Marlin Business Services Corp (NASDAQ:MRLN) Q2 2019 Earnings Conference Call August 2, 2019 9:00 AM ET
Lasse Glassen - ADDO Investor Relations
Jeffrey Hilzinger - President, CEO & Director
Louis Maslowe - Chief Risk Officer & SVP
Michael Bogansky - SVP & CFO
Conference Call Participants
Christopher York - JMP Securities
Brian Hogan - William Blair & Company
Greetings, and welcome to the Marlin Capital Solutions Second Quarter 2019 Earnings Conference Call. [Operator Instructions]. As a reminder, this conference is being recorded.
It is now my pleasure to introduce your host, Lasse Glassen, Managing Director of Investor Relations. Thank you, sir. You may begin.
Good morning, and thank you for joining us today for Marlin's 2019 Second Quarter Earnings Conference Call. On the call today is Jeff Hilzinger, President and Chief Executive Officer; Lou Maslowe, Senior Vice President and Chief Risk Officer; and Mike Bogansky, Senior Vice President and Chief Financial Officer.
Before beginning today, 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 these projected or implied statements due to a variety of factors. We refer you to Marlin's recent filings with the SEC for a more detailed discussion of the risks that could impact the company's future operating results and financial condition.
With that, it's now my pleasure to turn the call over to Marlin's President and CEO, Jeff Hilzinger. Jeff?
Thank you, Lasse. Good morning, and thank you, everyone, for joining us to discuss our 2019 second quarter results. I'll begin with an overview of the key highlights from this past quarter along with our ongoing efforts in executing our strategy to transform our company from an equipment lessor into a nationwide provider of capital solutions and small businesses. Lou Maslowe, our Chief Risk Officer, will comment on portfolio performance; and Mike Bogansky, our Chief Financial Officer, will follow with additional details on our financial results and financial guidance for the remainder of the year.
Marlin delivered a productive second quarter, highlighted by outstanding growth in origination volume, stable portfolio performance and improving profitability. Second quarter total sourced origination volume was $231.5 million, up 28.9% year-over-year and a record for a single quarter. In line with recent quarters, year-over-year growth continues to be driven by strong customer demand for both our Equipment Finance and Working Capital Loan products, and we continue to benefit from strong growth in both our direct and indirect origination channels.
In addition, as part of Marlin's capital markets activities, we referred or sold $61.8 million of leases and loans that were better suited for our capital markets partners' balance sheets. Because of these origination and capital markets activities, our net investment in leases and loans reached nearly $1.1 billion, up 10.3% from a year ago. Total managed assets, which includes both our balance sheet portfolio and assets we've sold but continue to service for others, expanded to nearly $1.3 billion, an increase of 20.2% from the second quarter of last year. In addition, our focus on maintaining disciplined credit underwriting continues to be a top priority, and portfolio performance during the quarter remained stable and within expectations.
For the quarter, we reported GAAP earnings of $0.49 per diluted share compared with $0.52 per diluted share for the second quarter last year. Net income in the second quarter was negatively impacted by $0.02 because of severance expense associated with a staff reorganization that we implemented during the quarter. As we discussed last quarter, we continue to expect earnings to grow substantially during the second half of 2019 as the investments we've made in our sales force earlier this year continue to generate returns. And as Mike will expand on further in his remarks, it's important to note that we are reaffirming our earnings guidance for the full year.
I'd now like to move to an update on our Marlin 2.0 business transformation initiatives. 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 costs through origination and portfolio growth; third, improving our operating efficiency by better leveraging fixed costs from scale and through operational improvements to reduce unit processing costs; and fourth, proactively managing the company's risk profile to be consistent with our risk appetite.
I'd like to share with you the progress we've made on each of these areas since our last call. Beginning with our strategic market expansion, historically, the company operated primarily as a single-product, micro-ticket equipment lessor originating through equipment vendors. With the goal of scaling our business through growth, we have expanded our focus by becoming a broader provider of credit products and services to small businesses. As part of this effort, we have also broadened our go-to-market strategy by not only continuing to originate through our equipment vendor partners but also directly with our end-user customers.
To this end, we continue to be very satisfied with the performance of our Working Capital Loan product. Second quarter Working Capital Loan origination volume expanded by more than 63% year-over-year to $27.5 million. This marked the largest single quarter for Working Capital Loan origination volume since we began operating the product in mid-2015. It is a record for the company. Also, the Working Capital Loan portfolio performance continues to exceed our original expectations, and given our proven credit models and expertise in underwriting small business credit risks, we believe that Marlin is uniquely positioned to safely and profitably offer this product to our customers.
We also remain pleased with our efforts to provide financing solutions directly to our end-user customers. Marlin's direct origination channel leverages relationships Marlin has built with its customers over time, including our roster of more than 85,000 active small business customers, along with approximately 5,000 new customer relationships that we originate each quarter. The objective under our direct strategy is to identify additional financing opportunities with these existing customers by offering multiple products that meet a broader set of their financing needs. Importantly, this repeat business significantly lowers our blended customer acquisition costs over time because we do not take customer acquisition costs beyond the initial transaction. During the quarter, direct origination volume increased to $49 million, up from $36.3 million in the second quarter last year, resulting in a year-over-year increase of 35%.
We also made good progress during this past year on our second key priority, which focuses on leveraging Marlin's capital and fixed costs through growth. Driven by strong origination volume and solid portfolio growth over the past 12 months and during the second quarter, we were able to reduce Marlin's equity-to-assets ratio by approximately 97 basis points to 16.1% from 17% a year ago. In addition, we continue to manage the size and composition of our balance sheet through our capital markets activities. Marlin's asset syndication program remains very active, and during the second quarter, we sold $57.6 million of assets that generated an immediate net pretax gain on sale of approximately $3.3 million. Among other attributes, the syndication program enables Marlin to achieve portfolio optimization by better managing its overall size and composition in terms of returns, credit risk and exposure to particular industries, geographies and asset classes. Importantly, we continue to service the assets sold, which allows us to maintain an ongoing relationship with these customers, which complements our direct strategy. As of the end of the second quarter, we were servicing a loan and lease portfolio of approximately $214 million for others.
Turning to our third area of focus. We continue to make strides in better leveraging the company's fixed costs through growth and by improving operating efficiencies through ongoing process improvements. After adjusting for severance charges associated with the staff reorganization we implemented during the quarter, our non-GAAP, noninterest expense as a percentage of average managed finance receivables for the second quarter was 5.7% compared with 6.1% for the second quarter last year. The company's operating efficiency ratio, adjusted on the same basis, was 55.8% for the second quarter versus 54.3% for the second quarter last year. The increase in the ratio was due primarily to investments we made in building out our sales team at the end of last year. We do expect the efficiency ratio to improve as we continue to generate returns from our investment in the sales team. We also expect to continue to leverage our capital and fixed costs through portfolio growth and operate more efficiently as a result of our various process renewal initiatives.
And finally, we remain focused on proactively managing the company's risk profile such that it is commensurate with our risk appetite. Importantly, the key credit quality metrics over the last several quarters have remained stable, and our portfolio continues to perform within an acceptable range. Lou will provide additional details on the portfolio's performance in his remarks.
In summary, we enjoyed a solid first half of the year with momentum continuing to build, and we are poised for a strong year in 2019.
With that, I'd like to now turn the call over to Lou Maslowe, our Chief Risk Officer, to discuss the performance of our portfolio in more detail. Lou?
Thank you, Jeff, and good morning, everyone. Looking at the key asset quality metrics, Equipment Finance receivables over 30 days delinquent were 1.08%, down 5 basis points from the prior quarter and up 11 basis points from the second quarter of 2018. Equipment Finance receivables over 60 days delinquent were 0.67%, down 1 basis point from the prior quarter and up 11 basis points from the second quarter of 2018. On a sequential basis, the improvement in Equipment Finance delinquency in the second quarter is primarily attributable to consistent underwriting and a continued favorable economic environment.
As noted last quarter, the modest increase in year-over-year delinquency levels is consistent with industry trends. A benchmark that we utilize is the PayNet 31- to 90-day small business delinquency index, which increased 9 basis points year-over-year, while Marlin's comparable delinquency increased 11 basis points. We remain pleased with the level of delinquency in our portfolio as it remains well within our targeted range in the current economic environment.
Aggregate net charge-offs increased in the second quarter to 1.88% of average finance receivables on an annualized basis as compared with 1.83% in the prior quarter and 1.84% in the second quarter of 2018. Equipment Finance charge-offs increased by 11 basis points quarter-over-quarter and 5 basis points year-over-year to 1.75%. Equipment Finance second quarter charge-offs were in line with expectations. In comparison, PayNet's default index increased 3 basis points quarter-over-quarter and 10 basis points year-over-year. Demonstrating consistent performance, the Equipment Finance portfolio average charge-offs over the past three years has been 1.78% with a standard deviation of 18 basis points. We continue to be satisfied with the overall performance of our Equipment Finance portfolio, and we anticipate that the level of Equipment Finance credit losses in 2019 will remain within the range we have observed over the past 12 months.
Transitioning now to discuss Working Capital Loans. 15-plus day delinquency decreased 89 basis points in the second quarter from the first quarter, while 30-plus day delinquency decreased by 19 basis points. As discussed on our prior calls, Working Capital Loan delinquency and charge-offs tend to be more volatile than Equipment Finance given the larger balances and smaller number of contracts. Working Capital Loan charge-offs in the second quarter decreased to 4.82% of average Working Capital Loans on an annualized basis from 6.72% in the first quarter and 6% in the second quarter of 2018. We were pleased with this quarter's results as well as our overall experience since product launch in mid-2015.
During the second quarter, we rolled out some changes to make our Working Capital product more competitive. We have increased the maximum loans from $150,000 to $200,000 and are now offering a monthly repayment option to our strongest applicants. It is worth noting that since we began offering the Working Capital product, 80% of our Working Capital Loan volume has been to existing Marlin customers. We expect continued growth in the portfolio while we continue to target average annual losses of 6% in the current economic environment.
The allowance for credit losses was 1.59% of the average finance receivables, down 7 basis points in the second quarter due to a reduced allowance for the Equipment Finance and Working Capital portfolios of 9 basis points and 15 basis points, respectively. The reduction in the Equipment Finance allowance percentage is primarily attributable to improved delinquency migration results for the six months ending June 30 as compared to the prior quarter. The improvement in Working Capital is attributed to a higher percentage mix of portfolio originated by the direct channel, which has performed better historically than the indirect channel.
In closing, we continue to be pleased with the stable performance of the portfolio, and we continue to expect the credit environment to remain favorable through the end of 2019.
With that, I'll turn the call over to our CFO, Mike Bogansky, for a more detailed discussion of our second quarter financial performance. Mike?
Thank you, Lou, and good morning, everyone. Second quarter net income was $6.1 million or $0.49 per diluted share compared with $6.5 million or $0.52 per diluted share for the second quarter last year. As Jeff noted, second quarter net income was negatively impacted by $0.02 per share as a result of severance expense associated with the staff reorganization that we initiated in the quarter. While expense reductions were a key consideration in the staff reorganization, reallocating resources to capabilities that are required for us to continue to take advantage of our transformation initiatives was also an important objective. We expect net annualized run rate expense savings of approximately $1 million associated with these actions, and we will begin to realize these savings in the third quarter of 2019.
While I will discuss our business outlook in more detail shortly, we are reiterating our earnings guidance for the full year, which indicates that earnings will be more heavily weighted towards the second half of 2019 as the investment in our sales force continue to pay off and asset sales ramp up in the second half of the year, particularly in the fourth quarter.
For the quarter, yield on total originations was 12.95%, up 19 basis points from the prior quarter and up 71 basis points from the second quarter of 2018. Second quarter yield on direct originations was 23.09%, unchanged from the first quarter. The yield on indirect originations for the quarter was 9.85%, up 9 basis points from the first quarter due primarily to product mix.
For the quarter, net interest margin, or NIM, was 9.38%, down 21 basis points from the prior quarter and down 93 basis points from the second quarter of 2018. The decrease in NIM on a year-over-year basis was primarily the result of an increase in interest expense on both deposit and long-term borrowings associated with the securitization that was executed in the second half of 2018, partially offset by an increase of 71 basis points in new origination loan and lease yields. We have previously discussed the current competitive pricing environment as well as our actions to pass through increases in our cost of funds as the market will allow. We believe that NIM will improve in the second half of 2019 as deposit costs stabilize and we expand risk-based pricing over the course of this year.
The company's interest expense as a percent of average finance receivables increased to 2.48% compared with 2.39% for the previous quarter due to an increase in deposit costs. Interest expense as a percent of average finance receivables increased from 1.59% for the second quarter of 2018, due primarily to a higher cost of funds associated with both deposit and long-term borrowings from the securitization. It is important to note that the increased interest expense on the securitized assets is more than fully offset by the increased leverage that was generated, with the net result being accretive to ROE over time as the company fully leverages the capital released from the securitization.
Noninterest income was $7.2 million for the second quarter of 2019 compared with $12.9 million in the prior quarter and $4.6 million in the prior year period. The decrease compared with the prior quarter is primarily due to our adoption of ASC 842 lease accounting on January 1, 2019, which increased noninterest income by $5.6 million for the first quarter of 2019 as certain lessor costs are required to be presented gross in the consolidated statement of operation. The year-over-year increase in noninterest income is primarily due to an increase in gains on sale from the company's capital markets activities as we sold $57.6 million of assets during the second quarter of 2019.
I would like to briefly provide some commentary on our overall strategic approach as it relates to asset sales. Our asset sales arise from three separate and distinct sources: First, we directly originate assets for sale in circumstances where the underlying transaction does not fit our balance sheet requirement. This could arise from a variety of factors including credit quality, loan size, term or interest rate. In these circumstances, we utilize our origination capacity to earn a gain on sale without utilizing the capital on our balance sheet, and our growth in this category in the current year is primarily driven by our acquisition of Fleet Financing Resources in 2018. This volume is reflected as assets originated for sale in the period and are included in total sourced origination.
Second, we earn a fee for acting as an intermediary in transactions between the obligors and open investor. We do not provide recourse on these transactions and the assets are never held on our balance sheet. This volume is referred to as assets referred in the period and are included in total sourced originations.
Lastly, we may sell Equipment Finance leases and loans from our portfolio to maximize capital efficiency or to capitalize our market opportunities. We would strategically evaluate the composition of our portfolio to assess asset to include in our syndication program based on the yield and credit profile in order to generate an acceptable return while minimizing the use of capital. Factors that could influence the amount and timing of these asset sales could include the mix of originations from lower yielding sources, strategic financing plans outside of Marlin Business Bank and general economic factors and market opportunities. We would generally hold these assets for a period of time prior to sale, and this volume would be presented in Equipment Finance originations upon closing and assets sold in the period upon sale.
We expect total asset sales for the remainder of 2019 to increase above the prior levels as the mix of our Equipment Finance origination has changed and a higher mix of our total sourced origination had been originated for sale, particularly as a result of our acquisition of Fleet Financing Resources late last year.
Moving to expenses. Second quarter noninterest expenses were $18.5 million compared with $24.8 million in the prior quarter and $16 million in the second quarter last year. The decrease in noninterest expense compared with the prior quarter was primarily due to the aforementioned adoption of ASC 842, which increased noninterest expense by $6.2 million in the first quarter of 2019 due to the change in presentation of property taxes paid. The year-over-year increase in noninterest expense is primarily due to higher employee-related expenses and an increase in commissions prior to origination.
During the second quarter of 2019, under our repurchase plan, we repurchased 72,824 shares of Marlin common stock for an average price of $23.44 per share. As of June 30, approximately $3.3 million of our current $10 million share repurchase program announced on May 30, 2017 remains available for future repurchases. Subsequent at the end of the quarter, our Board of Directors authorized a new stock repurchase program of up to an additional $10 million of Marlin common stock upon completion of the previous authorization. While we are constantly evaluating capital allocation alternatives, we continue to believe that share repurchases are an appropriate use of our capital at this time. Additionally, our Board of Directors declared a regular quarterly dividend of $0.14 per share payable on August 22, 2019 to shareholders of record as of August 12, 2019.
Now turning to our business outlook. We are reiterating our previously issued guidance for the full year ending December 31, 2019 as follows: total sourced origination volume is expected to finish approximately 20% above 2018 level. Total assets sold are expected to be $250 million to $280 million as we continue to integrate the acquisition of Fleet Financing Resources and execute loan and lease indications. We expect to achieve an immediate gain on sale margin of 6% to 7%. Portfolio performance is expected to remain in line with the results observed over the last 12 months. Net interest and fee margin as a percentage of average finance receivables is expected to be between 9.5% and 10%. ROE is expected to continue to improve in 2019 as the company continues to improve operating scale; and lastly, non-GAAP earnings per share is expected to be between $2.30 and $2.40.
That concludes our prepared remarks. And with that, let's open the call up for questions. Operator?
[Operator Instructions]. Our first question comes from the line of Chris York with JMP Securities.
So first, I just wanted to begin on guidance, which you maintained both your earnings per share and origination guidance for the year. The guidance implies, on my calculation, year-over-year EPS growth of like 37% to 47% over the second half of '18 EPS, but then also implies a deceleration in origination growth from the levels you achieved in the first half of the year. So could you maybe reconcile these items? Or said another way, what gives you such confidence for a big rebound in EPS growth in your model?
Sure, Chris. This is Mike. So a couple of factors here. We're -- we have -- we grew originations in the second half of last year, so we do think that growth will decelerate in the second half, which is why we're maintaining the 20% resourced originations growth. And it's a combination of mix in Working Capital Loans, the asset sale guidance that we provided and maintaining expenses in the second half that are contributing to the EPS guidance for the second half.
Okay. Fair enough. And then on your fee income yield. I noticed that it decelerated over the last couple of quarters. Is there anything, qualitatively, that is driving that?
No. It's really a mix of portfolio performance that's driving a reduction in late fee collections and billings. But there's -- that's really the primary driver.
Okay. And then maybe Jeff here, it appears that a lot of small business lenders are starting to expand their product offerings in Working Capital. So now as -- we know the market is incredibly fragmented and your product is tailored to your client base. I'm just curious whether you are seeing any marginal competition here that may have resulted in some of the changes to the product you mentioned in your prepared remarks.
Yes. That's a good question, Chris. So we originate mostly through -- the Working Capital Loan product mostly through the direct channel. So in the direct channel, where we see a lot less of this increased but fragmented competition than we do in the indirect side, we actually like the fact that we're originating 10% to 20% on the indirect side because it does give us a really good window into the market and a really good understanding of what competitors are doing and how they're evolving their product. We're -- our view is that there is an opportunity in the Working Capital Loan market to serve higher credit quality customers, and we've talked often about the fact that our credit strategy is not a subprime credit strategy. So we actually want to play more towards the top of the credit band in Working Capital Loan. So we're -- we really made a nice improvement to quality of our credit model in Working Capital because we now have a lot of our own individual experience in that. So through that process, it became clear to us that there was an opportunity to do it with better borrowers, and that led to an increase in the capital, from $150,000 to $200,000, and moving from a limit of daily and weekly to including monthly. So we're seeing good traction in the monthly product, and our average loan size of working capital is increasing as a result of the increase in the cap of our Working Capital Loan product size. So it's working like we had hoped it would work.
Got it. It's very helpful. And then lastly for me, just switching to the expense side. I noticed that it's more higher this quarter, which wasn't entirely unexpected. But I did notice an interesting metric, which I tracked as the annualized salaries and benefits expense for your FTE. That's up rather meaningfully year-over-year at 15%, and it's at an all-time high. So do you have any thoughts or explanation for this increase? And then maybe are you giving any merit increases to your employees or potentially hiring more expensive talent?
Look, I guess there's a couple of things, Chris. One is we do have an annual merit increase for certainly the employee base. We did notice an increase in our employee benefits expense relative to the prior year, which is contributing to that. And the mix of employees has changed as we hire different talent mix to get to the level of -- or the type of positions that we need for -- as we go through our transformation initiatives. So those three things are really contributing to that.
Okay. And then should we expect any onetime charges related to the resignation of Ed Dietz in salaries and benefits?
There will likely be a charge taken in Q3 for that.
Do you have a rough estimate about that?
It will probably be somewhere between $100,000 and $200,000.
[Operator Instructions]. Our next question comes from the line of Brian Hogan with William Blair.
First question is actually on the gain on sale business, which you're originating for sale there. And previously, you articulated maybe not more than 15%, if I recall it correctly, of your business. Has that changed? I mean, I think, there's seems to be like a material ramp and step-up in the -- what you expect to sell, obviously given the acquisitions you have made. But has there been any change to that?
And then coupled with that is the yield expectations on the gains. You said it was -- the gain was 3.3% in the quarter and as a yield on what you sold, it was 5.7% in the quarter. And your -- it was 6 point -- it was bigger than that in the first quarter. But I guess, what gets you comfortable with the range of being 6% to 7% going forward? And then fast forward to like even like next year on the gain on sale business, do you expect it to even grow from there? Is the $250 million to $300 million range kind of like a go-forward steady number?
Yes. That's a good series of questions, Brian. So I -- let me start with sort of the actual asset sale volume as compared to sort of a 15% number that we've talked about being sort of a target for gain on sale, which I still think is ultimately where we want to be. That 15% though was before we acquired HKF and before we acquired FFR. And in both cases, those transactions were structured in a way that included an assumption that we would sell the bulk of their production during a period of time when we were sort of paying the deferred purchase price, which is, actually, they are compensated on the basis of basically a supplemental commission. So ultimately, those are finite pools of assets that will be sold once the supplemental commissions are completely paid. So we view those as being temporary as it relates to the longer-term guidance of sort of 15%, which is really would be reflective more of sort of the ongoing sales out of the core legacy model business. And I think on the -- with respect to the volumes that we're expecting to sell and the gain on sale, I'll let Mike speak to that.
Yes. So the volumes -- on the volume projections that we provided, they're due to the reasons that Jeff had mentioned. And really, the market for -- the syndication indication market right now is strong, which is leading to our projected margins between 6% and 7%. In the quarter, it was slightly less than 6% and it was really just due to the mix of assets that were originated for sale that -- we think that's really a onetime lift for the quarter.
All right. I guess what are you seeing on the macro front? Demand-wise, have you seen any slowness in the industries you serve? I just -- obviously, we've seen the consumer being, from our perspective, very healthy, but there seems to be on the commercial side just a little bit of a slowdown. So sort of an interesting dichotomy.
Yes. We don't really see that Brian. It's -- the markets that we're in continue to be in good shape. There's -- our outflow continues to be significantly higher than it was a year ago, and our portfolio is performing really -- in a very consistent way with the way it's been for the last several quarters. So the competitive environment, other than a little bit of a discussion we talked about on the indirect Working Capital side, which is relatively small part of our business, it remains sort of as it has been for the last 6 to 12 months. Really not much change at all.
All right. The seasonal accounting, have you quantified there the impact that it has on your business? Maybe you qualified for the small company reporting stature and it gets delayed for you? But I mean -- but I just -- what is your outlook for like this?
This is Lou Maslowe. We are in the midst of working on our seasonal project, where it's our understanding that this potential deferral for small companies will not apply to us, so we're continuing to prepare for 2020. It's pretty immature to say what the impact is going to be, but we expect to have a clearer view of that over the next three months.
All right. And then just kind of going back to the efficiency ratio. I mean we always kind of get back to. And I appreciate your restructuring costs, and obviously, you had higher employees at quarter end. And you talked about the run rate savings. I guess can you go in a little bit more the puts and takes into getting better efficiency ratio, maybe closer to 50% over time from where it is currently? Just kind of -- is it good as revenue? Is it the gain on sale driving that? Or how do you expect to get down your -- improve your efficiency ratio?
Yes. On the cost side, where, obviously, the cost containment and fleet reorganization that we announced is going to factor into getting that ratio trended towards -- more towards 50%. And then we're -- obviously, we're expecting, anticipating revenue growth as well. And for this year, that is driven somewhat by the gain on sales from syndications but also our projection that we'll start to see NIM rise for the balance of this year and into 2020.
Thank you. We have reached the end of the question-and-answer session. I would now like to turn the floor back over to management for closing comments.
Thank you for your support and for joining us on today's call. I'd like to mention that on September 4, we'll be presenting at the Craig-Hallum FinTech Innovators Conference in New York City. We hope to see some of you at this event. If not, we look forward to speaking with you again when we report our 2019 third quarter results in early November.
Thanks again, and I hope you have a great rest of the day.
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a wonderful day.