Marlin Business Services Corp.
Q1 2017 Earnings Call Transcript

Published: 28 Apr 2017

[Operator:]

Greetings, and welcome to the Marlin Business Services Corporation First Quarter 2017 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host Mr. Lasse Glassen of Addo Investor Relations. Please go ahead.

[Lasse Glassen:]

Good morning, and thank you for joining us today for Marlin Business Services Corp's 2017 first quarter conference call. On the call today is Jeff Hilzinger, President and Chief Executive Officer; Ed Siciliano, Executive Vice President and Chief Operating Officer; Lou Maslowe, Senior Vice President and Chief Credit Officer; and Taylor Kamp, 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 variety of factors. We refer you to Marlin's recent filings with the SEC for more detailed discussions on 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?

[Jeff Hilzinger:]

Thank you, Lasse. Good morning and thank you everyone for joining us to discuss our 2017 first quarter results. I'll begin my comments this morning with an overview of the key highlights from this past quarter, including an update on our Marlin 2.0 initiative that is designed to transform our company from primarily a micro-ticket equipment lessor into a broader provider of credit products and services to small business. Ed Siciliano, our Chief Operating Officer will provide additional remarks on our first quarter operational performance, Lou Maslowe, our Chief Credit Officer will discuss portfolio performance, and Taylor Kamp our Chief Financial Officer will then discuss details about our financial results and business outlook. Our first quarter represented a great start to 2017 highlighted by excellent new asset production, strong portfolio growth and solid asset quality, along with continued progress on Marlin 2.0 that we expect will help take the company to the next level of growth and profitability. Total origination volume increased more than 49% from a year ago and was an all time record. This is particularly impressive for first quarter which tends to be our seasonally weakest quarter for origination volume. During the quarter we benefited from continued strong demand in our equipment finance business including a better than expected contribution from Horizon Keystone Financial, an acquisition we completed early in the first quarter. Funding stream, our working capital loan business continues to gain traction with 13.8 million or 8% of total first quarter origination volume. We also continue to enjoy solid contributions from our newer franchise and transportation finance channels. In total, our investment in leases and loans grew a record 824.9 million up 18% from a year ago. Importantly, our focus on maintaining disciplined underwriting standards continues to be a top priority and credit quality remained within expectations during the quarter. In addition to our strong financial and operational performance, we continue to fortify the Marlin Management team with the addition of new talent, as well as through well-deserved promotions from within the company. Subsequent to the end of the quarter, we announced the hiring of Timothy Bonagura, Michael Stanley and Matthew Manning, a sales team with more than 40 years of combined experience selling credit products and services directly to small businesses. The addition of Tim, Mike and Matt was part of a broader realignment of our sales organization that I will discuss in more detail in a moment. In their new roles, this team along with other existing Marlin resources will focus exclusively on offering Marlin's full suite of credit products and services directly to Marlin's existing small business customers. Also as part of his realignment, we promoted Mark Scardigli to Senior Vice President and Leader of the indirect team that will remain focused on originating through our equipment dealers and other important intermediaries. And we also promoted Rick Henderson, the first Vice President and Leader of the franchise and direct teams. I'm thrilled to have Mark and Rick in these important new roles and know the day in partnership with Ed Siciliano will accomplish great things for Marlin. And finally during the quarter we announced the promotion of Kathy McGurk, the Vice President and Leader of our activities with broker intermediaries. Kathy came to Marlin almost two years ago with more than 25 years of experience in strategic planning, sales and new business development including senior management positions at the DL and Advanta Business Services. Kathy will report to Mark Scardigli and continue to oversee the integration of Horizon Keystone, while also continuing to manage Marlin's broker relationships for both our equipment finance and funding stream products. As with Mark and Rick, I'm grateful to have somebody of Kathy's experience leading this important part of our business. Overall, I couldn't be more pleased with the world class team we're assembling at Marlin and I want to thank and congratulate all of our employees for their efforts and strong execution during the quarter. We are very fortunate and I am indeed grateful to have such an engaged workforce that is open to new ways of thinking and extremely committed to our success. I'd like to now move to the discussion to an update on our Marlin 2.0 business transformation initiative. As you may recall, Marlin 2.0 we expect to drive sustainable growth and improve returns on equity by first strategically expanding our target market, second better leveraging the company's capital base and fixed cost to origination and portfolio growth, and third improving our operating efficiency by better leveraging fixed cost through scale and through operational improvements to reduce unit processing costs. 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, historically the company operated primarily as a micro-ticket lessor with a single product and vendor centric model. At the heart of the Marlin 2.0 strategy is the company's transformation into a broader provider of credit products and services to small businesses. So rather than thinking of ourselves only as a single product micro-ticket lessor, we are now focusing on using multiple products to develop financing solutions for small businesses to help them grow and achieve their American dream. To this end, we are quite pleased with the continued success of our working capital loan product funding stream. While we are carefully managing the growth of this relatively new product, we continue to believe that Marlin is uniquely positioned to offer this product in a safe and sound manner given our proven credit models and expertise in underwriting credit products to small businesses. Having said that, first quarter origination volume was a single quarter record and we expect volume to increase modestly throughout the year. In addition, our franchise and transportation finance businesses which cater to the unique needs of franchisees and transport businesses, made solid contributions in the quarter and we expect activity to continue to increase throughout the remainder of 2017. Along with this current slate of products and services, we are also continuing to evaluate potential new products to further meet the financing needs of our small business customers. As I've mentioned previously, our expansion activities go beyond organic growth to also include strategic acquisitions. As previously announced, early in 2017 we completed the acquisition of Horizon Keystone Financial to extend our existing equipment finance business into new and attractive markets including office furniture, HVAC and the automotive aftermarket. Further by providing the Horizon team with access to our technology, marketing resources and low cost funding platform, we believe that the acquisition will further leverage our existing infrastructure while accelerating Horizon's future growth prospects. The integration of Horizon has gone well and the Horizon team enjoyed a very productive first quarter with origination volume exceeding expectations. In addition to expanding our product offerings, we are also beginning to broaden our go to market strategy. Historically, Marlin is viewed its equipment dealers, distributors and manufacturers as its primary customers. An important component of Marlin 2.0 is acknowledging that our addressable customer base also includes our end-user customers. As I noted earlier, during the quarter we realigned most of our origination resources into two teams with one focused on our traditional indirect or intermediary customers, and the second team focused on our end-user customers. With approximately 350,000 lifetime end-user customers almost 70,000 active end-users between 2000 and 3000 new end-user customer customers coming into the Marlin system every month. This is no small market for the company. Like our traditional vendor model, Marlin's end-user strategy begins by providing equipment dealers, distributors and manufacturers with financing solutions to help them sell equipment to their small business customers but under 2.0 end-user is then assigned to the end-user team which immediately works with the end-user to identify other financing needs they might have. Under this model, the indirect origination team creates a continuous flow of new end-user opportunities for the direct origination team and the direct origination team creates a continuous flow of new vendor opportunities for the indirect origination team. This dynamic creates a symbiotic self reinforcing relationship between the two teams. This model enables Marlin to present multiple products including equipment finance, franchise finance, working capital and other potential products directly to our end-user customers, thereby creating an ongoing relationship. Importantly, because we do not pay customer acquisition costs beyond the initial transaction, repeat business significantly lowers the blended customer acquisition costs on our total portfolio. This new model represents a dramatic shift for Marlin and is a critical factor in transitioning the company from a micro-ticket leasing company into a true small business lender. While this new go-to-market strategy is still in its early days, I'm very encouraged by the initial results. We also made good progress during the quarter on our second key priority which focuses on leveraging Marlin's capital and fixed cost through growth. Our continued strong origination volume and portfolio growth during the quarter allowed us to reduce our equity to assets ratio from 17.2% from 19% in the first quarter last year. To further leverage our capital base and increase return on equity in the future, we also still intend to establish a wholesale credit facility at the holding company level and expect to have this facility in place later this year. In addition, we also remain quite active with our secondary capital markets activities. During the quarter we sold another two portfolios with attractive economics and successfully expanded our investor base for future portfolio sales. Along with providing Marlin and other source of funding, we view these transactions as a means to optimize our portfolio by more precisely managing its overall size and composition in terms of returns, credit risk and exposure levels to particular customers, industries, geographies and asset classes. And finally, we also continue to make progress during the quarter in better leveraging the company's fixed costs as evidenced by our significant increase in origination volume with minimal changes to our production headcount. Our ability to further improve efficiencies and ultimately achieve our efficiency ratio goal of 45% by 2020, hinges on the success of our ongoing process improvement activities. Internal Marlin teams continue to work on process renewal initiatives with the overarching objective of achieving significant improvements in cycle times, quality and overall productivity. While our activities are not expected to be completed until later this year, many of the design team's early findings have been implemented and I'm quite pleased with what we are seeing in terms of the gains in throughput while maintaining current production headcount levels. Even with the record origination volume in recent quarters, many of our production teams are clearly working fewer late nights and weekends compared to historical periods when we had much lower origination volumes. I look forward to updating you on our continued progress on future calls. In conclusion, we had a terrific first quarter as evidenced by robust origination volume, portfolio growth and stable asset quality along with excellent progress on our Marlin 2.0 initiatives. Momentum continues to build and puts us on track to achieve our strategic objectives for 2017. I look forward to continuing strong execution of our strategy, enhancing our financial and operational performance, and driving shareholder value as we move forward. Before turning the call over to Ed, I'd like to provide some comments on the payment processing matter we first disclosed in our 10-K that was filed last month and then updated in the earnings press release we issued last night. As an FDIC-insured state chartered bank, Marlin Business Bank is subject to regular examinations by state and federal banking agencies including the Federal Reserve and the Utah Department of Financial Institutions. In the course of an examination, we received notice in February 2017 from one of the banking regulators describing preliminary findings in connection with the timing of certain aspects of the payment application processes in effect prior to February 2016 related to the assessment of late fees. We believe that the resolution of this matter will require Marlin to pay restitution to some customers. Our initial estimate of the restitution amount is $4.2 million which was charged against our first quarter earnings along with certain related professional fees and costs for a total first quarter charge of $4.4 million. Furthermore, because we revised our practices in February 2016, we do not believe this matter will have a negative impact on our operations going forward. Consistent with our 2.0 initiative and the end-user strategy that I discussed previously, I want to emphasize that the company's new management team is fully committed to leading this company into the future with an unwavering commitment to our customer success. I want to assure you that the senior leadership team and I are moving with a great sense of urgency to further enhance the governance framework and business practices that are in place. With that, I'd like to now turn the call over to Ed Siciliano, our Chief Operating Officer to discuss our first quarter operational performance in more detail. Ed?

[Ed Siciliano:]

Thank you, Jeff, and good morning everyone. My comments today will focus on first quarter originations, and capital markets activities. First I would like to briefly discuss a metric that will provide better clarity around Marlin's origination activities. As you may have seen in the first quarter earnings release, we are now reporting total source origination in conjunction with the previously reported total new originations funded. With the completion of the Horizon Keystone acquisition in the first quarter, along with our increased capital markets activities, a larger portion of our origination activity will not be held on Marlin's balance sheet but rather referred to other financial institutions for a fee. This has historically been Horizon Keystone's business model and as a unit of modeling, we intend to maintain this model, then over time migrate this business to our balance sheet. In the past, Marlin originated a small amount of referrals volume. However, with the addition of Horizon Keystone it is now material amount of our overall new asset production. With that in mind and in the hopes of being as transparent as possible with investors, going forward we will be reportable both total new originations funded, and total sourced originations, with the latter including referral volume. We believe the reporting of these new line items will more accurately reflect the growth within new originations and as such will enhance our overall origination reporting. New originations funded in the first quarter of $146.5 million broke the previous record established last quarter and was up 35% compared to the first quarter last year. Total sourced origination volumes of 168.8 million also reached a record level and increased 11% from the prior quarter and 49% from the prior year period. Now let’s look at our new originations funded during the quarter in more detail. Equipment finance origination volume declined slightly from the prior quarter due to seasonal factors but increased 30% from the prior year period to reach 132.7 million. Funding stream, our working capital loan product continues to gain momentum as evidenced by first quarter origination volume of 13.8 million. This was up 22% from the prior quarter and more than two times higher than a year ago. This past quarter, funding stream represented 8.2% of total sourced originations up from 7.5% of total sourced originations funded in the fourth quarter of 2016 and 5.6% in the prior year period. Due to the short funding stream tenors, the portfolio only increased by 3.4 million from the fourth quarter and still represents 2.7% of the total portfolio. We are also very encouraged to see that the continued growth in funding stream also help to increase overall total yield on new originations funded. For the quarter, total yield on new originations funded of 11.86% was up 36 basis points from the prior quarter and 17 basis points from the first quarter of 2016. The majority of funding stream loans were originated with existing Marlin customers and cross-selling our known customers will remain the focus of our origination efforts. Referral volume was 22.3 million, an increase over four times in the previous quarter. Contributing to this strong growth was the acquisition of Horizon Keystone, as well as some larger transactions best suited for our partners portfolio. All nearly all of Horizon Keystone's volume was syndicated during the quarter and we will continue to do so in the near future overtime our intention is to begin putting the Horizon Keystone origination volume on our balance sheet. While still in its early days, Marlin's process renewal initiatives continues to produce promising results. During the quarter, the company processed over 7000 finance transactions, an increase of 14% over the same period a year ago. We did this without adding any additional processing resources and was notably less friction on the system. As we have mentioned on previous calls, we believe process renewal will continue to have a positive impact on our profits and capacity as a result of significant improvements in productivity and streamlining. Added benefits will include improvements in cycle times, service levels, and quality. During the quarter we completed two portfolio sales totaling 7.6 million. This transaction in the first quarter generated an immediate gain on sale of $190,000 that was recorded in other income. Once again we continue to service the leases that were sold and will recognize service and fees over the life of leases. In closing, we are pleased with our results in the first quarter and now have even more conviction that as we scale the business, and continue to add operational improvements, we will realize our goals around growth and ROE ultimately increasing shareholder value. With that, I’ll turn the call over to our Chief Credit Officer, Lou Maslowe. Lou?

[Louis Maslowe:]

Thank you, Ed and good morning everyone. I am pleased to have the opportunity to provide an update on Marlin's portfolio performance. I will also explain the changes we are making to some of the credit metrics that are published in our supplemental quarterly data. Our 30 and 60 plus day delinquencies were both slightly higher than the prior quarter but they remain consistent with our expectations. It's important to note that delinquency typically arises in the first quarter and the results in the first quarter of 2017 are on par with the first quarter last year. Given the growth in our portfolio, we monitor not only delinquency percentages but other metrics to confirm that there is no evidence of portfolio deterioration. These metrics include analysis of delinquency in terms of number of contracts, vintage analysis by average credit score of booked portfolio, and approval rates. Overall, we are pleased with the ability of the portfolio as evidenced the above-mentioned metrics. Net charge-offs in the first quarter increased to 1.57% of average finance receivables on an annualized basis as compared to 1.4% of AFR in the prior quarter and 1.35% of AFR in the first quarter last year. We anticipate that net charge-offs will increase modestly over time as our high yielding funding stream product grows as a percentage of the total portfolio. Hence, it will be important to monitor separately the performance of the portfolios and this information is disclosed in our supplemental data. Net charge-offs in the leasing portfolio increased by 11 basis points and 14 basis points compared to the fourth quarter of 2016 and the first quarter of 2016 respectively. It should be noted that 146 basis points of net charge-offs for equipment leasing in Q1 2017 was equal to the average monthly net charge-offs since January 2013 which demonstrates consistent portfolio quality and performance. Funding stream charge-offs of $294,000 in the quarter represented 5.51% on an annualized basis which is in line with our expectations for this product and what we view as an acceptable and profitable level. Given the nature of the product in still relatively small portfolio size, funding stream results are subject to volatility from one quarter to the next as evidenced by the range of charge-offs over the past five quarters, from the low of 1.11% to a high of 5.51%. As you may recall from the fourth quarter earnings call, Taylor mentioned that one of our initiatives during the first quarter of 2017 would be a review of the credit metrics that we disclosed in our quarterly supplemental data. As a public company, it is our duty to provide sufficient transparency to Marlin's investors while protecting information that could be proprietary. As part of this process, we have reviewed the credit data disclosed by our publicly traded competitors and other financial services companies. Overall, we have found that the data currently published by Marlin is in line with the market but we want to let you know of a few changes that we will make. Beginning with this first quarter earnings release, we will add for both our equipment finance and funding stream business lines not accrual percentages, as well as a risk-adjusted net interest margin calculation. Beginning with our second quarter earnings release, we will no longer publish the static pool loss and delinquency by vintage data. With that, I'll turn the call over to our CFO, Taylor Kamp for a more detailed discussion of our first quarter financial performance. Taylor.

[Taylor Kamp:]

Thank you, Lou. Marlin delivered a strong first quarter led by record growth in originations which drove portfolio size to an all-time high while maintaining credit performance consistent with expectations. Excluding the charge, first quarter net income on an adjusted basis was $4.3 million or $0.34 per diluted share compared to $3.7 million or $0.29 per diluted share for the first quarter last year. Our investment and leases and loans grew approximately 4% from last quarter and 18% year-over-year to 825 million in all-time record. It is important to note that through March 2017, Marlin has originated more than $5.1 billion in loans and leases since its inception. Excluding the charge, return on equity on an adjusted basis was 10.44% up 70 basis points from a year ago. The increase in adjusted basis ROE from a year ago was primarily the result of improvements from growth and scale, the contribution of Horizon Keystone and syndication fees. We expect ROE to continue to increase throughout 2017 as the business grows and we better leverage fixed cost through increasing scale and via benefits from process renewal. For the quarter, net interest margin was 10.91%, 67 basis points lower than a year ago. The decrease in margin percentage from a year ago was primarily driven by the aforementioned reduction in late fees, the decrease in end of lease income, the roll-off of higher yielding assets, growth in lower yielding equipment finance channels and an increase in the company's cost of funds due to the series of fed rate hikes. There is usually a small time lag between the repricing of new originations and new deposits. For the quarter, the allowance for credit loss reserves was 1.42% of total finance receivables and 247.1% coverage of 60-day delinquencies. It is important to note that our reserving methodology is very sensitive to small, short-term changes in delinquency and loss emerges. First quarter other expenses were $19.6 million compared to $12.7 million in the first quarter last year. In addition to the first quarter, $12.2 million charge, the increase in other expenses from the first quarter last year was due to an increase in salaries and benefits and legal and consulting costs. Legal and consulting costs for the aforementioned charge were approximately $300,000. The company's efficiency ratio for the first quarter was 76.79% compared to 58.23% in the first quarter last year. Excluding the impact of the charge, the efficiency ratio in the first quarter of 2017 was 59.47% up seasonally from the previous quarter. Our capital position remains strong in the quarter with an equity to assets ratio of 17.22%. 181 basis points below last year. The continuing decrease in the capital ratio quarter-to-quarter while accelerated by the charge was by design and resulted from strong asset growth. I am pleased to report that our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on May 18, 2017 to shareholders of record as of May 8, 2017. We remain committed to carefully balancing our growth strategy while continuing to deliver strong returns, robust profitability and value to our shareholders. We will continue to evaluate capital investment alternatives and adjust our capital trajectory as needed with the best interest of our shareholders in mind. The continued development of our syndication capability and continuous monitoring of capital account allows us to very precisely manage capital. As communicated earlier, we have introduced new reporting in our supplemental package which better reflects our revolving Marlin 2.0 business model, our credit monitoring activities and our commitment to being transparent to our investors. You should expect that we will continue to evaluate the information we present and tailor to best measure, monitor and report our progress toward our strategic objectives. Now turning to our business outlook. Full-year 2017 new originations funded is expected to finish at least 20% above 2016 levels. Credit quality is anticipated to continue to remain within our expected range. Net interest margin is expected to move slightly lower in 2017 with the roll-off of higher yielding legacy leases and continued growth in lower yielding equipment finance channels partially offset by expected growth in the company's higher yielding funding stream loan business. And finally, we expect ROE to grow to the low teens on an adjusted basis by the end of the fourth quarter of 2017 as strategic initiatives gain traction and the company continues to improve operating scale. In conclusion, Marlin's first quarter performance continued a trend of record origination volume, portfolio growth, improving EPS and achievement of strategic goals. This was a strong start to the year and we look forward to attractive growth and profitability in 2017 and beyond. And with that, I will turn the call over to the operator for Q&A.

[Operator:]

[Operator Instructions] Our first question comes from Chris York with JMP Securities. Please proceed with your question.

[Chris York:]

Thanks for taking my questions, good morning guys. I'm looking to get a little bit more color on production. So could you provide, maybe Ed, provide us with the monthly production numbers in the first quarter and then the numbers to date in April, and then lastly the breakout in transportation and franchise?

[Ed Siciliano:]

Sure, Chris. I'll start with the monthly production. So, January was roughly 39 million, a move to 41 million in February. And we had a big March with 52 million. That’s on the equipment finance side. I don't have funding stream, but it was pretty straight line through those three months totaling 13.8 million. So that was roughly $30 million growth year-over-year. About half of that came from the new investment channels, transportation and franchise that was 17 million between the two channels, Chris. And the other 13 million came from our core channels which also grew nicely. I think driving some of that growth across all channels was, we were able to successfully move our average ticket up which is something we've been focused on to basically a 20 year high at 20.4 million. I forgot the very last part of your question because the phone is chirping here.

[Chris York:]

April.

[Ed Siciliano:]

So April. I touch you about demand in general. Right now for the first time in many, many years I think I might have mentioned this on the last call, we’re feeling a little bit of a tailwind. Small business confidence is up, and demand across all of our channels is up, and we’re kind of enjoying that. So our applications through the door have really continued - it's been 18 months now. 18 consecutive months, our application through the door haven't increased and that is the case in April as well. So we still got a little bit of time left in the month today to wrap up I think as of yesterday, we're 36 million or 37 million, and then we usually have a big close. So we’re continuing on the year-over-year substantial growth rate.

[Chris York:]

Great. Sorry, go ahead Jeff.

[Jeff Hilzinger:]

I would just say that I think - so those numbers are all terrific, and they’re better than we expected. But I think the thing that I'm feeling is there is just you can feel the momentum building in the business. It's not like it's just one channel that's performing better than expectations. Whether it's Horizon Keystone, whether it’s transportation, funding stream, the core retail business, it's all benefiting I think from a lot of things that we've done in the company and I think a lot macro sort of tailwinds that the business is experiencing now. So all in all I think it's going to continue, and I think it's going to particularly accelerate as we get to the second half of the year.

[Chris York:]

That's great. Just to clarify. So the numbers you've provided are on balance sheet originations, or are they now the new metric sourced originations?

[Jeff Hilzinger:]

So 39, 41, 52 is on balance sheet equipment finance. So on balance sheet we had 13.8 million for funding stream that totals the 146 million on balance sheet total.

[Chris York:]

Okay. And then switching gears. So have you had any updated discussions with you regulators that may have given you any indication that the 15% risk based capital threshold may be revised in the future?

[Jeff Hilzinger:]

Chris, this is Jeff. So we've obviously been working through the payment processing issue that we discussed, that's sort have been our priority on the regulatory front over the last six weeks or so. We just had an exam completed out in Salt Lake. We're close to having it completed in the next couple of weeks. So we want to let that happen because we think that the results from that will be fine. And so we've made some progress on refining the actual plan to change the calm agreement, and would hope that we’ll be in a position to begin to advance that soon. There's a lot of dynamics around it at the moment that, that's about as comfortable as I am in sort of talking about timing.

[Chris York:]

Okay, fair enough. So on the weighted average yield, the highest I think since the third quarter of '13, it appears to be from mix, is that correct? And then are there any other trend that are worth pointing out by product type?

[Jeff Hilzinger:]

Yes, very good question, Chris. Let me just start by saying we’re really pleased to have average weighted yield on new originations increase at the same kind that we’re increasing originations by 35% year-over-year. That really doesn't happen very often in our business. So there are really a couple of competing factors. One is mix. So we actually expected our first quarter yield to decline about 27 basis points in the first quarter based on what we expected to come in by channel mix. But at the same time, we successfully implemented a 25 basis point price increase generally on an average across all channels in the quarter which held equipment yields on new originations on the equipment finance site neutral as you saw it about 9.6% to 9.7%. And then on top of that, growing funding stream origination, and that’s really why we wound up at the highest new origination yields for the past five quarters. So we’re actually pretty pleased with that.

[Chris York:]

Great, color was helpful. Switching to expenses, we know there were some one-time expenses in salaries and pennies this quarter. So Taylor, could quantify how much of that was one-time or alternatively the recurring level of expenses in the quarter?

[Taylor Kamp:]

Yes, thanks Chris. I will do my best. When comparing to prior year, we had some really I'd say continuing expense relating to senior executives. There was $700,000 year-over-year increase. We also are obviously up in volume growth. So we had some commissions. So you’d expect those to continue with the business. We did have stock-based and other types of comp come through the quarter. That is about $225,000. That’s more of a seasonal expense that only occurs in the first quarter generally. Not all of that was taken in the first quarter. Much of our stock-based comp didn't get valued and priced in until right at the end of the first quarter. So we would expect to see some expense come through in the second quarter for that. Probably I like kind amount come through the second quarter. We did have some non-payment processing issue charges come through, not related to payment processing. Some consulting charges come through for about $100,000. We had some relo expense for some new executives come through in the first quarter. That was a relo and temporary recruiting expense. That was about $200,000. And we had a data processing charge in the first quarter which was about almost $280,000. We have a little bit of an uptick which is more of a permanent uptick in our FDIC-insurance of $100,000. And then you need to note that, we announced this in the third quarter that we're now reporting our insurance product broadly across both revenue and expense. It used to be, up until the third quarter of '15 that used to be recorded basically as one number in the revenue side. And so there was about $300,000 in our expense account in the first quarter. That is clearly an overage to the prior year. But that kind of expense will continue going forward.

[Chris York:]

That's helpful. Lot in there. And so if I combine I’ll probably have to go back to that transcript. But if I combine some of those one time or as I exclude that going forward, and then how should I think about the core run rate because you got some new hires and the sales team that should probably drive up some expenses in Q2. And then I think last quarter we talked about the efficiency ratio getting to maybe 52% by year end. So how we think about operating expenses maybe just on an absolute basis, near term and then maybe efficiency ratio as well.

[Taylor Kamp:]

Yes, let me take the second one first, I believe our guidance that it would be in the low 50s or 52 falls in that category by the fourth quarter of 2017 still holds true. It's not linear it's - we see really the scale benefits and renewal benefits really start to come home to roost right in the last half of the year especially in the fourth quarter. I would say that in our expense, you take out the relo and recruiting and the DP expense and the consulting expense that along with this RSUs, some of our RSU expense which are restricted options expense, you get to more of a consistent run rate, it will fluctuate because we do have a ramp up of volumes throughout the year and so that in any variable comp associated with commissions and credit bureaus and things like that, you will see a little bit of an uptick. But if you adjust out those other items that gets you back to a better run rate for the company and as Jeff has said, we do expect at the core that Marlin 2.0 will be a growth strategy without a lot of added expense.

[Chris York:]

Helpful, that’s it from me. Thanks for taking my questions guys.

[Operator:]

Thank you. Our next question comes from Brian Hogan with William Blair & Company. Please proceed with your question.

[Brian Hogan:]

Good morning. First question is on referral. I think in your comments you tell it's for a fee, so I guess my question is where does that show up and how much is the fee and how we should think about that line going forward?

[Taylor Kamp:]

Yes, the fee show up in the other income line, it’s not in the NIM, so those are syndication fees, our referral fees, along with our insurance all shows up in that line. And so those are really its just a fact or tons of balance. So if you’re referring to $10 million it's, ex-times $10 million basically is how those fees are calculated.

[Brian Hogan:]

And what is the fee rate, I mean what is the yield - what was it in the quarter, I mean calculate then it myself.

[Taylor Kamp:]

Give me a second.

[Brian Hogan:]

The referral fee income.

[Taylor Kamp:]

I mean it does move around by asset class, give me a second here. In the quarter, the syndication income and gain on sale and other revenues you're looking at 1 million in a quarter, something like that. And those - as I said those factors that are applied to the volume that is basically referred ranges from two points to seven point on that - on those. And I would say that Horizon Keystone is a large portion of that from a referral standpoint and those I don’t want to get into the particulars of the pricing on those but they are at the higher end of that range.

[Brian Hogan:]

So I guess, I mean if you said 1.25 from the syndication and gain on sale, then if that other income was 2 million, the balance of 175 was the referral. Is that what I'm thinking about right, I’m just going to - how to think about this line going forward?

[Taylor Kamp:]

So the total other income was 2 million and let's say syndication income and gain on sale of syndications was about that 550,000 of that, the rest of it was pure referral so that was about $800,000. Yes, the 500 should be a continuing number and then there is some insurance policy fees in there to tune of about $400,000 think.

[Jeff Hilzinger:]

Brian this is Jeff. I think about 800 of it is from either Horizon Keystone or from - we had a couple of large transactions that we were able to originate and syndicate for fee. Those - will do those as often as they come, but I wouldn't consider them to necessarily be recurring. They're not central to the strategy, they just work we're able to accommodate them, given that we got this capital markets capability now. And on the piece that comes from Horizon Keystone, that's going to be shifting over time because as Ed had said in his comments, we're going to be shifting that volume on balance sheet over the course of the year and so what will end up happening is that the gain on sale which is less efficient than having it on our balance sheet for its life will migrate towards interest income time really beginning 100% in 2018. So it's - it could be a little confusing I know because we're kind of in a transition with respect to that that flow, which we managed purposely that way because it's critically important that the platform continue to experience the same composite approval rate being part of Marlin as it has being independently in order to maintain its competitiveness. So we've let them continue to sell while we we're confirming that as we bring those flows on balance sheet, they will get the same approval rates that they've got before and get the same operational support that their customers are used to getting as well. So we just want to be very careful and deliberate in the integration process and that's why we're taking our time here. So it's less about wanting to gain on sale on that volume. We want to put it on balance sheet as quickly as we can without disrupting the Horizon Keystone value proposition to its customer base.

[Taylor Kamp:]

And before you ask the question, I'll try to answer it here. Horizon Keystone was accretive in the first quarter net-net and that was through really a referral strategy we would expect clearly be accretive would we bring it on balance sheet as well. So it's been a very positive acquisition.

[Brian Hogan:]

And the credit quality of those originations and obviously your referral what I mean, but you got to have some indication –

[Taylor Kamp:]

Yes, the good news is Brian that they been - their partners, their syndication partners are banks. So you know they're originating pursuant to a set of bank credit boxes and you know we've back run certainly the January, I think maybe even the February origination volume to Marlin's models and the approval rates are comparable and we're not even giving them the benefit in this spec testing of the personal guarantees which there is a significant amount because we don’t have the authority to rerun with personal guaranty. So those are Corp. only approval rate. So I think it's - I think everybody is feeling good about the fact that Marlin's credit approval box when it's - when it's layered on top of the Horizon Keystone flows will give them at least the approval rate that they've gotten historically and in fact they might actually have an improved approval rate certainly - potentially at the top of the box given that we still have this capital markets capability.

[Brian Hogan:]

I appreciate the measured pace of which you migrating on balance sheet there and the critical - it seems a nice little transition. Switching gears, syndication volume was less than what I had expected and lower than last. Is it just a function of the markets and what to expect for the year.

[Jeff Hilzinger:]

I think we definitely have a budget in terms of the amount that we're assuming we're working to sell and there's an implicit gain on sale that's in the P&L. Having said that, every quarter what we're selling is really driven by the portion of the portfolio that we think would reside more efficiently on other people balance sheet. So if the budgets says we’re going to sell x, we're not necessarily focused on selling just x, we're focusing on selling those assets that make the most sense to be on somebody else's balance sheet. And so I think in this particular quarter, there was - when we did the sorts to figure out what the pools were that might make sense to be on somebody else’s balance sheet we just ended up with a little smaller pool than what we had bought when we put the plan together it's nothing other than that.

[Louis Maslowe:]

As the year progresses Brian we’re going to be trying to over originate knowing that we want to syndicate some of this business. So it will balance a little bit but I think overall the objective on average 10 million plus.

[Brian Hogan:]

All right appreciate that - Lou welcome one. And then two I guess if they what are your views of Marlin credit systems I mean what changes do you think that need to be made and just your broad views about the credit trends?

[Louis Maslowe:]

Yes, well thank you for the question yeah I have to say that now almost four months that I've been here I really was very impressed with what I found both from a really overall risk-management perspective, but also importantly risk culture. The company is really expert its lending the small businesses the credit model that have been developed and validated over a number of years perform very well. And our underwriting is really very consistent we’ve got veteran team of underwriters and management that really I have to say do an excellent job. And I think the results demonstrate that and the consistency that we've seen over the years. They do a great job or we do a great job slicing and dicing the portfolio on a monthly and quarterly basis to see what the trends are and to tweak as necessary the models on an ongoing basis. So I think that as we move forward were constantly looking to see what improvements we can make to get greater efficiency. So as our scorecards for example we put in one change this quarter in Q1 to raise the order decision or what we call the instant order decision rates. In Q2 we’ll do another one we implemented recently large ticket scorecard to continue to again focus on improving efficiency while maintaining quality. So I think that both from a portfolio analysis perspective and underwriting perspective Marlin does great job. In terms of looking forward we see continued all the evidence we have is that the numbers and performance will remain consistent to where we are. As I mentioned in my comments earlier funding stream which is actually performed better than we anticipated, but we expect a general increase in the overall credit losses as that portfolio becomes a bigger part of the total. But again we’re really pleased with how that is performing and really focused on providing that product to our existing customers and roughly 80% of the applications that we have in funding stream are to existing Marlin customers. So we know those customers and that’s probably a big part of the reason why that portfolios is performing as well it is, but it's still early and we’re continuing to monitor that very closely. So I would say those were the key points.

[Brian Hogan:]

Sure, thank you for the color. And continuing on that credit quality obviously the loans loss rate increase in the quarter to 5% thereabout, is that the appropriate run rate do you start to figure a little higher I mean that the yield came down a little bit, what is the appropriate mix there?

[Louis Maslowe:]

We actually think that around a 600 basis points is probably where it's going to be in these current economic times and that gives us a pretty good profitability on the product. This is really the first quarter where we experienced that and a lot of that was due to we had one large charge-offs in January and that can happen that’s the nature of the product relatively large for Marlin. So but to answer your question yes I think that we would expect to see and our plan is that we would see risk cost along the lines of what we saw in Q1.

[Brian Hogan:]

All right. And then just take an even a step back and looking at the credit quality trends in general and comparing that with actually with yields your originating in the lease business with bigger tickets and transportation hopefully it's better credit quality comes with some lower yields but I mean the credit quality actually charge-offs increased in the quarter. Si I’m just trying to balance and even look static pool analysis there I’m to get a grasp of the trends there can you help?

[Louis Maslowe:]

Well again I wouldn't consider Q1 on trend I mean if you look back and again as I said in my statement back to 2000 beginning of 2013, what we experienced in Q1 is really right in line with the averages and the charge-offs will fluctuate 18 to 20 basis or standard deviation in the 15 to 20 basis point range. So I think it’s too soon to really characterize what we see particularly on the leasing side as a trend. We’ll just have to monitor that?

[Brian Hogan:]

I guess try to reconcile your comments about it you expect critical to even charge-offs to increased from here a little bit I guess?

[Louis Maslowe:]

That was funding stream.

[Brian Hogan:]

That was for funding stream.

[Louis Maslowe:]

We’re taking specifically about funding stream yeah and then well the funding stream influenced on the overall portfolio but of course as funding stream grows so I would expect all else being equal the yield the portfolio because it’s higher yield business.

[Brian Hogan:]

The number of sales personnel in the quarter normally you had that in your press release maybe I missed it but I didn’t see it?

[Jeff Hilzinger:]

Yes Brian, we no longer consider sales headcount as a metric for growth it was basically completely flat for the foreseeable future sales headcount will be flat overall headcount the company increased by 12 but that was purely from the Horizon Keystone acquisition. The only thing that's likely to change going forward in terms of sales headcount is a slight reductions just through normal attrition on the vendor side and moving those headcount over to the direct side focused on small business customers directly. So there’ll just be no changes going forward but sales headcount is not going to drive originations growth on go forward basis. We've got a couple years headroom here with basically the same sales headcount.

[Ed Siciliano:]

I think that's right for the next couple years it's not a linear relationship I never thought that sales people and origination volume really ever worry one year relationship. So I think as with everybody else in the company we’re asking people to do more what we have and whether that’s process renewal on the operation side or it sales force effectiveness on the front end it's all it’s an expectation that the existing infrastructure will be scaled over the next couple of years.

[Brian Hogan:]

This is probably quick one the tax rate was 24 in the quarter, but 38% going forward is that there about?

[Taylor Kamp:]

I would say that it might be a less than 38% this is a permanent change that we had to catch up and really it was a catch up and also the quarter has, this all pertains to the stock comp accounting. And we had a fair amount of stock comp accounting in the quarter and so really the difference is that the tax pieces the fair value at investing the book piece is fair value that the grant date which the grant date would have been in the end of March. And so it had a big impact on the quarter but I would expect 36%, 37% tax rate going forward?

[Brian Hogan:]

Okay competition. Can you discuss competition in the environment out there banks coming back in or your other competitors being rational?

[Ed Siciliano:]

Yes, I mean before I speak to competition directly Brian I would say and we've mentioned it before, but overall the environment is very good for us right now and I think it’s good for our industry. So I think all funding sources right now are seeing a slight uptick based again on business confidence or what have you the economy picking up a little bit. So everybody is doing a little bit better right now. I think Marlin doing a little bit better than average and I think that’s because some of the head-to-head competitors we compete with on the indirect space had had a few issues and we’ve been able to capture some market share. Banks continue to move up ticket from our perspective so we picked up some market share and right now our offering is very, very solid I mean we’re feeling extremely competitive in the marketplace right now. I think the sales force is energized, the business is growing, moving ticket is up, we’re adjusting capital price. The value props is very strong so we look at competition but it's really we’re in such big market that you know it's kind of blue sky for us and that's what you're seeing in terms of origination growth. So we track it, it’s a good market some of our competitors are weaker than others, but for us for Marlin we’re just doing quite well right now. If you’d add anything Jeff?

[Jeff Hilzinger:]

Yes, I mean Marlin's market share Brian I mean it’s spec so if we were three times as big as we are today we would still be a spec. So it's just such a teeny amount of such a large market that we’re clearly taken share because the industry didn't grow by 49% year-over-year but having said that I think the market is so huge that there's a lot of room for us to take share and before we sort of run into competitive issues.

[Ed Siciliano:]

And the biggest change Brian is taking share from that existing captive base of customers we already have. And that’s a tip of point we just made we’re really excited about how big that could be for us in terms of a market, in terms of yields we can get from that business. So we look forward to reporting that over the next few quarters on our progress there.

[Jeff Hilzinger:]

Yes, that's an excellent point and I agree with that completely that it still the marketing objective here is to try to convince our existing end-users if they should do more business with us that's what we want. And so you’re going to see us the reorganization of the sales resources is the first thing of whole series of changes that you’re going to see over time that are designed to allow that to happen whether that’s more products, whether that's making the sales force more effective, whether that's improving the customer experience through the end-user experience to process renewal I mean all these things are geared towards sort of supporting this strategy of becoming the preferred lending source to small businesses in the U.S.

[Brian Hogan:]

Sure. And I guess the originations and the market share you’re taking today the ROEs that you generated on originations today is that in line with your 15% the 20% what are ROEs on today’s origination?

[Jeff Hilzinger:]

Yes, we don't need an expansion of current yields for NIM to be able to get to the objectives, the ROE objectives that we’ve set for ourselves. It's as much about leveraging our fixed cost and better utilizing our capital those two things are just as important as trying to optimize yield or optimize NIM I think we need to make sure that NIM that risk-adjusted NIM is correct. If we get risking us if we can make sure that risk-adjusted NIM is right which we talked about on this call a few times and that's really the partnership between Lou and Ed make sure that we’ve got that right balance. As long as we've got that and we’re growing and leveraging our fixed costs and leveraging our capital the road is going to take us to our ROE goals.

[Brian Hogan:]

All right, I appreciate your time today.

[Operator:]

[Operator Instructions] There are no further questions at this time. I would like to turn the call back over to Mr. Jeff Hilzinger for closing remarks.

[Jeff Hilzinger:]

Thank you, Operator. Thank you everybody for your support and for joining us on today's call. As always we look forward to speaking with you again when we report our 2017 second quarter results at the end of July. Thank you very much.

[Operator:]

Thank you. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation and have a great day.