. During the first quarter we sold nearly $53 million in assets that generated an immediate net pre-tax gain on sale of approximately $3.6 million. Importantly we continue to service the assets sold, which allows us to maintain an ongoing relationship with these customers in support of our direct strategy. As at the end of the first quarter we were servicing a portfolio of approximately $193 million for others


Moving on to our third area of focus, we also continue to make strides in better leveraging the company's fixed cost growth and by improving operating efficiencies through ongoing process improvements. After adjusting for temporary acquisition related cost and the change in accounting lease standard adopted January 1st this year. Our non-GAAP non-interest expense as a percentage of average managed finance receivables for the first quarter was 6.1% compared with 6.5% for the first quarter last year. The company's operating efficiency ratio adjusted on the same basis was 57.8% for the first quarter versus 55.8% for the first quarter last year.

The increase in the ratio during the first quarter was due primarily to increased investment in our sales force and a reduction in deferred origination cost. We do expect the ratio to improve on a year-over-year basis as we generate returns from our investment in the sales force and as we continue to leverage our capital and fixed cost through portfolio growth and operate more efficiently through our various process renewal initiatives.

Our fourth and final key area of focus it is proactively managing the company's risk profile to be in line with our risk appetite. Notwithstanding the impact from last quarter's vendor fraud, the key credit quality metrics over the last several quarters have remained stable, as they did again in the first quarter. And our portfolio continues to perform within an acceptable range. We will provide additional details on the portfolio's performance in his remarks. In summary, we enjoyed a solid first quarter with momentum continuing to build and we are poised for a strong year in 2019.

With that, I'd like to now turn the call over to Lou Maslowe, our Chief Risk Officer to discuss the performance of our portfolio in more detail. Lou?

Louis E. Maslowe -- Chief Risk Officer & Sr. VP

Thank you, Jeff, and good morning, everyone. Looking at the key asset quality metrics, equipment finance receivables over 30 days delinquent were 1.13% up five basis points from the prior quarter and six basis points from the first quarter of 2018.

Equipment finance receivables over 60 days delinquent were 1.68% up three basis points from the prior quarter and up two basis points from the first quarter of 2018. Increased equipment finance delinquency in the first quarter is primarily attributable to the higher delinquency in the 90 plus day bucket, due to greater than typical save rate. As noted last quarter, the increase in delinquency that we have observed over the past year is consistent with market trend. A benchmark that we utilize as the PayNet at 31 to 90 days Small Business Delinquency Index, which in February was up 10 basis points year-over-year. The modest increase in the delinquency level is still within our expected range. Aggregate net charge offs decreased in the first quarter to 1.83% of average finance receivables on an annualized basis as compared to 2.30% in the prior quarter and 1.68% in the first quarter of 2018. Equipment finance charge offs decreased by 55 basis points quarter-over-quarter to 1.64% and remained flat year-over-year.

Sequential quarter improvement was primarily due to last quarter's $1.2 million charge offs that resulted from fraudulent activity by a single vendor. The entire fraudulent portfolio was charged off in the fourth quarter. During the first quarter, we implemented additional fraud prevention tools and resources and expect to continue to do so, as fraud prevention remains a top priority for the company. Equipment finance charge offs in the first quarter benefited from strong recovery and the higher save rate noted earlier. With the exception of the fourth quarter fraud incident, we remain satisfied with the overall performance of our equipment finance portfolio. And we anticipate that the level of equipment finance credit losses in 2019 will remain within our targeted range.

Transitioning now to discuss working loans, 15 plus day delinquency was relatively unchanged in the first quarter from the fourth quarter, while 30 plus day delinquency decreased by 69 basis points. As discussed on prior calls working capital loan delinquency and charge offs are more volatile than equipment finance even larger balances and smaller number of contract. Working capital loan charge offs for the first quarter increased to 6.72% of average finance receivables on an annualized basis from 5.28% in the fourth quarter and 3.1% in the first quarter of 2018.

The increase in charge offs from the prior quarter was driven by the charge off of two large contract in January that were the primary cause for the higher 30 plus day delinquency at the end of the fourth quarter. While the working capital charge-offs exceeded the annualized 6% that we target in the current economic environment. The average charge-offs over the past five quarters was a very acceptable 5.1%. We do not believe that the first quarter results signal the change in expected performance or credit quality.

Based on our projected loss curve, like the charge-off performance for the working capital when the product was a 78% of target losses, we anticipate that the working capital portfolio continue to perform within our targeted rate. The allowance for credit losses was 1.66% of average finance receivable, up four basis points in the first quarter due to an increase in the equipment finance allowance from 1.52% to 1.56%. The uptick as a percentage of finance receivables was primarily driven by the higher late stage delinquency mentioned earlier. Based on projected lifetime loss curve, the working capital loan product allowance decreased from 4.02% to 3.94%. Looking ahead, we continue to expect satisfactory portfolio performance through 2019. Our outlook is based on Marlin's stable credit quality metrics as well as continued favorable small business optimism and small ticket portfolio benchmarks that we monitor.

With that, I'll turn the call over to our CFO, Mike Bogansky for more detailed discussion of our first quarter financial performance. Mike?


Thank you, Lou, and good morning, everyone. First quarter net income was $5.1 million or $0.41 per diluted share compared with $6.2 million or $0.50 per diluted share for the first quarter last year. As Jeff noted first quarter net income was negatively impacted by $0.04 per share. As a result in the timing of expense recognition influenced by the adoption of the new lease accounting standard. This included $0.03 per share from the acceleration of the provision for uncollectible property tax revenue and $0.01 per share from a reduction in the amount of allowable deferred cost associated with lease origination. We are reiterating our earnings guidance for the full-year and we continue to expect earnings to be more heavily weighted toward the second half of 2019 as the investments in our sales force continue to generate returns.

For the quarter, yield on total originations was 12.76%, up 40 basis points from the prior quarter and up 32 basis points from the first quarter of 2018.First quarter yield on direct originations was 23.09%, up 130 basis points from the prior quarter due primarily to the mix of working capital loans and our ability to pass through base rate increases in this channel.

The yield on indirect originations for the quarter was 9.76% down 21 basis points from the fourth quarter due primarily to the continued shift in our origination mix toward platforms that generally have lower yield but with lower credit risk.

For the quarter net interest margin or NIM was 9.59% down 17 basis points from the prior quarter and down 84 basis points from the first quarter of 2018. The decrease in NIM on a year-over-year basis was primarily the result of an increase in interest expense partially offset by an increase of 32 basis points in new origination loan and lease yield over the last year. We continue to experience a competitive pricing environment. And as we've discussed previously, we will continue to pass through increases in our cost of funds as aggressively as the market will allow.

We are also addressing the competitive pricing environment by continuing to refine risk based pricing in our direct channel and implementing it in certain portions of our indirect channel, so that we can balance yield on new business with the underlying credit risk at a more granular level. We will continue to roll out these new features over the course of this year. The company's interest expense as a percent of average finance receivable increased to 2.39% compared with 2.20% for the previous quarter due to the growth in the balance of net investment and leases and loans funded with deposit coupled with an increase in the interest rate on deposit.

Interest expense as a percent of average finance receivables increased from 1.49% for the first quarter of 2018, due primarily to the impact on funding costs from the securitization we completed in the third quarter of 2018 as well as an increase in deposit rate. It is important to note that the increased interest expense on the securitized assets is more than fully offset by the increased leverage that was generated with the net result being accretive to ROE over time as the company fully leverages the capital release from securitization.

Non-interest income was $12.9 million for the first quarter of 2019 compared with $7.1 million in the prior quarter and $5.2 million in the prior year period. The increase compared with the prior and year ago quarters is primarily due to the company's adoption of ASC 842 lease accounting, which was effective on January 1,2019 .The adoption of the new lease accounting standard requires a gross presentation on the consolidated statements of operation for certain lessor costs paid by the lessee. Accordingly, non-interest income increased by $5.6 billion for property taxes that we paid on behalf of our lessee. This was off that by an increase in general and administrative expenses for the associated property tax expense.

The increase in non-interest income compared to the year ago quarter is also attributable to an increase in gains on sale and an increase in insurance related income. We realized strong assets sale execution in the first quarter of 2019 due to the flat yield curve as lower swap rates enabled us to achieve better spreads on the assets we sold. First quarter non-interest expense was $24.8 million compared with $16.4 million in the prior quarter and $16.6 million in the first quarter last year.

The increase in non-interest expense compared with the prior year ago quarters was primarily due to the adoption of ASC 42 which increased non-interest expense by $6.1 million due to the aforementioned change in the presentation of property taxes in the consolidated statement of operation. Additionally the year-over-year increase in non-interest expense is primarily attributable to a number of items, including $700,000 of investment related to our prior acquisition and the addition of 12 employees to our sales force at $300,000 our increase from temporary acquisition cost.

And finally $300,000 of non-recurring expenses associated with the launch of our new brand and ancillary expenses as we complete renovations on our leased building that we recently expanded. During the first quarter of 2019, we repurchased 29,947 shares of Marlin common stock for an average price of $23.86 per share. To date, we have utilized approximately half of our share repurchase program that was announced on May 30th 2017, as $5 million of the $10 million authorization remains available for future repurchases.

While we continue to evaluate capital allocation alternatives, we continue to believe that share repurchases are an appropriate use of our capital at this time. And finally our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on May 23rd 2019 to shareholders of record as of May 13th 2019.

Now turning to our business outlook, we are reaffirming our previously issued guidance for the full year ending December 31 2019, as follows. Total sourced origination volume is expected to finish approximately 20% above 2018 level. Excluding the vendor fraud experienced in the fourth quarter of 2018, portfolio performance is expected to remain in-line with the results observed over the last 12 months. Net interest and fee margin as a percentage of average finance receivable is expected to be between 9.5% and 10%..

ROE is expected to continue to improve in 2019 as the company continues to improve operating skill, and lastly, non-GAAP earnings per share is expected to be between $2.30 and $2.40. That concludes our prepared remarks.

And with, that let's open up the call for question. Operator?

Questions and Answers:


Thank you. (Operator Instructions) Thank you. Our first question comes from the line of Brian Hogan with William Blair. Please proceed with your question.

Brian Hogan -- -- Analyst

Hey, good morning.


Good morning.

Brian Hogan -- -- Analyst

Just one little housekeeping thing first. Your tax rate going forward, a little lower than I anticipated, what do you expect from that?


Hi this is Mike, Brian. Tax rate should probably be somewhere between 25% and 26% going forward. We just had some temporary reductions due to some state tax rate.

Brian Hogan -- -- Analyst

All right. And then on the gain on sale it was consistent with the last quarter, but the yield went up. I guess what are the pace of sales that you expect and then the yield you're expecting to get on that?


Yeah, the yield in the first quarter was higher due to the flat yield curve and we had strong execution gains from reduction in swap rates. So we wouldn't expect that to continue through the pace of the year. But the asset sales would remain at a fairly consistent pace for the second and third quarters and then usually the fourth quarter is more seasonally increased.

Brian Hogan -- -- Analyst

So the $53 million of sales, you're saying that should continue in the second and third quarter and even higher from there?


No, sorry, the $53 million of sales includes the $12 million of assets that was originated for sale, so we sold $40 million of other assets. So we would consider the pace that was in the prior years with increasing into the fourth quarter.

Brian Hogan -- -- Analyst

All right. Outside of lower yields?



Brian Hogan -- -- Analyst

All right. And next question is focus on the adjusted operating efficiency ratio up year-over-year. And I guess what are you investing in? Because I've been expecting that trend to improve and you've articulated that you continually expect it to improve, and as well as on prior calls, you've made that statements that it seems to be going consistently in the wrong direction. I guess what are you investing in? Well, how are those returns showing up and when can we expect that? You know the scale benefits that you're talking about to actually show through the -- yeah just the operating efficiency ratio, I mean, your portfolio is meaningfully larger than several years ago, you're doing a lot of syndication gain on sale, just help me understand the investments you're making.

Jeffrey A. Hilzinger -- PRESIDENT & CEO

Yeah. Good morning, Brian, this is Jeff. So the primary reason for the increase for the year-over-year quarters because of the fact that we acquired FFR in the fourth quarter. And so, you know, we've got the expense associated with that platform and it continues -- it's continuing to ramp that it ramped during the fourth quarter and it's continued to ramp during the first quarter. And it's now, you know, in March and April it's now originating at the pace that it was originating prior to the disruption that experienced when it sort of began engaging in the sale process.

So we feel good about that. And I think as the -- as we've gotten to know the platform and then working on integration I think we're all even more convinced that there's a lot of upside in terms of what the platform could bring to us and what we can bring to it. So, you know, we expect that -- that fixed platform costs will continue to be leveraged as the FFR volume continues to continue to ramp. The other -- the other addition to the operating efficiency changes that we added 12 salespeople to the core Marlin sales force, six of those were filling in positions in our indirect business.

If you recall last year, you know, we went through a period of time where we were really having trouble getting to a full complement of salespeople. And so, you know, we gave them a lot of effort toward the end of last year and we were able to successfully fill those six positions. And then finally the last six we added to the direct business and we made that decision because we really feel like -- we really feel like we've got the right recipe and direct at this point. And so we wanted to add resource to really take advantage of the fact that the business wants to do more working capital loan business and in the direct side, you know, 50%, 60% of our volume is working capital.

So, you know, if we want to grow working capital and we want to do it, you know, in a meaningful way we need to continue to invest, you know, in the direct platform. So having said that the, you know, those investments are now made and we're not planning on adding any more sales resources over the balance of the year. And I think as FFR continues to scale and as the 12 sales positions that we added continue to season over the course of the year, you know, we begin to -- we begin to experience through the P&L the deleveraging of the operating expenses that we've talked about and that you mentioned.

Brian Hogan -- -- Analyst

All right. Have you seen any change in the competitive landscape?

Jeffrey A. Hilzinger -- PRESIDENT & CEO

No. Nothing material Brian, I think it's, you know, it's a competitive place. It's a competitive market right now. And I think, you know, where our flows are smaller ticket and they're more retail oriented. In other words, we sort of control the relationship with the end user both indirect and direct. I would say it's less competitive than it is, you know, when we're competing within the context of larger, you know, vendor programs with larger average transaction sizes. So as the ticket size gets larger and as our ability to be able to control the relationship with the customer decreases, it becomes much more competitive from a price standpoint.

Unidentified Participant -- -- Analyst

All right. And then from a -- what do you see in the economy? You know from our standpoint it's, you know, relatively stable. But you're seeing a lot of -- work a lot of small businesses, I guess. What is your view on the economy and any changes in any regional specific regions?

Louis E. Maslowe -- Chief Risk Officer & Sr. VP

Hi, this is Lou, Brian. You know we monitor probably all the same things that you guys are seeing, but for our business we focus on for one small business optimism, which I said the same thing last quarter while the results have tempered a little bit, they're still at historically high levels. The indices that we monitor in terms of portfolio performance continue to be stable. We have our own mix of leading indicators that we monitor that includes portfolio metrics as well as macroeconomic factors.

So summing all of that up, you know, we see stability while keeping a close eye on potential changes, you know, our underwriting remains consistent and until we see really a material change, we'll continue to do that, stay consistent.

Brian Hogan -- -- Analyst

All right. Thanks for taking my questions today.

Jeffrey A. Hilzinger -- PRESIDENT & CEO

Thanks, Brian.


Thank you. We have reached the end of the question and answer session. I would now like to turn the floor back over to management for closing comment.

Jeffrey A. Hilzinger -- PRESIDENT & CEO

Thank you for your support and for joining us on today's call. I'd like to mention that later this month on May 20, William Blair Securities will be hosting us on an ideal roadshow to visit with investors in several cities in the Midwest. And on June 4, we'll be presenting at the LD Micro Investor Conference in Los Angeles. We hope to see some of you at these events. If not we look forward to speaking with you again when we report our 2019 second quarter results in early August. Thanks again. I hope you have a great rest of your day.


Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.

Duration: 32 minutes

Call participants:

Lasse Glassen -- Managing Director, Investor Relations -- Analyst

Jeffrey A. Hilzinger -- PRESIDENT & CEO

Louis E. Maslowe -- Chief Risk Officer & Sr. VP


Brian Hogan -- -- Analyst

Unidentified Participant -- -- Analyst

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