Marlin Business Services Corp.
Q3 2017 Earnings Call Transcript

Published: 27 Oct 2017

[Operator:]

Greetings, and welcome to the Marlin Business Services Corporation Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host Lasse Glassen, Addo, Investor Relations. Please go ahead, sir.

[Lasse Glassen:]

Good morning and thank you for joining us today for Marlin Business Services Corp's 2017 third quarter results conference call. On the call today is Jeff Hilzinger, our President and Chief Executive Officer; Lou Maslowe, Senior Vice President and Chief Risk 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 a 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 third quarter results. Before I begin today, I'd like to first acknowledge our colleagues, customers and their communities in Texas and Florida who have been affected by the devastation of Hurricanes Harvey and Irma. A primary importance to us is the wellbeing of our employees and ensuring that we provide as much assistance as possible to our customers who have been impacted. Turning to Marlin's third quarter results, I'll begin with an overview of the highlights from this past quarter, including our recent progress on the Marlin 2.0 strategy that is designed to help transform our company into a provider of credit products and services to small business. Lou Maslowe, our Chief Risk Officer will comment on credit performance, and Taylor Kamp, our Chief Financial Officer will then wrap up our prepared remarks with details on our financial results and business outlook. Overall, Marlin’s third quarter results were mixed. We continue to benefit from strong growth in origination volume in our core channels, continued strong yields and growth in net interest income from the record size of our portfolio. However, earnings were impacted due to hurricane provisions and weaker portfolio performance, particularly within our transportation channel. While there was a modest increase in net charge-offs our allowance for credit losses increased significantly as it is very sensitive to recent delinquency trends. Total third quarter sourced origination volume of $160.4 million was up 21% from the same period last year but down 4% from the previous quarter, driven by the intentional pull-back in our transportation channel as we pivot to a new strategy to improve the channel’s ROE. The year-over-year growth was due to strong customer demand in our Equipment Finance business. In addition, our working capital loan product, Funding Stream, continued to make a meaningful contribution with third quarter origination volume of $13.8 million, or nearly 9% of total sourced originations. This is up from $10.3 million, or 8%, of total sourced originations a year ago. Our Direct origination initiative also continued to gain traction, with origination volume increasing to $16.5 million during the quarter, an increase of 7% over last quarter and 61% over the third quarter last year. We expect growth in direct originations to continue to accelerate in the future. Also in the quarter, we referred or sold $22.7 million of volume as part of our ongoing capital markets activities. At quarter end, total Investment in Leases and Loans expanded to a record $883.8 million, up 3% compared to the previous quarter and up 17% from a year ago. While credit quality remains acceptable, we are proactively addressing recent trends to ensure that near-term portfolio performance improves. Overall, the fundamentals of our business remain very strong and we made good progress during the quarter on our strategic objectives to drive long term growth in profitability. For the third quarter, we reported GAAP net earnings per share of $0.26, excluding the impact of credit losses and insurance claims related to Hurricanes Harvey and Irma, earnings per share on an adjusted basis were $0.31. The increase in the general loss provision from weaker credit performance further impacted earnings per share by approximately $0.05. Taylor Kamp will provide more details on the impact of the hurricanes and the increased loss provisioning on our results in his remarks. During the quarter, we completed the transformation of Marlin senior leadership team with the addition of Aswin Rajappa as Senior Vice President and Chief Marketing Officer. Given Aswin's extensive experience especially with data analytics, digital marketing and digital transformation, he is ideally suited to manage our marketing activities at a more strategic level and to lead Marlin's marketing functioning to the future. He will undoubtedly play a key role as we move forward with Marlin 2.0 transformation particularly as we expand our direct strategy and develop new customer response and credit targeting models. Subsequent to the end of the quarter, we announced the promotion of Mark Scardigli to the newly created position of Senior Vice President & Chief Sales Officer. Previously, Mark served the Senior Vice President and Leader of Marlin's indirect sales team. In his new role, Mark will have responsibility for leading the company's overall origination activities and will report directly to me. At the same time, we announced the departure of our former Chief Operating Officer, Ed Siciliano, who steps down earlier this month to pursue personal interest. We've begun the process of transitioning as responsibilities to members of the company senior leadership team and we do intent to refill the COO position. With Aswin's appointment and Mark's promotion, Marlin senior leadership team is now fully in place and across the Board I couldn't be more pleased with the team that we've assembled. I'd now like to switch gears and provide an update on our business transformation initiative that we refer to as Marlin 2.0. Through Marlin 2.0, 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, and third improving our operating efficiency by better leveraging fixed cost through scale and through operational improvements to reduce unit processing cost. I'd like to share with you the progress we've made in each of these areas since our last call. First, a key objective of the Marlin 2.0 strategy is to transform the company from primarily a micro ticket lessor into a broader provider of credit products and services to small businesses. As a result, our go-to-market strategy now includes offering multiple products to small businesses, as well as providing additional financing solutions directly to our end user customers. Within this context, during the quarter we completed an extensive analysis of our product and channel level profitability and now have a much better understanding of the through the cycle return on equity for each of origination platforms. This analysis is now being used to help us make informed choices of about where capital and human resources are best deployed. Within Equipment Finance, this analysis has begun to informed choices we are making to optimizer our channel mix and is caused us to revisit the strategies we've been executing in our transportation and franchise channels, both of which were launched in early 2016. In transportation, during the quarter we made the conscious decision to significantly reduce our volume and pivoted a new strategy that is focused on financing transportation equipment used by small businesses as opposed to financing equipment used primarily by transportation companies. This more vocational approach to the transportation space is much more consistent with our direct strategy, where we have better insight into our customers' credit histories and should drive much better risk adjusted returns through the cycle. Franchise too is undergoing a significant shift as we adjust our risk appetite and financing products in way that will generate more attractive risk adjusted returns through the cycle while also having franchise remain an important part of our direct strategy. These changes have slowed our growth in both channels but will ultimately cause them to become more relevant to our direct strategy while also improving their own risk adjusted returns. In addition to these changes, the results of our channel profitability work also validated the attractiveness of investing in our direct strategy. While equipment dealers, distributors and manufactures have historically been Marlin's primary customers, it will always be a critical importance to the company and equally important part of Marlin 2.0 is leveraging our approximately 350,000 lifetime end user customers including approximately 2,500 new small business customers entering Marlin system every month. The objective under our direct strategy is to identify additional financing opportunities with these existing end user customers, offer multiple products and to create ongoing relationship with these customers. In addition to creating a proprietary flow of follow on financing opportunities with these existing end users customers, it is important to note that we do not incur customer acquisition cost beyond the initial transaction. So this follow on business significantly lowers our weighted average customer acquisition cost. As I mentioned earlier, this initiative is gaining good traction as is evidenced by the 16.5 million of direct origination volume funded during the quarter which represents a substantial increase over prior periods. With Aswin Rajappa now on Board, I expect this growth to accelerate as we begin better leveraging Marlin's data and low cost access to small business customers. We also made good progress during the quarter on our second pillar of Marlin 2.0 which focuses on using capital more productively. Our portfolio growth during the quarter allowed us to further reduce our equity to asset ratio to 16.4% this quarter from 16.7% in the prior quarter and 18.3% in the third quarter last year. Additionally, we continue to improve our ability to manage the size and composition of our balance sheet to our capital market activities. Investor demand and pricing for Marlin's products remains very strong and execution on the portfolio sales during the third quarter was excellent. We view these transactions as means to optimize both the economic and credit composition of our portfolio and to enhance ROE over time. And finally we did make progress during the quarter and better leveraging the company's capital through growth, there remains significant room for improvement in the company's operating efficiency. While our process renewal initiative has worked well, we are current evaluating other areas of the company that could benefit from a similar approach, including our sales organization where our sales leaders have embraced the process renewal approach with a view to improving sales force effectiveness. And now with most of the 2.0 investment is complete, we are focused on controlling cost and operating more efficiently as we continue to grow. In conclusion, while we are focused in the near term on improving our portfolio performance and on adjusting our channel mix to optimize the company's risk adjusted returns, strategic momentum continues to build and I have more confident in the value with the Marlin platform today than I was a year ago. In addition, the company continues to show the strength of its core earnings through continued growth in its net interest and fee income which provides a strong foundation on which to build. There is much to do and I look forward to continuing to focus on the execution of our strategy, enhancing our financial and operational performance and driving superior value for all of our stakeholders as we move forward. With that I'd like to turn the call over Lou Maslowe, our Chief Risk Officer to discuss the performance of our portfolio in more detail. Lou?

[Lou Maslowe:]

Thank you, Jeff. My comments today will focus on Marlin's third quarter portfolio performance. I will specifically the drivers for the increasing trends in delinquency and charge-off. I will also explain factors leading to the $1.9 million increase in allowance for credit losses which drove a significant increase in the third quarter provision. Finally and most importantly, I'll discuss the actions being taken to ensure that our credit quality and performance remain strength as we continue to grow Marlin's portfolio. Consistent with Marlin's overall third quarter results, the portfolio performance in the third quarter was mix. While delinquency and charge-offs in the Equipment Finance portfolio continue to increase in the third quarter, the Funding Stream portfolio continue to perform very well with steady delinquency and better than target charge-offs. Equipment Finance receivables over 30 days delinquent were 115 basis points, up 21 basis points from the second quarter and 35 basis points year-over-year. Equipment Finance receivables over 60 days delinquent were 63 basis points, up 9 basis points from the second quarter and 17 basis points above the third quarter of last year. The quarter-over-quarter increase in Equipment Finance 31 day's delinquency was observed across our business where the year-over-year increase is largely attributed to updates to collection strategy, portfolio sales and higher delinquency in the transportation channel. The increase in the 60 plus day delinquency quarter-over-quarter was driven by significant increase in the transportation channel and to a lesser extent other channels such as office equipment and national account. While an increase in the transportation channel delinquency was anticipated given the maturation of the portfolio, the magnitude of the increase was greater than expected. As Jeff mentioned, we are shifting our strategy in transportation to focus on financing transportation assets for our customer base active in broad range of industries, as opposed to serving companies only in the transportation industry. This change in focus was significantly reducing cycle risk and provides an overall higher risk adjusted return. Funding Stream delinquency remained excellent as the 15 day delinquency decreased from 89 to 77 days this point and increased slightly in the 30 day bucket from 35 to 42 basis points. Aggregate net charge-offs in the third quarter increased to 1.73% of average of finance receivables on annualized basis, as compared to 1.65% in the prior quarter and 1.36% in the third quarter of last year. As mentioned last quarter, we anticipate that net charge-offs will continue to increase modestly over time as our high yield funding stream product grow as a percentage of a total portfolio. Although the third quarter increase was driven by Equipment Finance. Net charge-offs in the Equipment Finance portfolio increased by 18 basis points and 32 basis points compared to the prior quarter and prior year period respectively. Third quarter charge-offs in Equipment Finance were higher than expected largely due to spike in transportation channel charge-offs of $429,000 which was more than double expectation and the primary reason for the quarter-over-quarter increase. It is important to note that charge-offs excluding transportation are performing in line with our channel loss expectations albeit higher than the strong performance that we experienced in 2016. Funding Stream charge-offs of $198,000 represented 3.05% on an annualized basis which is well below the 600 basis points target for this product in the current economic environment. And what we view as a very acceptable and profitable level for the product. The allowance for credit loss is increased by $1.9 million in the quarter to $14.5 million, a 15.5% quarter-over-quarter increase. This compares to an $872,000 increase from Q1 to Q2. The increase is due to the hurricane provision of $500,000, approximately $300,000 due to growth in the portfolio and $1.1 million due to higher delinquency and charge-offs. Marlin's reserve methodology is highly sensitive to changes in delinquency and charge-offs. The calculation projects the next 10 months of losses based on delinquency migration and charge-offs trends over the prior six months. As we expect delinquency and charge-offs to level off, we don't expect further increases of this magnitude in the near future. While the overall rolling fourth quarter average portfolio performance is within expectations, we are proactively addressing the increasing trend in delinquency and charge-offs and Equipment Finance portfolio. For transportation, we have tightened our underwriting criteria while we make this strategic changes described by Jeff earlier in order to improve the portfolio quality and overall profitable of the business. Over the past month, we've commenced a number of initiatives to assess and address the root causes of the increase in delinquency and charge-offs. These initiatives focused on credit quality, collection effectiveness and operational policies and procedures. In order to assess credit quality, we've recently rescore the entire Marlin portfolio in order to determine if there is evidence of material degradation in credit quality as compared to the credit scores at origination. We were pleased to find that there has been only a very minor downward migration in the credit scores which would equate to less than the 100 basis points increase in annualized charge-offs expectation. We are also adding resources to our collection's department to ensure adequate coverage on our growing portfolio, which is growing 21% in asset under management year-over-year without any corresponding changes in collections headcount. We are also developing a behavior model to help our collectors improve the efficiency of their calling efforts. Having been part of the Marlin team now for nine months, I can say that I am very pleased with the company's strong risk and credit culture. While the increasing delinquency and charge-offs represents at least in part a return to more historical norms following the period of extraordinary portfolio performance, we will continue to make adjustments to our credit, collection and operational processes in order to optimize portfolio performance. In the near term, I expect our portfolio performance metrics to stabilize and remain within our targeted range. With that I'll turn the call over to our CFO, Taylor Kamp for more detailed discussion of our third quarter financial performance. Taylor?

[Taylor Kamp:]

Thank you, Lou and Jeff, and good morning. Third quarter net income was $3.3 million, or $0.26 per diluted share, compared to $4.3 million, or $0.35 per diluted share, for the third quarter last year. As Jeff mentioned on an adjusted basis, our third quarter 2017 earnings per share included a $0.05 per diluted share negative impact due to the provisioning of Hurricanes Harvey and Irma. And $0.05 due to credit provisioning previously discussed by Lou and an additional penny due to final senior leadership team recruitment and relocation expenses. As mentioned last quarter, we continue to benefit in the third quarter from the successful pass through of rate increases within our Equipment Finance business, driving a three basis points increase in yield over last quarter. This was partially offset by an 11 basis points decrease in the yield on Funding Stream origination. For the quarter, total yield on new originations funded of 12.18% was down three basis points from the prior quarter, and up 49 basis points from the third quarter of 2016. Approximately 72% of Funding Stream's loans were originated with the existed Marlin customers as we continued to be focused on maintaining superior credit quality in this product. Referral volume of $12.8 million was down $0.4 million from the prior quarter, but increased over 3x from the third quarter of 2016. Most of the referral volume continues to come from Horizon Keystone which was acquired in the first quarter of this year. However, as previously communicated we are beginning to put more of this volume on balance sheet. In the third quarter, Marlin kept approximately 52% of Horizon Keystone's production on balance sheet which is up from approximately 13% last quarter. This migration of HK's asset to Marlin's balance sheet will continue through the balance of the year. Entering 2018, we are likely to place all of HK's originations on our balance sheet. During the quarter, we completed the portfolio sales totaling $9.6 million. This generated an immediate net pretax gain on sales of $252,000 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 the leases. We are currently servicing over 43 million in assets for our funding partners which allows us to maintain an ongoing relationship with these customers. Our investment in leases and loans grew approximately 3% from last quarter and 17% year-over-year to $884 million, an all time record. Total managed assets increased 21% from a year ago. For the quarter, net interest margin was 10.73%, down 14 basis points from the prior quarter and 57 basis points lower than a year ago. The decrease in margin percentage was primarily driven by the decline in late fees and end of lease revenue based on certain updated servicing practices. Growth in the mixed of lower yielding Equipment Finance channels and an increase in the company's cost to fund. The decrease due to mix and fees was partially offset by an increase of 49 basis points in new origination loan and lease yield over last year. The portfolio continues to perform within acceptable ranges in the third quarter. The allowance for credit loss reserves was 1.64% of total finance receivables and coverage of total 60 days delinquency was 235.6%. As we mentioned earlier, it is important to note that our reserve methodology is very sensitive to small, short-term changes and delinquency and loss emergence. Third quarter operating expenses were $15.7 million, compared to $12.8 million in the third quarter last year. The increase from the third quarter last year was primarily due to an increase in expense stemming from the Horizon Keystone acquisition including intangible amortization expense and higher salaries and benefits. Expenses also increased due to the aforementioned hurricane provisioning, a true-up of uncollectible property tax and FDIC insurance. Investments in the company's direct originations initiative in Marlin senior leadership. The increase from the prior quarter was primarily due to investment in the senior leadership team, provisioning for hurricane related insurance claims, and increases in FDIC insurance partially offset by reduction in legal and external consulting fees relating to the regulatory matter. The company’s efficiency ratio for the third quarter was 58.7%, compared to 55.2% on an adjusted basis for the prior quarter and 54.9% in the third quarter last year. On an adjusted basis for the impact of the extraordinary expense relating to the hurricanes, the efficiency ratio was 57.1%. The impact of recruiting new senior executives resulted in a decrease in efficiency of 0.8 percentage points. Lastly, sales bonus compensation relating to the over achievement in our recent acquisition also decreased efficiency 0.8 percentage points in the quarter. Our capital position remains strong in the quarter within equity to asset ratio of 16.42%, 184 basis points below last year. The ongoing decrease in the capital ratio quarter-to-quarter was design and resulted from continued strong asset growth. In addition, I am pleased to report our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on November 16, 2017 to shareholders of record as of November 6, 2017. We remain focused on the precise execution of our growth strategy and maintaining our commitment to deliver strong returns, increasing net income and value to our shareholders. Now turning to our business outlook. Total sourced originations volume is expected to finish the year approximately 20% above 2016 levels. Portfolio performance is expected to level off and remain within our targeted range. Net interest margin as a percentage is expected to remain relatively constant for the remainder of 2017. And finally, ROE is expected to improve in the fourth quarter of 2017, as the company continues to improve operating scale. And with that I'll turn the call back to Jeff. Jeff?

[Jeff Hilzinger:]

Thanks Taylor. To wrap up, I'd like reiterate my earlier comments that we are focused in the near term on improving our portfolio performance and on adjusting our channel mix to optimize the company's risk adjusted returns. Strategy momentum however also continues to build and I am more confident in the value with the Marlin platform today than I was a year ago. In addition, the company continues to show the strength of its core earnings through continued growth in its net interest and fee income which provides a strong foundation on which to build. I look forward to continuing to focus on the execution of our strategy, enhancing our financial and operational performance as we go forward. With that let's open up the call to questions. Operator?

[Operator:]

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

[Chris York:]

Good morning, guys. And thanks for taking my questions. So I am still having a little bit of tough time understanding what specifically happened in transport. So can you be explained this little bit more? And then when did signs of this issue pop-up in the quarter? Can you hear me?

[Jeff Hilzinger:]

Good. And Lou can talk little bit too this sort of the metrics when we noticed issues. The problem with the transportation strategy as it was originally conceptualized it was essentially a wholesale originated strategy focused on financing Class 7 and Class 8 trucks. They are used almost exclusively by transportation companies. The good news about wholesale is that it allows you to grow very quickly because you are basically leveraging equipment dealers in a wholesale way. The bad news is that the pricing is very low and Class 7 and Class 8 especially with small fleets and owned operators is a very risky segment. So we over the course of the last six months or so we've been proactively shifting it from -- trying to shift it from owner operators to small fleets. One of the pieces of the ROE analysis that Lou did was basically a deep dive on whether we would be able to get to enough small fleet to have it performed the way that we needed it to perform in the ROE analysis. And the issue we faced was that the definition of small fleet to get you to better credit performance would require watch such large deal sizes that we just won't comfortable putting those deal sizes on our balance sheet. And because it's a wholesale originated strategy, those assets aren't liquid. So you can't use a capital market strategy to try to mitigate the deal size. So when you put all that together and you put it through in ROE analysis, it became clear to us that from a pure return standpoint it didn't make sense. And then again because it's focused on transportation companies as opposed to small businesses as we evolved our direct strategy, that original transportation strategy was just becoming obsolete now from a strategic perspective. So really from every angle we look at it, whether it was liquidity, whether it was strategic relevance, whether it was expected return over the course of the cycle, it just became very clear to us that we needed to either exit transportation completely or we needed to pivot to a different strategy which is what we decided to do which is more vocational, which makes I think a lot more sense. It's certainly for Marlin because transportation asset as a class are in high demand by small businesses. And lots of small businesses need trucks and transportation assets to operate and we refer to that is more of vocational strategy and so I think taking this -- making this shift to vocational strategy allows us to improve the returns. It's completely relevant with our direct strategy. And because it's not going to be originated on a wholesale basis, it will be originated through direct relationship that we have, it's liquid as well which will means that we can bring capital market tools to bear on it. So it's -- I think it's the right strategy for Marlin but it's taken us a few months to figure out exactly how we want to pivot and what exactly that pivot was going to look like.

[Chris York:]

Great, thanks. That's great color. I have a much greater understanding what's going on there so that helps. Maybe just diving a little bit more deeper there, maybe at the effect on lease volume, so from your decision to pull back there. So maybe what did you do in transport in Q3 and then what was that relative in Q2?

[Jeff Hilzinger:]

I have to look at this specific numbers but the transportation volume in the third quarter was 40% less than it was in the second quarter. So I don't have the actual numbers in front of me here but it was a pretty significant reduction and that reduction was primarily as a result of -- we basically constrained the credit box as we were going through in anticipation of the return analysis and in anticipation of shift in the strategy.

[Chris York:]

Got it and then --

[Taylor Kamp:]

Hi, this is Taylor. So TFG from the second quarter to the third quarter went from $13.7 million to $8.5 million

[Chris York:]

That's great. All right. So I guess if we were add --so just annualize that 8.5 call it 32-ish, I mean how should we think about the impact to your originations in 2018 from the pull back in transport. And then maybe even in franchise as well.

[Jeff Hilzinger:]

Yes. I think the transportation volume in 2018 is going to be of much less than what we had -- what we had projected when we were originating under the wholesale strategy. I think we got something between $20 million and $25 million of transportation volume in our 2018 plan. Now that's within a context of total originations volume that we still expect to grow approximately 20% next year. So it's in addition to pivoting transportation in transportation there is also this growing commitment to direct which mitigate the pull back to a great degree. And then I think it's important that we point out that the other indirect channel that we have are growing well. And they are growing pursuing the plan and they are working the way that we want them to work. And they all came through the ROE, the deep ROE analytical that we did in a very positive way.

[Chris York:]

That's great to hear. Okay, so for 2018 you are still thinking roughly a 20% year-over-year growth in loan and lease origination is achievable?

[Jeff Hilzinger:]

Yes. We are still finalizing our plan but it's going to be somewhere between 15 and 20.

[Chris York:]

Perfect, okay. And then in your press release and in your prepared remarks you did note a targeted range for delinquency so could you help me understand what that mean? I mean can you quantify the targeted range maybe on the 30 day and the 60 day metrics? And then secondly what is your outlook for performance as you mentioned there in the press release too for charge-offs and then maybe your loan loss reserve ratio?

[Lou Maslowe:]

Sure. Let me take this one. Chris, this is Lou. When we are referring to the range frankly we were more focused on the charge-offs line when we were talking about that. And as you may recall from last quarter, we are talking that about range talked about 1.76 which came out of our ROE analysis that we have been talking about. The delinquency that we have today I'd say is higher than our target. Although I don't have an exact number but that's would grow the higher allowance. So our objective is to get the allowance number down moderately we think through a reduction in delinquency. But I'd say -- and then we would be allowance -- would then adjust through next year in accordance with our portfolio growth. So overall I don't expect a big adjustment in allowance. Like I said, we saw a particular increase in the 31 to 60 days bucket and that's where we are really focusing to get it down. And that should help us level off the allowance that around 156 basis points where we are today. As far as charge-offs go for next year, as we've commented that we expect them to level off in the ballpark of where we are really, in the current environment we are comfortable, as this current level it was up a bit as a result of the transportation group as we mentioned and we expect that to continue to have an impact on our charge-offs really for most of 2018. I wouldn't expect a significant difference one way or the other from where we are this quarter.

[Jeff Hilzinger:]

Yes. I think Chris from forecast perspective. I think a couple of things to keep in mind here. The weakness in the portfolio performance is real for sure and there are lots of things that we can do and are doing to address it. But I think the good news; I want to emphasize the fact that we've not materially changed our underwriting standards over the last year. And I think the rescoring of the portfolio and the fact that the rescoring process showed that there has been very little deterioration in the underlying credit worthiness of the portfolio validates that and I think it helps direct our efforts to really a more tactical approach to how we better collect the portfolio that we have. So I mean when you look at the macro environment remains benign when we do our outreach to folks who are in the same business as us and trying to get an understanding of what's happening to their portfolio. We don't see much change year-over-year. So I think issues here are borrowing specific and I think they are the kinds of thing that we can deal with in a relatively straight forward way in the near term by doing the things that Lou talked about in his opening comments.

[Lou Maslowe:]

I think on the top of that Jeff, it's important to mention it really our underwriting standards have remained constant. I mean there is always minor tweaks here and there but for the most part our underwriting approach and the credit scores, our approval rates are all very much consistent which is the basis for why we expect fairly steady results.

[Jeff Hilzinger:]

And so all those comments exclude the transportation portfolio.

[Lou Maslowe:]

Right. So obviously there we really constructed the credit box and really took much more narrow view with respect to the dealers that we are doing business with. And the rescoring statement that we made that excludes the transportation portfolio as well.

[Chris York:]

Great, that color is very helpful. Thanks Lou, thanks Jeff. Switching to maybe yield. So, Taylor, I think you said that there was some impact in regards to base rate increases quarter-over-quarter. Now what are your expectations for that to continue? Maybe in your ability to price increases to new customers for 2018.

[Taylor Kamp:]

Yes, historically we've proven that we can pass along those rates as elasticity in the demand. So to the extent that the rates go up in December again we would try to pass those along and believe that we can pass those along.

[Jeff Hilzinger:]

Sure. I mean they are easier to pass in some segments than in others. And I think the other shift that you will see in 2018 Chris is as we move into new the transportation strategy that's going to grow in over rate and mitigate that to a great extent with the growth indirect. What's going to happen is that mix shift is going to cause the weighted average yield that the enterprise level to rise counterintuitively it's also going to cause our target net loss proxy to rise as well because the loss rates indirect are higher than they are in transportation but the pricing indirect is much, much higher than it is in transportation. So when you take that into account you will actually have rising ROE as we make this shift in our channel mix even though the company's enterprise level target net loss rate will rise as a result of that because mark NIM and yield in the direct business will rise in a passive rate and the loss as well. So it really the opposite of the wholesale transportation issue which is where you -- because you have very little if any control over the origination process, you actually have under priced risk as opposed to direct where we think we have over priced risk. So the shift is a good one. The bad news is that because it's a more retail oriented -- direct is a more retail oriented origination strategy, it takes longer to build in. But we believe strongly that shift in the strategy is absolutely significant source for better risk adjusted returns per ROE and better enterprise value for the business.

[Taylor Kamp:]

Yes. And Chris I would refine my statement a little bit and that we don't need that discrete event of interest increases to try pass things along. We are seeing a little bit of increase in our cost to fund, cost to deposit, just simply because they price outside of the Fed rate. So we try to pass that along as it happened.

[Chris York:]

Got it. And then follow up maybe in your guide for the NIM to remain relatively constant, is that includes or not include any changes in base rate?

[Taylor Kamp:]

It currently doesn't include but I would say that our NIM will remain relatively flat but there maybe some upward pick in that even in the fourth quarter.

[Jeff Hilzinger:]

Yes. We've been able to use the announcement of Fed rate hikes Chris as an opportunity to be able to raise pricing, because many of our customers expect an increase in price because that such a public announcement. Where we lag is when the bond market or the fixed income market, swap rates in particular is rising gradually over time or in an anticipation of an event that like. And they are typically a company like this will have its margins squeezed until it gets squeezed modestly until it gets to a point where there is an opportunity to put through a price increase and then you recapture those margins. And hopefully actually you can put through a price increase that's large enough that you actually more going to recover those margin but the timing -- the sequencing of the timing is staggered typically.

[Chris York:]

Make a lot of sense. Last topic for me. So we were pleased to learn that you are spending in Marlin 2.0 is complete which you said in the prepared remarks. But thinking maybe a bit longer term how much investment should we expecting transformation to Marlin 3.0 maybe in tech going forward. And then the timing of that potential spends.

[Jeff Hilzinger:]

Right, we are working on our plans as I said before so nothing locked at this point. But when we look at our sort of our spend from an IT standpoint to keep the lights on as opposed to spend that's dedicated towards evolving the automation of our processes or in the sort of continue to evolvement of our portals and the customer interfaces. I mean it's significant but it's not something that the company can't afford and can't -- would keep us from being able to ultimately meet our objective of getting to a 15% ROE over the course of the next few years.

[Chris York:]

Great. And then just for the Q3 and maybe Q4 expenses meaning you had a couple changes in senior leadership bringing on Aswin and then separation with Ed. So can you quantify if there are any one time expenses in Q3 and then should we expect any one time expenses from the separation in Q4?

[Jeff Hilzinger:]

Yes, that's a good question, Chris. And we have a given that a lot of thought. And I allude to it in my comments but generally in Q3 we did have some hurricanes Irma and Harvey expense related to insurance -- projected insurance claim. And that was a little over $400,000. We had some additional recruiting expense related to what we talked about sort of finishing our investment in SLP that was a couple of hundred thousand dollars. You had some bonus commissions for paid to HK for their over achievement of their volume targets in the year in Q3. Now and so you sort of kind of take those out as a little bit of extra expense that goes the other way in Q4 but the big item in Q4 will be with Mr. Siciliano's exit there some one time expense related to that offset by some recapture, that in net-net is probably about $500,000 pretax that we will have to pay next quarter.

[Operator:]

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

[Brian Hogan:]

Good morning. Question on kind of follow up to last one. Efficiency ratio, your outlook there I think last quarter you got better and you said at least you had thought that the third quarter was going to be the inflection point and improving from there. And obviously we had the hurricanes and but even exit absent hurricane, efficiency rate and the recruiting stuff that you just called out, efficiency ratio went to the wrong direction, I guess can you comment on the outlook for the efficiency ratio and how fast you could go there and obviously you change in your transportation thing just kind of give us a more thoughts there please.

[Taylor Kamp:]

Yes, so that's a good question too I think. I think it's the other side of the coin from what we just talked about. But if you remove in Q3, if you remove the impact, recalculate efficiency ratio after -- before the impact of the hurricane or Horizon extraordinary bonus and our recruiting expense, you get back into that range of 55% or so and the next quarter is that falls -- as other things follow up we continue to build scale ignoring the amounts for Mr. Siciliano. I think we exit the year with an efficiency ratio in the low 50. So I think we are not that far off from the guidance that we gave before with respect to the efficiency ratio. We just had some unexpected items really in the last half of this year.

[Jeff Hilzinger:]

We didn't grow as faster. [Multiple Speakers]

[Lou Maslowe:]

The reasons that we've outlined Brian.

[Brian Hogan:]

Sure. And then can you comment on the ROE outlook not just for fourth quarter but longer term maybe giving some longer term comments there. I mean previously last quarter you said like low-teens and this quarter was call it 9-ish percent there about. Do you -- what is increased from -- is it up from 8 or I mean just kind of comment on the fourth quarter and then what is your longer term outlook? Is that changed given your -- I mean going through your originations a look on ROE study.

[Taylor Kamp:]

In the short run while we gave some guidance last time around a low teen, a very low teen number. I think Q4 this time adjusting for whether it's late charge end of lease along with some other expenses I think we are going to be in the very low double digit with respect to ROE, when I say double just over 10 I think for the fourth quarter. The long-term outlook I think we do reset a little bit but we have strategic initiative that we believe will help replace transportation and other things that we've deemphasize that shouldn't put us that far behind in the long run from the guidance we've given before.

[Jeff Hilzinger:]

Yes. I think Brian -- I think the results of the channel profitability work that we done and the repositioning of the channel mix that we've discussed today probably extends getting to the future state ROE by 6 to 12 months. But I would say that we are replacing volumes and platforms that was primarily wholesale originated with this direct strategy which I think ultimately creates, it gives much more strategic volume and creates a lot more strategic value in the platform because there are customers we control, we capture all of the margin at that point. We have the ability to leverage our initiative origination cost better than we do with the wholesale originations and it's worth waiting. So I think the trade off of what ultimately will going to look like would be taking us 6 to 12 months longer to get there is a very fair trade off.

[Brian Hogan:]

Can you comment on the originations demand in a competitive environment please? Obviously you have a pretty strong originations growth outlook for 2018 being 15% to 20% I just kind of -- what do you see out there competitively?

[Jeff Hilzinger:]

Yes. I mean our competitive environment really hasn't changed much in terms of who we compete against. Again I would say that Marlin is within the context of the even the small ticket equipment finance business, it has really a spec of market share. So we really don't need to increase our market share by much to have a pretty significant impact on the company as we try to achieve scale objective. And we see that even today. I mean we had notwithstanding the conscious decisions we made around transportation and franchise in the third quarter, the other channels all performed very well. And going into the fourth quarter we continue to really experience record application levels and we think that October as an example should be close to a record month for the business. So there is a lot of momentum which I think we really need to highlight here. There is a lot of momentum beyond franchise and transportation that I think bodes well for both the portfolio and continues growth in originations volume next year and next year's volume is occurring with the channel mix that I think is a lot more attractive. And that ultimately will build a lot more attractive portfolio over time.

[Brian Hogan:]

Understood. And can you comment on the jump in the restructured loans? I mean it is a pretty hefty jump.

[Lou Maslowe:]

Yes, it's really -- this is Lou. I have some specific statistics but the hurricanes are driving higher restructure activity. In fact I have these numbers as of October but just to give you some example, some idea that we have booked restructures for Hurricane Harvey 39, restructure is totaling $1.1 million and for Irma 74 totaling $1.7 million. This is actually we think a good new story and that these are customers staying-- they are staying in business they just need a little bit help while they get back on their feet.

[Brian Hogan:]

All right. And then you commented on this little bit earlier, just give me little bit more color, your ability to pass through increases in rates and even more than that but obviously the yield being relatively steady while your cost to fund went up, can you just -- I am trying to understand that a little bit better. Can you comment on that please?

[Jeff Hilzinger:]

Yes. So I think you got -- I think there have been 75 basis points worth of Fed price increases over the last month or so. So the yield in our origination volume today is 49 basis points higher than it was before. So we haven't passed through everything Brian but we passed through a fair amount of it. And I do think that our price increases are going to lag the increasing base rates or increasing rates from Fed price movement. So it's normal to lag going up and it's normal to lag coming down. And but I think the good news is that we've shown that we are able to pass through 50 to 75 basis points. And it's -- again this is a big difference between retail oriented channels and wholesale oriented channels. Wholesale oriented channels the basis of competition is much more on price and it's much more difficult to pass through price increases. And so again I reiterate this shift from wholesale originations primarily in transportation into direct gives us a lot of control over our ability because it's fundamentally less competitive. If we have more control over being able to pass through price increase. Plus I think in the direct channel as we see in our retail business, there is value to the customer to have the process to be convenient. So there is an opportunity for convenience pricing as well. And I have said this before and I think a platform like Marlin especially as we pivot towards this direct strategy we should always be testing the price elasticity of demand whether we have rising rates or not. And so that's a discipline that we are working on and instilling in the business. We are not there completely yet but I do think that whether it's in funding stream or whether it's in equipment finance beyond whether the price is proper for the risk, there is also an opportunity I think here for us to press price on a convenient basis.

[Brian Hogan:]

All right. Last question. I think previously on the call you discussed the precipitating -- the [precipice] our capital structure or maybe a little bit of bond deal. Can you comment on your progress there?

[Taylor Kamp:]

. Yes. So, hi Brian again this is Taylor. Right now with the way our capital has been declining with our organic growth and the fact that we've been able to very successfully manage capital through our syndications. We've had that on hold really. So we haven't really needed it and it's -- it doesn't mean that it isn't in our mind going forward but over the last few months we haven't needed it. And there is a little additional cost upfront with that and we thought that we can -- everything is pretty much Ts and Cs are all worked out and we can pull the trigger in a pretty quick fashion. But we've chosen to put that -- push that out a little bit.

[Operator:]

Thank you. Our next question comes from Bill Dezellem with Tieton Capital Management. Please proceed.

[Bill Dezellem:]

Thank you. A couple of questions. So first of all continuing down the transportation, is that your lowest yield and maybe I should be asking a lowest ROE category or are there that are lower?

[Jeff Hilzinger:]

Hi, Bill. This is Jeff. The transportation was the lowest through the cycle ROE by far, at least in its wholesale originated form. So there were -- there are others that I need to have some worked on that in terms of positioning and in terms of the way that we work to enhance the ROE. As I said before there are 6 or 7 levers that impact ROE deal size operational intensity obviously yield tenor credit loss expectation. And so what the ROE analytic allowed us to do was basically quantify those levers within each of our platforms. And be able to develop strategy that need to the platforms to be able to optimize the ROE by pulling those levers or adjusting those levers in a way that we think optimizes the way that we compete in each of those channels. And that's -- we've identified those and so even in the channels that made through the process with the green light that doesn’t mean that the way that the ROE that they are generating today is the ROE that they should be generating or that they ultimately could generate. So that work that we did -- it isn't like we just said, well, either you platform pass or you don't pass and we exit. It was -- every platform has an opportunity to have its ROE improved in the case of transportation and franchise, they both required significant change in strategy and in transportation case we felt that we needed to really constrain originations volume and to really tighten our credit box while we were going through that process.

[Taylor Kamp:]

And if you overlay the fact that transportation assets are not nearly as liquid as other assets, we couldn't manage that as well with our secondary marketing and syndication strategy.

[Jeff Hilzinger:]

Yes. You can't underestimate that because the more you originate the more you -- because you are not liquid the more you have you are forced to live with the asset for its life. So you feel differently that you had a platform where you are trying to optimize ROE but you felt that risk reward was fundamentally balanced or that if ultimately it didn't make sense for us to keep it on our balance sheet, we could either mediate to somebody else's where it might make sense. But in transportation's case that option wasn't available which is why we felt we had to move quickly once we reached the conclusions that we did.

[Bill Dezellem:]

Thank you. And then if we heard you correctly early in the call there was also reference to changing how you address the franchise of category. Would you talk into some more detail about that, if we heard correctly?

[Jeff Hilzinger:]

Yes. I think our thoughts how we want to evolve franchise or less evolve than they are in transportation. And so the franchise platform was always conceptualized as being sort of a mini version of what we are trying to do as a company which is develops relationship with franchisee in order to get access to initial transaction with franchisees and then basically follow a direct strategy. Then I still think that approach is valid but the question becomes how much resource should we apply against it and realistically how much can we rely on that platform under that strategy to provide growth. And the jury is still on out that. And we have a relatively conservative number in our 2018 plan for franchise. But because we aren't certain about exactly what that's going to look like. We have lots ideas about and we are working with the team there to understand what is the ultimate best future state for the franchise platform. I think there is important role that the franchise business can play in the future of Marlin. But I don't think it's going to be -- I know it's not going to be the high growth platform that we had thought it was going to be or that the company had thought it was going to be when it entered in late 2015 early 2016.

[Bill Dezellem:]

That's helpful, thank you. And then finally I hear some clarity and this is just my ignorance and lack of understanding on the provision going forward. And so I think we heard you say that the provision is really based off of the last six months. And assuming then that the December quarter look similar to the September quarter with the current level of charge-offs and delinquency. You would be dropping Q2, adding Q4 which Q4 would be higher than Q2, so does that then imply that the provision goes up or because your portfolio performance stays constant, does that actually imply that it stays flat. So can you help me try to put that together a little better please?

[Lou Maslowe:]

It's a very good question. I'll try to do that for you. This is Lou. Yes, so first of all just to be clear so there is -- in terms of credit loss provision on the P&L there is really the two component right. There is the charge-offs and then there is loss balance. You are referring to that really have the big impact this quarter. And you are right. So when we go back two quarters you have to look at the migration patterns and the ending delinquency in the quarters that you are dealing with to see what the impact is going to be. So in theory it could be that if with -- if our migration remains constant this quarter there could be some increase in the allowance but it really has a heavy dependency on where the delinquency end. Because you base your calculation off of the ending delinquency going forward 10 months. So it's a very mechanical but I would summarize it to say that if we are able to able to keep delinquency where we are or reduce it, then I would expect that there would be no material change in the allowance going forward except for as I said growth is always going to have an impact on the allowance but much more modestly than higher delinquency and charge-offs. Is that help?

[Bill Dezellem:]

It does. And just to make sure that I am totally clear that if the delinquencies are flat at the end of December versus the end of September that the provision should be very similar assuming zero growth but since likely will have growth it would be higher as it naturally is when there is a growth in the portfolio.

[Lou Maslowe:]

That would be my expectations.

[Bill Dezellem:]

That's helpful. Thank you.

[Lou Maslowe:]

Yes. I think the one caveat that we have here for the fourth quarter of course is the impact of the delinquency related to the hurricane. We are hoping to keep that and again our expectation is that it won't have a material impact but that's the one I would say unknown that will know better over the next 30 to 60 days.

[Operator:]

Thank you. We have a follow up question from Chris York with JMP Securities.

[Chris York:]

Yes, just one follow-up. Lou, what were the reasons for the $1.2 million increase in the non transport reserve?

[Lou Maslowe:]

So the way we broke it down for Q3 is we break it down into how much is portfolio growth, how much is credit and how much was due to the hurricanes. So the place to start, first of all the allowance went up $500,000 so that was out of the -- the total allowance increase was $1.9 million. Right, so you take the $500,000 out for the hurricane. Then we calculate portfolio growth was about $344,000, the difference being the $1.1 million okay. And I think that's the number you are asking for the credit piece right.

[Chris York:]

Yes.

[Lou Maslowe:]

Okay. So that's really is asking where is the delinquency, what's drove the higher delinquency. We've talked about transportation was one of the major segment that grew the delinquency -- impact to delinquency and to some extent some of that was expected because we started to building that portfolio in the beginning of 2016. So we just really seen as that portfolio is maturing a growth in delinquency in that area. Other than that we've seen -- we saw quarter-over-quarter increase is really in the major component of our business, retail, OEG or Office Equipment Group. So I would really say with across the board where we saw the increases in the delinquency and the migration in the portfolio.

[Chris York:]

Got it, okay retail office and the migration. Okay, that's it for me. Thank you.

[Operator:]

Thank you. I would like to turn the call over Jeff Hilzinger for closing comments.

[Jeff Hilzinger:]

Thank you for your support and for joining us on today's call. We look forward to speaking with you again when we report our 2017 fourth quarter and full year results in early February. Thank you very much.

[Operator:]

This concludes today's teleconference. Thank you for your participation. You may disconnect your line at this time.