Marlin Business Services Corp.
Q4 2017 Earnings Call Transcript

Published: 2 Feb 2018

[Operator:]

Greetings, and welcome to the Marlin Business Services Corp Fourth Quarter and Full Year 2017 Earnings 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, Investor Relations for Marlin Business Services. Thank you. You may begin.

[Lasse Glassen:]

Good morning and thank you for joining us today for Marlin Business Services Corp's 2017 fourth quarter and full year results conference call. On the call today is Jeff Hilzinger, President and Chief Executive Officer; Lou Maslowe, Senior Vice President and Chief Risk Officer; and 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 thankyou everyone for joining us to discuss our 2017 fourth quarter and full year results. I will 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 from an equipment lessor into a provider of credit products and services to small businesses. Lou Maslowe, our Chief Risk Officer will comment on credit performance and Taylor Kamp, our Chief Financial Officer will then conclude our prepared remarks with details on our financial results and business outlook. Marlin wrapped up 2017 with a strong fourth quarter highlighted by record origination volume, improved portfolio performance and excellent earnings growth. Total fourth quarter sourced origination volume of $186.5 million was an all-time record for a single quarter and increased 16% from the prior quarter and 23% from the fourth quarter last year. The growth was primarily driven by strong customer demand in our equipment finance business. In addition, our working capital loan product funding stream continued to make a meaningful contribution during the quarter. I'm also pleased with the early success of our direct origination initiative that identifies additional financing opportunities within our existing customer base. Also, in the quarter we referred or sold a combined $42.5 million of leases and loans as part of Marlin's ongoing capital markets activities. As a combined result of these origination and capital markets activities, our investment in leases and loans grew to a record $911.2 million up more than 3% compared to the previous quarter and up 15% from a year ago. During the quarter, we took swift action to proactively address trends that were beginning to impact the performance of our portfolio these efforts included a strategic pivot within our transportation and franchise channels to ultimately improve the risk reward profile both businesses. Importantly, fourth quarter 30 plus and 60 plus day delinquencies improved sequentially for the first time in six quarters due primarily to a decision to increase our collection resources. Excluding charge-offs from the transportation channel, the portfolio for the full year in 2017 continued to perform in a range that was consistent with what we've seen over the past four years. Lou will provide additional details in his remarks including more detail on our transportation portfolio, but in the near term. we expect our portfolio performance to continue to stabilize and remain within our targeted range. At the bottom line, we reported GAAP earnings of $1.27 per diluted share, compared to GAAP earnings of $0.38 per diluted share for the fourth quarter last year. Fourth quarter 2017 earnings included an impact of a net tax benefit resulting from the Tax Cuts and Jobs Act of 2017, which required the company to revalue its deferred tax assets and liabilities and resulted in a $10.2 million one-time benefit recorded in the quarter. Excluding the impact of this and other nonrecurring items, fourth quarter net income on an adjusted basis was $5.9 million $0.47 per diluted share compared with $4.8 million or $0.38 per diluted share a year ago. A reconciliation of GAAP to adjusted basis net income is available in the press release issued yesterday afternoon. Due to strong origination volume, improving operating efficiency and stabilized portfolio performance, the fourth quarter was a strong period of profitable growth for Marlin and show the underlying earnings power of 2.0 Strategy even after excluding the tax benefit. We expect these trends to continue into 2018 and I want to thank all of Marlin's employees for their hard work and dedication to the company's success in 2017. I'd now like to switch gears and provide an update on our business transformation initiative that we refer to as Marlin 2.0. As you may recall, 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. Third. improving our operating efficiency by better leveraging fixed cost through scale and through operational improvements to reduce unit processing costs and four, which is a newly elevated strategic objective for 2018, proactively managing the company's risk profile to be consistent with our risk appetite. I'd like to share with you the progress we've made in each of these areas since our last call. Touching first on our strategic market expansion initiatives, while Marlin has historically operated primarily as a micro-ticket equipment lessor, a key goal of Marlin 2.0 is to transform the company into a broader provider of credit products and services to small businesses. In addition, this strategy also looks to expand our go-to-market strategy by providing additional financing solutions directly to our end user customers. Over the past year, we saw meaningful contributions from credit products and services that reached beyond our indirect equipment finance business. This is most clearly evident with the ongoing success we are seeing with our funding stream working capital loan business and our direct go-to-market strategy. During the fourth quarter, funding stream origination volume of $16.5 million comprised nearly 9% of total sourced originations. This was up from $11.3 million or 7% of total sourced originations a year ago. For the full year, funding stream originations totaled $59 million up nearly 65% compared to 2016. Since introducing this product to the market late in 2015, we've now originated over $100 million of funding stream loans and overall, we are very pleased with both the market's growing demand for this product as well as funding stream portfolio performance, which continues to exceed our expectation. At the same time, we continue to be pleased with the results that are direct strategy is producing. While equipment dealers, distributors and manufactures have historically been Marlin's primary customers and will always be of critical importance to the company and equally important part of Marlin 2.0 is leveraging our approximate 350,000 lifetime end user customers, including approximately 8,000 new small business customers that became part of the Marlin ecosystem during the fourth quarter alone. As a reminder, the objective under our direct strategy to identify additional financing opportunities with these existing customers by offering multiple products and to create ongoing relationships with these customers by meeting a broader set of their financing needs over time. As I mentioned earlier, this initiative is gaining good traction as is evidenced by direct origination volume of $26.9 million in the fourth quarter and $91.1 million in the full year. This reflects year-over-year growth rates of 22% and 80% respectively. Moving on to the second pillar of Marlin 2.0 that focuses on using capital more productively, we continue to make good progress. Thanks to the strong portfolio growth during the year, we were successful in further reducing our equity to assets ratio to 17.3% for the full year in 2017 from 18.2% in 2016 and 19.4% in 2015. Additionally, we continue to improve our ability to manage the size and composition of our balance sheet to our capital markets activities. Throughout 2017, we sold $66.7 million in assets, which was well over three times higher than asset sales in the prior year. Investor demand and pricing for Marlin's product remains very strong and execution on the portfolio sales during the year and particularly during the fourth quarter was excellent. We view these transactions as a means to optimize both the economic and credit composition of our portfolio and to enhance Marlin's ROE over time by monetizing platform's ability to originate assets that our customers need, but that ultimately reside more efficiently on other's balance sheets. As we made progress in more productively using our capital through growth and capital markets activities, we are also committed to entering the securitization market during 2018. While our cost of funds under securitization will be higher than our bank funding costs, the capital required to support the securitized portfolio will be substantially less, thereby allowing us to continue to scale within our existing capital base while also generating a better return on equity than we can currently generate in the back. Taylor will speak more to this initiative in his comments. With respect to our third strategic pillar, we also continue to make progress in better leveraging the company's fixed cost through growth and by improving operational efficiencies through our process renewal initiatives. So far, process renewal efforts have primarily focused on achieving improvements in cycle times, quality and overall productivity on activities once a loan or lease application has been received. As evidence of the gains we have generated from these efforts, during 2017 the company originated $2.1 million per employee as compared to $1.6 million in 2016 and $1.2 million in 2015 or increases of 29.3% and 30.2% respectively and we expect this trend to continue in 2018. This increased productivity led not only to an improvement in our adjusted operating efficiency ratio to 51.8% in the fourth quarter from 54.6% a year ago, but also contributed to our significant growth in origination volume during 2017 by allowing for better execution against our value proposition of speed, convenience and consistency, which led to a much better experience for our customers. Earlier this year, we launched the next phase of process renewal, which has begun reviewing processes upstream prior to the receipt of a loan or lease application. This is really taking a comprehensive look at how we originate, including how our sales force and marketing resources are deployed with the overarching goal of improving the effectiveness of our origination function. As activities are just underway on this effort, I look forward to updating you on our progress on future calls. And finally, with respect to our fourth pillar regarding proactive risk management, we fully implemented during the fourth quarter, the strategic pivot that we discussed at length on our last call with respect to our transportation and franchise channels. Due to the results of an extensive analysis to improve the cycle credit losses and channel level profitability completed in the second half of 2017, both channels have undergone significant strategic shifts. Within transportation, we have now moved towards a vocational oriented strategy that focuses on financing transportation equipment used by small businesses rather than equipment used by transportation companies. Similarly, within the franchise channel, we've adjusted our risk appetite and financing products in a way that will generate more attractive risk-adjusted returns through the credit cycle. Lou will speak more to the specific changes in our transportation channel in his comments, but we expect these changes to have a significantly positive impact on our portfolio performance in ROE in 2018 and beyond. Before wrapping up my remarks, I'd like to briefly comment on the macroeconomic conditions in which we are operating as well as opportunities specific to Marlin. There is no doubt that the tax reform legislation recently passed by Congress has resulted in greater economic optimism among our small business customers, which we expect will result in increasing demand for equipment and working capital in the future. At the same time, the lower tax rate will greatly improve Marlin's earnings power and create a more rapid accumulation of capital. This in turn, will significantly broaden our strategic options to potentially include a combination of enhanced organic growth, increase capacity for acquisitions or the return of additional capital to shareholders. Moving forward, our momentum continues to build and I'm very confident in our ability to continue driving profitable growth as we look ahead to 2018 and beyond. All in all, these are exciting times for Marlin and I thank our customers, shareholders and employees for their continued support. With that, I'd like to now 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 and good morning, everyone. My comments today will focus on Marlin's fourth quarter portfolio performance. I will also discuss additional details on our previously discussed pivot and strategies within the transportation channel. Overall, we are pleased with our fourth quarter portfolio performance, which demonstrated better results in the previous quarter. Both 30-day and 60-day delinquencies improved for the first time in six quarters, while total charge-offs increased modestly. Equipment finance receivables over 30-days delinquent were 104 basis points down 11 basis points from the third quarter and up 22 basis points year-over-year. Equipment finance receivables over 60 days delinquent were 56 basis points, down seven basis points from the third quarter and nine basis points above the fourth quarter of last year. We estimate this indication activity in 2017 had a negative impact of about seven basis points year-over-year. The quarter-over-quarter decreases in both equipment finance 30-day and 60-day delinquencies was primarily attributable to the additional resources that were added to our collections department. Aggregate net charge-offs in the fourth quarter increased to 187 basis points of average finance receivables on an annualized basis as compared to 173 basis points in the prior quarter and 140 basis points in the fourth quarter of last year. The increased quarter-over-quarter was due to higher charge-offs in the equipment finance portfolio, which increased by 13 basis points and 37 basis points compared to the prior quarter and prior-year periods respectively. It is important to note that charge-offs excluding transportation continue to perform in line with our performance in recent years as well as our channel loss expectations. To demonstrate this point, Marlin's average quarterly net charge-offs excluding transportation over the past four years has been 150 basis points for the quarterly standard deviation of 18 basis points. Net charge-offs excluding transportation in the fourth quarter of 2017 and for the full year 2017 were 169 basis points and 158 basis points respectively. Funding stream charge-offs of $225,000 represented 331 basis points on an annualized basis, which remains at a level that we view as very good and highly profitable for the product. The allowance for credit losses increased by just $300,000 to $14.9 million, a 2.4% quarter-over-quarter increase, due primarily to growth in the portfolio. This compares to a $1.9 million increase from the second to third quarter. Last quarter we noted the allowance would likely begin to level off in the fourth quarter and we were pleased to see that the results were in line with our expectations. I would now like to provide some additional details as well as an update on the pivot to our Transportation 2.0 strategy. Over the last few months, it has become even clear that the shift in strategy was necessary in this channel. We recently completed an analysis on what we're calling the transportation 1.0 portfolio, which is the entire transportation portfolio booked through the end of 2017. The Transportation 1.0 portfolio net investment as of December 31 was $55 million and had a weighted average remaining tenor of 44 months. Our analysis shows that over the remaining life of the portfolio, we expect to potentially incur up to $2 million in total incremental losses over and above the losses we would have expected when the company made the original decision to enter the transportation channel in 2015. The swift action we took to change our entire transportation strategy and underwriting has significantly mitigated future negative impact on the company. Based on the size of the transportation portfolio, the projected negative variance in the Transportation 1.0 portfolio performance will not have a material impact on Marlin's overall portfolio performance. This was evident 2017 where we saw the transportation's net charge-offs of 229 basis points had only a four-basis point negative impact on Marlin's total equipment finance net charge-offs. As mentioned last quarter, in addition to expecting the Transportation 2.0 strategy will attract a better-quality portfolio, we have also significantly tightened our underwriting criteria in order to achieve better performance going forward. I'd like to provide an update now on the portfolio and the regions impacted by hurricane Harvey and Irma. In the third quarter, we booked a provision of $500,000 for potential hurricane-related credit losses. In total, we have restructured 161 contracts representing total net investment of $3.2 million. It is too soon to assess the restructured portfolio performance at this time as most contracts had only their first post restructure payment due in November or December. Jeff mentioned a proactive risk management has been added to the fourth Marlin 2.0 strategic objective. This entails continuing to build out our enterprise-wide risk management program, which started in 2017. We recently developed and received Board approval for our Marlin risk-appetite statement, which defines the aggregate level and types of risk Marlin is willing to assume in order to achieve our strategic objective. We've expanded our focus beyond credit risk to include a number of other risk types with particular emphasis on operational risks, reputation and compliance risk, liquidity risk, interest rate risk and asset rest. We've continued to enhance our capabilities to manage and monitor these risks with oversight provided by Marlin's Management Risk Committee and Board Risk Committee. In closing, we are satisfied with the progress we've made during the quarter on improving the performance of our portfolio and we also remain satisfied with our overall risk profile. We will continue to closely monitor portfolio performance and make the necessary timely adjustments to our business strategy and underwriting, in order to achieve our desired results, just as we did with the transportation channel. With a continued positive economic outlook, we expect our portfolio performance in 2018 to remain in the range we've seen over the past few years. With that, I'll turn the call over to our CFO, Taylor Kamp for a more detailed discussion of our fourth quarter and full year financial performance, Taylor?

[Taylor Kamp:]

Thank you, Lou and Jeff and good morning, everybody. Marlin delivered a strong fourth quarter marked by very good financial performance, including robust growth in originations and record portfolio levels while maintaining credit performance consistent with our expectations. Fourth quarter net income was $15.9 million or $1.27 per diluted share, compared to $4.8 million or $0.38 per diluted share for the fourth quarter last year. As Jeff mentioned, our fourth quarter 2017 earnings per share included a one-time tax benefit of $10.2 million or $0.82 per diluted share, related to the Tax Cuts and Jobs Act of 2017. Excluding the impact of this and other nonrecurring items, fourth quarter net income on an adjusted basis was $5.9 million $0.47 per diluted share, compared with $4.8 million or $0.38 per diluted share a year ago. For the full-year 2017, the company generated net income of $25.3 million or $2.01 per diluted share up from $17.3 or $1.38 per diluted share in 2016. For the full-year 2017, adjusted basis net income was $18.9 million or $1.50 per diluted share compared to $17.3 million and $1.38 per diluted share in 2016. Fourth quarter yield on equipment finance originations was 9.46% down 53 basis points from the prior quarter due to channel mix. The yield on funding stream originations for the quarter was 32.73% compared to 33.51% for the third quarter. For the quarter total yield on new originations funded of 11.59% was down 59 basis points from the prior quarter and up nine basis points from the fourth quarter of 2016. Approximately 80% of funding stream's loans were originated with existing Marlin customers as we continue to be focused on maintaining superior credit quality in this product. Referral volume of $6.5 million was down $6.6 million from the prior quarter but up $1 million from the fourth quarter of 2016. Most of the referral volume continues to be generated by Horizon Keystone acquired in January of 2017. As previously communicated, we are continuing to put more of this volume on balance sheet as demonstrated by the fourth quarter, where Marlin kept approximately 78% of Horizon Keystone's production on balance sheet, compared with approximately 52% in the last quarter. As we look ahead to 2018, we currently expect to continue this migration of assets until all of HK's originations are on Marlin's balance sheet. During the quarter, we completed a record high $36 million in portfolio sales, nearly three times more than assets sold in the third quarter. This generated an immediate net pretax gain on sale of $1.95 million that was recorded in other income. The substantial increase in the fourth quarter syndication volume was made possible by a very receptive market and very attractive pricing. We continue to service the assets sold and we'll recognize servicing fees over the life of the leases. We are currently servicing over $74 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 15% year-over-year to $911 million, an all-time record. This record portfolio size was driven by strong origination growth with the full year 2017 total sourced origination volume totaling $683.6 million, an increase of 30.9% from a year ago. Total managed assets increased 21% from a year ago. For the quarter, net interest margin was 10.57% down 16 basis points from the prior quarter and 87 basis points lower than a year ago. The decrease in margin percentage was primarily a result of a decline in late fees and end of lease revenue based on certain updated servicing practices, growth in lower yielding equipment finance channels and an increase in the cost of funds, partially offset by an increase of nine basis point in new origination loan and lease yield over last year. The cost of funds increased to 145 basis points compared to 139 basis points for the previous quarter and 114 basis points for the fourth quarter of 2016. The portfolio continued to perform within acceptable ranges in the fourth quarter. The allowance for credit loss reserves was 1.63% of total finance receivables and coverage of total 60-day delinquencies was 263%. As we've mentioned earlier, it is important to note that our reserve methodology is very sensitive to small short-term changes in delinquency and loss emergence. Fourth quarter operating expenses were $15.4 million compared to $15.7 million in the prior quarter and $13.5 million in the fourth quarter last year. The decrease from the prior quarter was primarily due to $0.4 million of hurricane insurance claim reserves recorded in the prior quarter, partially offset by expenses associated with the exit of the COO. The increase from the fourth quarter last year was primarily due to an increase in expense related to Horizon Keystone acquisition, including intangibles amortization expense, higher salaries and benefits and higher sales commissions. Expenses also increased due to investments in the direct origination initiative, the exit of the COO, consultants and expenses associated with building out Marlin Senior Leadership team. The company's efficiency ratio for the fourth quarter was 53.3%. The fourth quarter adjusted efficiency ratio improved to 51.8% compared to 57.1% on an adjusted basis from the prior quarter and 54.6% in the fourth quarter last year. It is important to note that the Q4 efficiency ratio would have been approximately 100 basis points lower without the special bonus commissions paid to Horizon Keystone. Our capital position remained strong in the quarter with an equity to assets ratio of 17.27%, 92 basis points below last year. The decrease in the capital ratio from last year was by design and resulted from continued strong asset growth. As Jeff mentioned, we plan to roll out a new secured funding source early in 2018. This will add the third leg to our funding stool along with deposit funding in the bank and secondary marketing. The securitization structure had been mostly finalized late in 2016 which sit on the back burner throughout 2017 as we successfully built out our syndication capabilities. Now that our syndication machine is operating at full speed, we invested off our plan to fund assets in the holding company for the first time since 2010. This will entail diverting a meaningful portion of our origination flow over the course of a quarter or two into a short-term aggregation facility in [Holco]. This pool will then quickly be turned out in the market. In the end, we expect to realize almost three times the leverage in Holco as we do in the bank and still protect the safety and soundness of our bank. In addition, I am pleased to report that our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on February 22, 2018 to shareholders of record as of February 12, 2018. 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 for 2018. Total sourced origination volume is expected to finish the year approximately 20% above 2017 levels. Portfolio performance is expected to level off and remain within our targeted range. Net interest margin as a percentage is expected to be between 10% and 10.25%. ROE is expected to improve in 2018 as the company continues to improve operating scale. EPS is expected to be between a $1.95 and $2.10 per share. And finally, the effective tax rate taking into account the new corporate statutory rate is expected to be in the range of 25% to 27%. And with that, I'll turn the call back to Jeff, Jeff?

[Jeff Hilzinger:]

Thanks Taylor. After a mixed third quarter, we bounced back in the fourth quarter and ended 2017 from a position of strength. Both macro and company-specific opportunities provide strong tailwinds as we embark on a new year profitable growth. I look forward to continuing to focus on the execution of our Marlin 2.0 strategy, while enhancing our financial and operational performance as we move forward in 2018 and beyond. Although I am proud of our competence 2017, I've even more excited about what lies ahead for Marlin, quite simply our future has never been brighter. With that, let's open up the call to questions, operator?

[Operator:]

Thank you. [Operator instructions] Our first question comes from the line of Chris York with JMP Securities. Please proceed with your question.

[Chris York:]

Good morning, guys. And thanks for taking my question.

[Jeff Hilzinger:]

Good morning, Chris.

[Chris York:]

So, the margin guide was the only metrics better than our '18 estimates and the last couple of quarters, we had been discussing the trend for this metric to maybe it's on the floor and then the benefits from repricing. So, could you talk a little bit about the change in the trajectory potentially and then some of the drivers for the decline?

[Jeff Hilzinger:]

I am sorry, Chris, which metric was that?

[Chris York:]

The margin and it's margin?

[Jeff Hilzinger:]

The NIM?

[Chris York:]

Yeah.

[Jeff Hilzinger:]

Taylor can talk I think a little bit about the guidance that we're giving on that, but what we're seeing is that the NIM that we've used in the channel level ROE analytics is pretty consistent with what we've been expecting. There's a mix shift that's going on between the more legacy higher yielding but higher loss segments with some of the growth year segments that we've entered, although that is offset by direct directives at least as good as the retail segment of our indirect channel. But it's -- for me what's important to remember is that as the channel level ROE analytics prove, every channel that we have today is on a path towards creating an accretive ROE. So, some are high-yielding what high losses. Some are lower yielding with lower losses, some are operationally intensive and some aren’t. All those factor into what the expected return on equity is from each flow and that's really what we're focused on, is maximizing the channel mix so that we optimize ROE as opposed to just looking for high yield for high yield.

[Taylor Kamp:]

I would add a point to that Jeff that in the fourth quarter compared to the third quarter, there was $24 million additional dollars of volume in those lower yielding channels over the fourth quarter and that contributed not only to the new business yields going down quarter to quarter being a little bit tamped down, but that obviously flows into the overall portfolio yield and it will over time. The other piece of the NIM and we expect NIM to be relatively flat that we gave a range in our guidance, but relatively flat throughout 2018. You have two things happening. You're going to have, we believe that interest rates will be going up a little bit obviously based on the guidance we've gotten from analysts. But we also have this phenomenon where our cost of funds, our deposit costs actually leave that a little bit because they reprice a little quicker than we can pass that along even before there is a rate increase in the market and so we get squeezed a little bit. So that kind of offset, the general increase over time in yield. So, and as Jeff said, just because yields are flat to down, that doesn't mean profitability in those channel is down.

[Chris York:]

Makes a lot of sense. Okay. And then maybe shifting gears, could we drill down a little bit on the sales referrals of leases and then your outlook for capital markets flows, which Taylor you touched on a little bit from HK and then the lumpiness that we could expect for all other income lines throughout '18? And then as a follow-up what is your decision making or your primary decision-making criterion retaining the lease on balance sheet today versus selling one?

[Taylor Kamp:]

Yeah. So, let me see if I can sort of go through those questions logically Chris. So, we sold 69 million of assets during 2017 on a plan of 60 million. So, we did sell a little bit more than we had in the original plan, but not that much. There definitely was a shift from the third quarter to fourth quarter. We undersold in the third quarter, primarily because we felt that we would have friendlier market conditions in the fourth quarter, which we definitely did. So, we deftly shifted a little bit from the third to the fourth quarter to take advantage of that and then we sold a little bit more than what we had in the original plan again because the pricing that the market presented to us in the fourth quarter was really, really good. So that it was really more opportunistic than it was -- than it was strategic. Let me try to -- let me move to your last question next, which was what's the criteria that we used to sell? So basically, what we're doing is trying to originate as much as we can originate that our customers demand, but doing it in a way where risk rewarded balance that we ultimately know is liquid and it can be intermediated to somebody else's balance sheet. So, you look at -- there's a fair amount that we can originate that it just doesn't make sense on a bank balance sheet that has 15% capital when we can intermediate it to a bank that's got 8% or 10% capital. That makes a big difference in terms of the relative attractiveness from an ROE standpoint even though the retail level economics and the lease instrument are the same. I think actually we eluded to this into in our comments in terms of using I think some of our improved profitability to maybe enhance the retention of our organic growth, between the lower amount of capital that will be required to hold against these portfolios in a securitized environment, coupled with the fact that our cost of capital is lower just by virtue of having lower tax rate, now suddenly assuming that doesn’t get pass through to generally reduced pricing at the retail level, which we don't think that will happen, that makes a portion of flows that if weren’t securitizing our tax law hadn’t changed, we would be forced to intermediate in order for not to be destructive ROE. So, as we continue to evolve our analytics and we move away from yield and we really can look at channel level ROE it's the ROE on our balance sheet versus what we think the ROE could be on somebody else's balance sheet that really determines what we'll sell. There are lots of other nonfinancial benefits that come from it as well. If we sleep better at night knowing that our portfolio is liquid and understanding what its value is, from a market standpoint, we get lots of feedback on the quality of our documents and our operational processes. So, there's a broader validation benefit that comes by virtue of being in the market on a regular basis with what I refer to as sort of over origination at least as it relates to what makes sense for Marlin to hold to further duration of the assets.

[Jeff Hilzinger:]

Just to add to that, HK's we would expect 100% of those assets to be on balance sheet in Q1 of '18.

[Chris York:]

Okay. All that color is tremendously helpful. Thanks. Tax reforms is clearly a beneficiary to your business on multiple fronts. So, can you talk a little bit maybe how you plan managing the additional income they will receive from lower tax rate and then like how are you investing today in the business and how much should maybe fall to the bottom line?

[Jeff Hilzinger:]

Yeah, that's still a work in progress, Chris. I think we've been really spending the last six weeks or so trying to really understand exactly what the -- trying to quantify the magnitude of the positive impact on the company and we've been spending a lot of time with our Board trying to figure out what makes the most sense or what's the most rational use of this improved level of effectively of retained earnings that the company has. So, I think as I said in my comments, we talk a little bit about why holding more of our origination volume might make sense. There are a lot of acquisition opportunities that we've been looking at that could make a lot of sense for the company. There's probably a piece of it that we may want to return to our employees in one form and we're working our way through what that might look like and then of course there's a strong rationale especially at the current stock price to return additional capital to shareholders. So, I really -- other than giving you a sense as for the process we're going through that we really haven’t reached any conclusions yet is exactly what the former or mix of use is going to be.

[Chris York:]

Fair enough. Last question for me and then I'll hop in the queue. So, you kept your origination guidance essentially flat, but the backdrop on an economic environment perspective has materially improved over the last 90 days lending itself or maybe improved demand for equipment in all businesses across the country. So why should we think that your guidance is not conservative and then what would be the barricades to may be miss on your origination target.

[Taylor Kamp:]

I think 20% is I think that for a financial services company that's sort of in growth mode or high growth mode, I think 20% per year is a good number. I think it shows that the company has the ability to take market share, but we're not growing at a level that stresses the controls and the operating processes in the business. So that number isn't necessarily generated by a bottoms-up projection. It's really driven more by what we think is possible, but is also responsible. So that's how I think we're at the 20% number. It could be more. It could be a little less. If it's a little less, it probably won't be because there isn't demand. It will be because we've decided that we want to manage the mix particularly the channel mix in the portfolio a little differently.

[Chris York:]

Okay. Thanks guys.

[Operator:]

Thank you. Our next question comes from the line of Nick Grant with KBW. Please proceed with your question.

[Nick Grant:]

Hey. Good morning, guys.

[Jeff Hilzinger:]

Good morning.

[Nick Grant:]

So maybe follow-up on the NIM commentary real quick, does the guidance include securitization that in '18 and how should I think about the mix of funding stream originations relative to equivalent finance. So just some of the other moving pieces in the margin.

[Jeff Hilzinger:]

It does include the ability of some sort and then we haven’t completely dialed in how much leasing volume we would divert into that, but it's going to be North of $100 million more than likely. We wouldn't put funding stream assets into that facility. I would say that the funding stream growth target a little higher than on the volume side than the leasing assets. I won't tell you how much higher, but it still would remain a small percentage of our overall volume and portfolio. So, what was the third part of that Nick?

[Nick Grant:]

Oh yes. And then the mix of funding stream relative to your equivalent finance that's something but the lease yields versus loan yields?

[Jeff Hilzinger:]

So, funding stream volume will be about 6%, 7% something like that of overall lease volume, or overall volume I should say. And so -- but that turns very quickly. So, it doesn’t all manifest itself in that investment, maybe half of that. So, it still remains 3% of overall assets.

[Nick Grant:]

Okay. Great. And you discussed prioritizing M&A and you talked a lot about your strategy of becoming more of a full provider of solutions to small businesses. So, with that being said, on the M&A strategy, do you think about adding additional lending verticals or is it more of the same strategy?

[Jeff Hilzinger:]

Yeah that's a good question Nick. So, I think we think about M&A at two levels; one is extending our existing products and in a particular our equipment finance business. So, Horizon Keystone was a good example of that. That was a broker platform that we were able to acquire. We were able to capture the full margins that were in that flow at the retail level and we were able to enter two or three segments that Marlin had wanted to enter for a long time, but had difficulty doing it primarily because Horizon Keystone had created significant barriers in a number of those segments. There are a lot of platforms out there that look like Horizon Keystone. It's a very fragmented broker community. It's a broker community that's experiencing a lot of generational transitions and there's a lot of opportunity for a company like Marlin to be able to extend its equipment finance business through the acquisition of these kinds of broker platforms. And that's a very important part of what will be our M&A strategy going forward. And in fact, we reconceptualize the purpose of our brokerage platform from being exclusively focused on originating assets to really using its origination capability to be able to understand and create close relationships with brokers that we really respect and ultimately hopefully be in a position where we can be a potential acquirer when there's an event or there's some sort of a requirement on the broker's part that might having an acquisition by Marlin makes sense. The second level is more transformational one and that would be looking at acquiring something that brought another product at the level that we talk about equipment finance and working capital. Those exist for sure. They obviously would be a lot more transformational to Marlin than just a product extension. We're just as interested in those as we are in the product extensions and we're actively in the market looking at all of those things as well. So that's how we conceptualize. The extension acquisitions and then those that would be the acquisition of a new product or a new product family maybe is a better way to think about it. So that's our headset.

[Nick Grant:]

All right. Great. That's helpful. And then how should we be thinking about the rent and expenses here. Obviously, you're getting more efficient from the direct origination strategy where you also have a nice growth rate. So how should we think about moving on from this level?

[Taylor Kamp:]

That's a great question. I'll try to help you connect the dots on that. We would expect our efficiency ratio that we would exit the year in the fourth quarter somewhere at 50% or maybe slightly under that in the fourth quarter. I did want to highlight the fact that in the first quarter of 2018, we have some seasonality. There are large compensation payments we have. There is tax charge spike and things like that that blip a little bit in the first quarter. So, we would expect from fourth quarter to first quarter to go with $1.5 million or so sustainable fall back down to Q4 levels and then continue to be relatively flat from there on out, but the portfolio is going to be growing. So that's why our efficiency ratio improved throughout the year.

[Nick Grant:]

All right. Great. Thanks for taking my questions.

[Jeff Hilzinger:]

Thanks Nick.

[Operator:]

Thank you. [Operator instructions] Our next question comes from the line of Bill Dezellem with Tieton Capital Management. Please proceed with your question.

[Bill Dezellem:]

Thank you. I have a couple of them. First of all, would you talk about the change in strategy that you are implementing with the franchise business and then secondarily, Horizon Keystone you had mentioned that they had really put in some solid barriers for some product areas, which segments that were those?

[Jeff Hilzinger:]

Good morning, Bill. So, on franchises case, I think -- the way I think about it in is it isn't necessarily so much limiting what they were doing but we've limited what they would have to do in order to become $100 million platform. So, I think like transportation, I think once we had a chance to really look into the kinds of products and the kinds underwriting and the requirement that it would take in order for us to build a platform of that size and I think what was we originally talked about as being over two or three year period. We just were uncomfortable with I think more with the pace than we were with ultimately where that platform can go. And so, we used a series of constraints around the number of products and a series of constraints around the credit box as a way to just be very measured in how we're going to ultimately evolve that platform. Franchise is a very broad term. It can manifest itself in a lending company in a lot of different ways. There's a lot of different industries that you can specialize in. You can be an equipment-oriented franchise originator. You can originate on using enterprise level underwriting and do a lot of -- fund a lot of acquisitions. You can do concept refreshes. There's a lot of different ways to play and I think part of what we're doing with franchise is just making sure that we're very deliberate and very thoughtful in how we ultimately build a franchise business that works best and takes advantage of Marlin's strength. In the case of HK's, the three areas that they really specialized in were office furniture, commercial HVAC, which is heating and ventilation and air-conditioning equipment and aftermarket automotive. And I would argue that they had developed franchise flows in all three of those segments.

[Bill Dezellem:]

And what was their strategy to do that and is that something that you can replicate in other segments?

[Jeff Hilzinger:]

Yeah, well I would argue that in a lot of Marlin's existing segments, Marlin enjoys that franchise position. And so, I think ultimately if you want to create franchise value in a business like this, you have to create franchise value at a low level. And so that again goes back to the franchise conversation is you don't want to just be out there originating everything that's called franchise. You need to -- I think you need to know what you're good at and you need to know what you stand for in a segment and you need to develop a strategy that leverages those -- that leverages those strengths. And I think in HK's case, I think they had success in all three of those segments and they ultimately decided that that's where they wanted to focus and it took them 20 years to get to where they are because you don't build these kinds of franchise flow overnight. But I think as is evidenced by at least our experience with HKs once you build them, they're very defensible and so ultimately, we would like all of our flows to enjoy that same kind of franchise value that the HK's flows through and I think most of certainly Marlin's legacy flows definitely have high franchise value to them, but it takes a long time to do it right.

[Bill Dezellem:]

And one additional follow-up if I may, automotive or aftermarket automotive that you referenced, what is that exactly?

[Jeff Hilzinger:]

It's test and measurement systems that you see in independent -- in garages, it's lifting systems, it's the equipment you see when you take your car and to get it repaired.

[Bill Dezellem:]

Great. Thank you.

[Operator:]

Thank you. Our next question is a follow-up from the line of Chris York with JMP Securities. Please proceed with your question.

[Chris York:]

Yes guys, what are your targets for optimizing the balance sheet considering that securitization should not require as much equity that is required at the bank?

[Taylor Kamp:]

That's another good question Chris. So right now, we're -- I think we ended the year about 17.2%, 17.3% equity assets ratio. All of our assets are financed in the bank. We have a 15% floor in the bank. And so, we view that -- there's a little bit more leverage that we could put on the company if we continue to fund exclusively in the bank, but not a lot because you can't obviously can't go straight down to 15%. We can get closer to 15% now that we have capital markets capabilities because we can manage the size of the balance sheet a lot more precisely, but you probably can't get below 15.5%. 15.75% safely if you just stay in the bank. If you begin to securitize the banks that the advance rate in the bank is basically 85% of original equipment cost, once we take assets to the term market in today's world, we should be somewhere in the 93% to 95% advance rate. So, every asset that we take out of the bank where we divert from the bank and we securitize in today's market, it's not always feel like this because that's still of course the issue with the securitization market is that it's very cyclical. But in today's market, we're probably talking about decreasing our capital from 16% or 17% against assets in the bank down to 5% to 7% in a term securitization. So, on a $1 portfolio it's the amount of capital that can be released. It's pretty significant and then you couple that with the fact that we have a lower tax rate, we're retaining more of our earnings. That's why we made the comment we made that the company's ability to accumulate capital especially in a securitized environment with lower tax rates is significant.

[Jeff Hilzinger:]

And I would add to that that we also are looking at -- looking at everything on the balance sheet, on the asset side of the balance sheet looking at nonearning assets that can't be leveraged and try to minimize those. We don't have a lot, but every $4 million, $5 million, $6 million counts.

[Chris York:]

That's helpful. And thinking about it for '18, as a follow-up, Jeff, have you had any discussions with your bank regulator to remove that 15% floor and de novo treatment?

[Jeff Hilzinger:]

Yes. That's an ongoing conversation Chris and I think we remain hopeful that ultimately, we'll make progress on that, but it's such an uncertain environment and it's such a politicized process that we just -- you just can't count on it. So, I think we continue to press in that direction. We think the bank continues to play a really important part in Marlin's overall funding strategy. Its value is less when you're in a highly liquid securitization environment like we are now but it's value is extremely high when the securitization market cycles. So, we like the bank. We want to keep the bank. There's a role for the bank even at 15% capital, but we need to move on and we need to take control of our own capital structure going forward and we think by securitizing outside the bank that that will -- we can get the best of both worlds. And the way we think about it Taylor referred to sort of a three-legged stool. You got depository funding. We've got -- now got this developed -- pretty well-developed capital markets capability and then the third is a wholesale funding capability and at any point in the credit cycle there's a mix of those three things that's optimal. But it looks very different at the top of cycle than it does at the bottom of the cycle, but by virtue of having more than a single way to find ourselves, we can change that mix over time so that we're optimizing the company's capital structure and our access to the capital, so that we can keep our origination efforts uninterrupted as possible over the course of the cycle.

[Chris York:]

Great. Yeah, that makes a lot of sense. Last question for me is I am aware that previous co-owners of Marlin are back up and running and equipment lessor, so I recognize that your strategy under Marlin 2.0 and 3.0 is much different than 1.0, but do you expect any disruptions in the business volumes or operation from this new venture?

[Jeff Hilzinger:]

I would say that there has been a lot shift in the independent equipment finance part of the commercial finance industry over the last six months. You have -- Leaf is now owned by a bank, [Vitus] is now owned by a bank. You got Newman which is a start up with a bank and I think that -- I think that that's actually all is good for the industry and we don't really compete that directly against any of them and the reality is that if you talk all of those independent finance company then you add it all their origination volumes together, it's a spec of market share. So, it's a huge market that's very fragmented. There's a ton of opportunity for a lot of people and it's not a zero-sum game in any way. So, it's the way the world works and we feel like we're as competitive as anybody. And that we ultimately can win in any environment. So, we watch those things and we make sure that we're in a competitive position and that we're operating at our optimal way but we don't really worry about it.

[Chris York:]

Great. That's it for me. Thanks Jeff. Thanks Taylor

[Jeff Hilzinger:]

Thank you.

[Operator:]

Thank you. Since there are no further questions, I would like to turn the floor back to you for any final 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 2018 first quarter results in early April. Thank you.

[Operator:]

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