Marlin Business Services Corp.
Q2 2015 Earnings Call Transcript

Published: 5 Aug 2015

[Operator:]

Good morning, ladies and gentlemen. Welcome to the Marlin Business Services Corp Second Quarter 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded and is being webcast simultaneously on the Investor Relations section of Marlin's website at www.marlinfinance.com. The recording of the call will be archived on the website for approximately 45 days. I would like to remind you that this conference call may contain statements that are forward-looking within the meaning of the applicable Federal Securities laws and are based on Marlin Business Services Corp's current expectations and assumptions, which are subject to a number of risks and uncertainties that could cause actual results to differ materially from those anticipated. Factors that could cause actual results to differ from those anticipated are detailed in the Company's Securities and Exchange Commission filings. Listeners are cautioned not to place undue reliance on these forward-looking statements. Such forward-looking statements speak only as of the date of which they are made and the company does not undertake any obligation to update any forward-looking statements to reflect events or circumstances after the date of this call. Speaking to you today will be Dan Dyer, Chief Executive Officer. Also, on the call is Ed Siciliano, Chief Sales Officer. The company will begin the call with prepared comments and follow-up with a question-and-answer session. It is now my pleasure to introduce your host, Dr. Dan Dyer, CEO of Marlin Business Services Corp. Thank you, Dan. You may begin.

[Dan Dyer:]

Thank you. Good morning, again, to everyone and welcome to today’s call. Let me begin with a few opening remarks on business. To begin, second quarter sales momentum was favorable with lease originations up 14% over first quarter levels. We also saw pricing on new originations higher this quarter. As Ed commented on, we are upbeat on the momentum growth indicators for the core business for the second half of the year and continue to add and invest in our sales force. We are excited on the launch of the new customer loan portal FundingStream.com and how it finds into our small business strategy. We believe the company is ideally positioned to growth this part of our business from several advantage points to include credit underwriting, technology and importantly the sizable base of more than 65,000 customers we do business with today. The portal offers Marlin's customers a highly intuitive simple to use experience when applying for working capital loan online. At the moment, the plan is to actively [ph] the customers and to begin test marketing to non- Marlin customers. While it is early in the product's launch, we fully expect the pace of loan production to accelerate during the second half of the year. Early feedback and results are encouraging. Looking ahead, we are seeing ample opportunity to generate significant level of volume. The preliminary estimate for 2016 is targeted to be $50 million of new loan production from this new product. In addition to targeting Marlin's customers, future plans also include building partnerships with B2B lenders and providers for both, leases and loans and towards this end, we have recruited an experienced industry veteran to lead this effort. For the quarter, investment spending tied to loan business and other core growth initiatives was $0.02 a share. Looking ahead for Q3 and Q4, quarterly EPS impact from incremental investment spending will range from $0.025 to $0.03 a share each quarter. Looking ahead to 2016, we anticipate the loan business to add an incremental $0.105 to $0.125 to EPS. As I may have commented on in the past, we also have plans to expand our insurance offers complementary to Marlin's existing insurance business and serving the needs of small business. We hope to have an announcement soon on this new venture. Portfolio asset quality trends remain in solid shape. Delinquency levels were favorable and we estimate second half charge-offs to remain flat to modestly lower than first half levels. In connection with our strong capital position, what we see as an attractive investment opportunity, 98,000 shares were repurchased this quarter. Also pleased to announce an increase to the quarterly cash dividend to $0.14 a share, all part of an overall plan to optimize the capital structure and enhance returns on capital. As we announced Taylor Kamp will be joining Marlin as the company's Chief Financial Officer. Taylor will be starting August 10th. On behalf of the Board and the entire management team, we are delighted to have someone like Taylor's experience and industry stature to join the organization. We are all looking forward to working with Taylor on the next chapter of Marlin's future success. With that, let me talk to the financial results for Q2. Net income for the second quarter was $4.1 million or $0.32 per diluted share. Return on equity was 9.5%, portfolio grew close to 5% year-over-year and again with new asset originations growth of 14% over first quarter levels. The yield on new originations for the quarter was 11.12%, up 33 basis points compared with 10.79% in the first quarter of '15 and benefiting partially from the higher yielding working capital loans originated this quarter. For the quarter ended, the net interest margin was 12.05%, 35 basis points lower than Q1 and 61 basis points from the comparable prior year period. Cost of funds remained relatively flat in second quarter or 85 basis points compared to the first quarter of '15, and were up slightly to 4 basis points compared to comparable prior year period. We see the net margin leveling off in line with the addition of the higher-yielding capital loan business. Credit quality remained strong and in line with expectations, 30-plus day delinquencies declined to 70 basis points from 87 basis points in the first quarter of '15, while net charge-offs increased 1.84% of our originated investment versus 1.7% in the first quarter, due primarily to the impact of the few large charge-offs in the quarter. On a year-to-date basis, charge-offs were 1.77% of average net investment. The provision for credit losses were lower for the quarter based on the outlook for more favorable future charge-off levels resulting from the lower portfolio delinquencies recorded this quarter. The allowance for credit losses remained strong at 1.34% of average total finance receivables and 296% coverage of 60-plus delinquencies. Additional information on status quo losses and delinquencies is available on our website. Second quarter expenses were $11.6 million versus $11.2 million in the first quarter of '15. Second quarter interest expenses was impacted by $300,000 of severance related expense associated with our CFO departure and $300,000 of expenses related to investments in the company's capital loan and franchise lending initiatives. Our efficiency ratio was 56% versus 50% a year ago. Company's efficiency ratio adjusted for the aforementioned severance and investment cost was 53% for the second quarter. Going forward, we anticipate the efficiency ratio to remain in the low 50% range. Our effective tax rate is 38.8% in the second quarter, consistent with the first quarter of '15. On a year-to-date basis, the tax rate is also 38.8%. Going forward, we expect the tax rate to remain in that range. Lastly, our capital position remained strong with an equity asset ratio of 23%. Company increased the dividend by 12% to $0.14 per share. Company repurchased approximately 90,000 shares of stock in the second quarter through our stock buyback program. As announcement, our Board has approved the repurchased of up to $15 million of share value. Our objective is to continue to prudently manage capital to a target range of 18% to 19%, driven by growing the business, share repurchases and dividends. With that, I will turn it over to the operator for questions.

[Operator:]

Thank you. [Operator Instructions] Our first question comes from the line of Bob Napoli with William Blair. Your line is open. Please go ahead.

[Bob Napoli:]

Good morning, everybody.

[Dan Dyer:]

Good morning, Bob.

[Bob Napoli:]

Let's see. The capital loan product getting to $50 million, correct, of originations in '16. I mean, how do you see that ramping up? You did a $0.5 million this year, so it is still very tiny. You are making the investments. What do you expect from a ramp up perspective and is the vast majority of that going to be cross-sells to your current lease base?

[Dan Dyer:]

Sure. Thanks for the question, Bob. It will be a progressive ramp up in '15, building into the estimate $50 million for '16. Let me break it down. As just announced last week, the portal is up and running. With the portal up and running, we are going to now start to active solicit and market to our customers. We held off doing that until the portal was up and running, because it was an important part of the value proposition. With that in place, market is going to pick up and it is going to be primarily to our customers, right? Looking at next year, we would estimate that 60% to 70% of loan production will be through Marlin's customers. Now, as I mentioned on the call, we are going to do some test marketing to non-Marlin customers. We also, in our core lease business, do business with lease brokers, some of which sell loans. The balance, the other 30% will be approximately will be from leased and loan brokers, right? Now, another part of the sort of the growth plan is, as I commented on the call, we built the technology and the infrastructure to establish alliances with - to the banks, other lenders or other B2B providers and we just hired a industry veteran, we will announce it soon, who will lead that initiative, so we are going to look to partner with others that are in the B2B space and hopefully create an opportunity to generate business through these alternative channels. Now, with respect to the ramp up in '15, in the month of - again the numbers are small and we are building momentum by approximately $300,000 in the month of July, so I estimate for the third quarter we will do somewhere around $1 million to $1.5 million, right. Then in the fourth quarter, be somewhere maybe $3 million to $3.5 million, so that will give us some runway as we again continue to ramp up and build into '16. I do not have a breakdown by quarter for '16. It is too early, but you are just going to see a steady build up in momentum through the balance of this year and continuing into '16.

[Bob Napoli:]

Then can you just give a little more color that product, exactly what it is?

[Dan Dyer:]

Sure. It is a cash loan and it is used primarily and we post our customers - every business needs working capital for a variety of reasons, primarily business expansion, inventory, whatever their use of working capital is for that specific business. The term ranges from as low as three months to 24 months. Now, the sweet spot is 10 to 12 months, all right? The loans can vary from 10,000 to 100,000. I think our average loan is in the $40,000 to $45,000 range and it is an amortizing loan and they pay us back on a daily basis and that is how it works and we can turn around the decision from time of application to approval and funding in this little as 48 hours. Now, the underwriting leverages off of our core competency in small business underwriting and we enhanced it in a number of ways, and I am pleased to say with the pilot that has been underway. Our credit quality has been pristine year-to-date and that is important to emphasize that, because this is relatively unsecured product, but our credit quality has been fantastic, which we are very pleased about.

[Bob Napoli:]

Okay. Then would you show a syndication volume, are those essentially what the industry would call marketplace loans, are you selling those loans retaining servicing? You are syndicating, I mean, what is the syndication volume that you are showing?

[Dan Dyer:]

Yes. Ed? If you can comment on that?

[Ed Siciliano:]

Yes. Bob, we want to be a one-stop shop for our vendor customers to place all their credits and we have been doing syndication on a fee based model for years, but now we partner with the larger bank for the larger credits, where we are retaining servicing, but selling that loan, so that is the only syndication volume that we are counting, even though we syndicate a lot more for just straight ups these.

[Bob Napoli:]

Okay. Then just last question on your core lease business. I mean, you have added a good number of sales people, you had a nice jump from the first quarter, but you are still only up 3% year-over-year. Where do you expect that, and where do you see, what is going on with that core lease business, how is the competitive environment and do you expect that business to grow significantly or we are going to see most of the growth out the working capital product?

[Dan Dyer:]

We absolutely expect the core business to grow and it has been growing, Bob. In regard to the sales force, our initial guidance going into this year is, we want to increase the sales force size 10% to 15%. We are feeling a little more bullish about that, so we are going to increase the sales force by 20% this year. Our end point last year was 115 reps if we were to increase the sales force size 20%, we would end with 138 reps. The majority of those are actually into the core business not into loan. There is only so many in loan, we needed to increase the sales force size. Now, we are kind of pleased with the traction we are getting. We are actually able to add some reps that are ramping faster, because we are pulling them out of our competitors in some cases. Blair does a kind of average productivity by rep. In the second quarter, we were approaching $3 million per rep, but we really think we can get it back to $3.5 million. With a larger sales organization size, say, between 135, 140 at the end of the year, average productivity at $3.5 million, that sets us up really well heading into 2016 to really make a dent in growing the size of the portfolio, which obviously we need to do.

[Bob Napoli:]

Great. Thank you. Appreciate it.

[Dan Dyer:]

Thank you, Bob.

[Operator:]

Thank you. Our next question comes from the line of Chris York with JMP Securities. Your line is now open.

[Chris York:]

Good morning, guys. Thanks for taking my questions.

[Dan Dyer:]

Good morning.

[Chris York:]

Could you talk a little bit more about asset pricing during the quarter, because we find it hard to reconcile the sequential decline in the interest in the field to 12.9%, especially when we consider the pickup in new yields on leases.

[Dan Dyer:]

Okay. Chris, the 12.9%, what is that?

[Chris York:]

NIM.

[Dan Dyer:]

The NIM before cost of funds, okay, obviously, the 12.9% of the NIM on the portfolio is blended in aggregation of current quarter origination, current year origination and in prior year. What we see here is that the NIM is being impacted by obviously the marginal pricing you are putting on a new business, but also we have to factor in the fact that what is the yield on prior originations, so we still see the amortizing effect of higher yielding business that was put in prior years running off and being replaced by marginally lower pricing new originations. Now, our weighted average life our business is two years. Reasonably soon, we will see a troughing [ph] of that NIM. Now, that does assume that we get stable pricing on what we are putting on today. In the second quarter pricing was favorable up over Q1, so it is influenced by obviously the new originations and the amortizing of the old portfolio. It is not so transparent, because we only report on quarterly new originations and you do not really see it in the aggregate on the portfolio NIM, but that is what is going on there.

[Chris York:]

That is helpful and I am trying to get a sense and maybe trying to predict or trend out when we potentially see that trough, so if we have kind of two years of a duration in the lease portfolio, is it may be safe to kind of think about a trough there in regards to the interest income and fee yield maybe in 2016? Is that how you guys are thinking about it? The overall cost of fund, all of the net of cost of funds, it was 12.07% for - cost of fund from the 12.09%. It was 12.07% for Q2, so the aggregate not NIM, but net interest fee margin, net of cost of funds, we estimate to be 12.12% in Q3 and 12.29% in Q4. Now, let me just qualify that by, that assumes a blending in of new loan origination volume, right, which will be a pick up to yield and it also does assume a stable pricing on new lease originations factored that in as well, so there was a two variables that will have to play out, but we do expect that the new loan business to have a positive impact on margin. Based on Q2, we have seen some stabilization. We are going to have to see how that plays out. It is still somewhat volatile in terms of pricing in the market. We have signaled that we are seeing some stabilization, but it is still not there entirely, so we do anticipate that that margin to flatten out and then increase if the loan business comes on. In terms of maybe giving a little bit more color to what I just said, I think we can get you on the phone with our finance group and we can sort of walk you through the pieces of the NIM.

[Chris York:]

Got it. I appreciate that. Just to clarify, it seem like if we are moving from a net interest and fee margin, which includes the cost of funds there on Q3 and Q4 that - in Q2 it troughed potentially if you are assuming that we are 12.12% and I think you said 12%...

[Dan Dyer:]

If the new loan originations come on as we anticipate and we get stable pricing on new lease originations in the future.

[Dan Dyer:]

Correct.

[Chris York:]

Okay. Great. Then shifting gears a little bit, Dan, you said you expected efficiency ratio to remain in the low-50s, so does this include any near-term anticipated marketing expenses and the capital loan product?

[Dan Dyer:]

Yes. It factors that in.

[Chris York:]

Okay. Then are there any one-time expenses associated with the hire of Taylor?

[Dan Dyer:]

No. There will be a fee associated with a recruiter, that we are engaged, professional recruiter.

[Chris York:]

Got it. Okay. That is it for me.

[Dan Dyer:]

Thanks Chris.

[Operator:]

Our next question comes from the line of Brian Holland with Sidoti. Your line is now open. Please go ahead.

[Brian Holland:]

Hey, guys. Thanks for taking my call.

[Dan Dyer:]

Hi, Brian.

[Brian Holland:]

You touched on this, but what in particular drove the lease equipment volume growth. Do you expect that trend to continue?

[Dan Dyer:]

Yes, sure. It is a good question, Brian. Really, I would say a few things. The size of the sales force is helping. In fact, we have more growth there, but really all channels were contributing, so our existing core channels as well as some of our newer channels are contributing to that growth. I will give you some numbers that specifically as for in the call and I think it will be helpful. In April, we booked $29.8 million, in May $29.5 million. Then in June, which is the quarter ending month, we did $32.8 million. We had a little bit of syndication of a little loan, and you get the $93 million. We are really pleased and feeling like we turn the corner in July, we did $33.3 million in the quarter. If you add syndication loan, we did $34 million. I have been here eight years, so we have never had a July, be the June, which is the quarter ending month, so I think that is really significant and speaks to size of the sales force, our dealer activity being higher, our new channels starting to contribute, loan has not even started to contribute yet, so we are feeling really good that we have turned the quarter. We are bullish on the second half. If I were to throw a number out there, I would expect the second half to be 20% higher in originations than the first half and that will set up very well for 2016 for us. Hope that helps, Brian?

[Brian Holland:]

Yes. That helps a lot. If I could just ask one follow-up, what primarily caused the yield on the lease and loan originations to take up the 31 basis point, sequentially? Was it a big factor due to the higher yields on the small business loans or are you seeing overall improved pricing in sort of the quarter leasing business, could you break that a little bit?

[Dan Dyer:]

Yes. It was absolutely mixed. We have a retail channel that focuses with an inside sales model focuses on smaller dealers, smaller businesses and they will really turned it up in the second quarter and that is one of our highest yielding channels. When we say mix that channel turns up. Now, in the beginning of Q3, which we just started we saw our national account start to pickup and yields were a little bit lower. The guidance there is, we are going to be 25 basis points to 30 basis points up and down in new originations depending on which channel is really productive in that quarter and we really cannot predict that. If we are down a little bit in yield from our core business that should be offset by loan originations, which have very, very healthy yield, yes, that was a little color on that work.

[Brian Holland:]

That is helpful. One more question and I will jump back into the queue. Can you give us a little bit an update on the franchise lending business? I mean, clients you can talk about or possibly just a little update on how the relationship with but then it is just going?

[Dan Dyer:]

Yes. I won't comment on particularly franchise concepts, but I will say that it is contributing in a more meaningful way. It was a part of our growth in the second quarter, so very, very optimistic on that being a meaningful channel for us going forward. We are really not going to be break out franchise or any the other new things that we are getting into on the core business side, but it is really helping us right now.

[Brian Holland:]

All right. Thanks.

[Operator:]

We have a follow-up question from the line of Bob Napoli with William Blair. Your line is now open.

[Bob Napoli:]

Thank you. Just thinking over the medium term here, what do you feel, Dan, an acceptable return on equity target for you guys? I mean, obviously, 10% ROE is not your target?

[Dan Dyer:]

Right. On the business revenue, so as profit side, we obviously want to be in the higher margin, higher return categories. Our lease businesses is highly profitable, the capital loan business is highly profitable, things we are doing on the insurance on the fee side, will obviously contribute to and boost our ROE.

[Ed Siciliano:]

With respect to the capital management side, as demonstrated this quarter, share buybacks and increasing the dividend will also help improve and strengthen ROE to get as closer to that stated goal of 13% to 15%. Now, the reality is that our capital levels and I mentioned this on the call, target 18% to 19%, we are above that, so we need to get it down through growth, primarily but also the dividends and repurchases. As you know, we have been very active in Q1 and in Q2 to get a close to that 18% to 19% capital and as close as we can to achieving at 13% to 15% ROE. I think to get that ROE, we continue need to focus on the higher return business segments that will contribute to earnings growth and effective use of capital. We were up in that 11.5% ROE range in our leg [ph] we obviously have taken the step back by continuing to accumulate capital and we have got a little bit of a flattening earnings curve here, but our goal and objective in terms of how we look at the business is to continue to strive for that as the goal in mind and the Board continues to look at various options in order to drive to that objective. Increasing the dividend this quarter was one, our active engagement in the market in terms of share repurchases, was another step in that direction and the Board continues to evaluate other options as well.

[Bob Napoli:]

Even that 18% to 19% your target, that is a pretty high capital level. Longer-term, can you get that down to 15%, which would still be high capital level?

[Ed Siciliano:]

Well, we would like to, but we are not and it is really - I think we maybe have probably commented this in the past. We were charged as IOC [ph] back in 2007-2008 and we have to adhere to a capital CALM agreement, capital adequacy loan liquidity management agreement and that stipulates that our capital has to be at a minimum of 15% risk based capital. You throw on a cushion on top of that, it gets you closer to 17.5% maybe 18%, so that is the foundation for the target. If we did not have to adhere to CALM agreement, our capital levels and [ph] would be closer to where the banking sector is as an average, but we will continue to work with the regulators to see if we can get some form of relief from that CALM agreement.

[Bob Napoli:]

Okay. Then the insurance product, what type of capital do you need on that insurance product? Can you explain a little bit more about what that insurance product is?

[Dan Dyer:]

Sure. Just to sort of layout, today we do have an active insurance program and it is insuring the equipment that we finance for our customers. Two things that we are looking to pursue, one is our coverage for other pieces of equipment our customers have that, where we do not have insurable interest so we are working on creating a policy that would allows us to insured other commercial equipment that our customers own and they have come to us and say can you insure other pieces of equipment. We like your program. We like the features and benefits that it offers that are existing, it is just not our policy - does not, so we are working on that as a product extension to what we do today. The other insurance related initiative that we are working on is building out our agency capabilities and working with insurers' commercial business owner policy insurers to be able to offer our customers on an agency fee basis, a business owner policy. We are working with some national providers just to establish our relationship where we would not underwrite the business owner policy. We would generate a fee for being the agent of record and being by definition the sales arm of the insurer, so we think we have done a lot of polling with our customers and we think that is an opportunity where we could generate some meaningful fee income if we were successful.

[Bob Napoli:]

What type of opportunities is that? Do you expect over the next year or two, what do you see kind of revenue from these new insurance initiatives?

[Dan Dyer:]

Well, I think on an average, BOP, policy is somewhere between $2,500 and $3,000. The agency fee would be somewhere in the range of 10% to 12%, so for every BOP policies that we originated, we can earned up the $200 in revenue, all right? We have 36,000, I think approximately 36,000 active customers on our existing program, all right? If you sort of do the math, when you up what we could earn $200 per BOP policy referred and multiply that by coming active customers, you could see how it could be quite a meaningful number and the margins are quite high. Yes. There is some marketing involve, there is some backend customer service, but insurance is a very high margin business. Again, we are not taking any risk here we are not taking any cash risk. The capital would be almost non-existence, so it would be purely a fee based business opportunity.

[Bob Napoli:]

Okay. Then just one question, your new CFO, congratulations on the hire, it looks like a nice hire. What are you expecting? Are you looking for additional value add beyond the traditional CFO role or what are you expecting out of Taylor?

[Dan Dyer:]

Yes. Absolutely. Taylor brings a diversified and well rounded background. His recent experience was obviously in business development in various capacities over a long stretch of time at CIT, so we have a very capable staff in terms of what you would call the traditional CFO role, so we see Taylor as a business partner to help us think through these new initiatives that we are talking about also help us with our - as we talked about with capital management and the bank and so forth, so we think that Taylor is sort of the right fit for the organization, where we are at and where we are headed and we are excited to have him decide to join us.

[Bob Napoli:]

Right. Thank you.

[Dan Dyer:]

Thanks, Bob.

[Operator:]

Thank you. I am showing no further question at this time. With that said, this does conclude Marlin Business Services Corp Second Quarter 2015 Earnings Conference Call. Everyone may disconnect. Have a good day.